Operational risk management (2)
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Operational risk management (2)

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  • <br /> ERM is becoming a very important issues for a variety of reasons: <br /> It is proven that The Street rewards companies with consistent earning by placing a premium on their stock price. <br /> Corporate governance initiatives are being implemented in virtually every major country <br /> Efficient allocation of capital is one way for companies to improve top and bottom-line growth, thereby, working to maximize shareholder value. <br /> We can use ERM to create a competitive advantage for our clients. <br />
  • <br /> In the mid-1980’s, Motorola was the initial developer of Six Sigma. Most credit the late Bill Smith, a senior engineer and scientist within Motorola, for inventing Six Sigma. In the past 15 years, Six Sigma has evolved from a focus on process improvement using statistical tools to a comprehensive framework for managing a business. DMAIC (Define, Measure, Analyze, Improve, Control) provides a structure for addressing problems. <br />
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  • Six Sigma provides powerful tools for identifying, assessing, monitoring, & controlling operational risk. <br /> Risk assessment matrices <br />
  • The Six Sigma approach ensures that procedures are well documented and measurable, providing an environment that facilitates internal audits. <br />
  • Six Sigma’s rigorous approach enables senior management to develop policies, processes, and procedures that are well-defined, documented, and measurable. <br />
  • Six Sigma provides powerful tools for identifying, assessing, monitoring, & controlling operational risk for both existing and planned products, activities, processes, and systems. <br />
  • Six Sigma demands regular monitoring as well as the implementation of process controls to reduce operational risk. <br />
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Operational risk management (2) Operational risk management (2) Presentation Transcript

  • Minimizing Operational Risk & Optimizing Institutional Performance
  • Interest in Enterprise-wide Risk Assessments is being driven by Financial & Economic Realities • Global spotlight on risk and corporate governance – Sarbanes-Oxley Act of 2003 & COSO ERM Framework • Increased involvement from the Audit Committee of the Board of Directors with regard to risk management – NYSE listing requirements • Capital adequacy requirements and the need for efficient capital allocation – Basel Capital Accord • Need for alternative risk solutions due to the current insurance environment • Maximizing shareholder value • Sustaining a competitive advantage 2
  • Basel Committee’s Definition of Operational Risk “The risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events” Operational risk can result in increased write-offs, additional expenses or loss of revenue 3 View slide
  • Operational Risk Management & Shareholder Value Examples of how operational risk management drives shareholder value? • Improving operating efficiency and thus operating margins, by identifying and prioritising process improvement and derisking opportunities • Improving management effectiveness by enhancing the governance structure • Enabling more effective capital usage by introducing processes to assess exposure & integrate this with an economic capital model • Protecting assets by reducing losses through improved risk control environment and financing programme • Enhanced organizational capabilities & subsequent competitive positioning through continuous improvement 4 View slide
  • How to Reduce Operational Risks? Understand Risks • Benchmarking • Scenario Analysis • Key Risk Indicator’s (KRI) De-Risking Operational Procedures • Define, Measure, Analyze, Improve, & Control Risk Finance & Transfer • Mapping to Insurance Products • Developing New Products • Financing Retained Losses • Transferring Risk to the Insurance & Capital Markets 5
  • Op Risk/Lean Six Sigma Linkage Op Risk Needs Six Sigma Can Provide Identification of critical processes and activities Hierarchical, process view of a business Monitoring of key indicators and warning of potential problems Process Management & Control Cure problems in existing processes Process Improvement via DMAIC & Lean Prevention of problems for new processes Process Design via DFSS 6
  • Six Sigma Defined • A data driven approach to understanding and eliminating process variation and defects • Three, universal, methodologies for process management • A performance target of 3.4 defects per million opportunities 7
  • Risk Management: How Can Six Sigma Help? • Six Sigma provides three powerful methodologies for: – Designing robust processes – Fixing broken processes – Controlling processes on an ongoing basis (i.e., keeping them from decaying and producing errors) 8
  • Risk Management: How Can Six Sigma Help? • Designing robust processes: – A structured methodology, DFSS (Design for Six Sigma), assures that: • New processes have high capability (satisfy customers and produce low defects) right from the start • New processes are designed to minimize the risk of failure 9
  • Risk Management: How Can Six Sigma Help? • Fixing broken processes: – A structured methodology, DMAIC (Define, Measure, Analyse, Improve, Control): • Uses powerful statistical (and non-statistical) tools to locate and eliminate the root causes of otherwise intractable problems • Focuses on removal and prevention of defects • Reduces process variability 10
  • Risk Management: How Can Six Sigma Help? • Controlling processes, so that their behavior is predictable (within limits). Six Sigma provides: – Special tools and techniques including a framework: • For measuring and judging process variation • For detecting special causes • To providing early warning of process changes – The ability to calculate Process Sigma, an index of process performance 11
  • Companies Pursue Six Sigma to … • Accommodate customer demands • Drive out waste, cycle time and variability • Direct improvement resource to the most significant opportunities • Establish a standard improvement methodology • Develop leaders • Reduce risk • Grow the top-line • Implement business strategy • Increase product reliability • Initiate cultural change • Accelerate improvement 12
  • Sigma is a Measure of Process Capability Performance boundary Sigma DPMO 1 2 3 4 5 6 680,000 298,000 67,000 6,000 400 3.4 Requirement 4 2 Process performance 5 6 3 1 Six Sigma is a level of process capability such that less than 3.4 “defects” are produced for every million opportunities. 13
  • Estimating the Benefits of Six Sigma Sigma Level Defects Per Million Cost of Quality 3 66,807 20-30% of Sales 4 6,210 15-20% of Sales 5 233 10-15% of Sales 6 3.4 < 10% of Sales Harry, Mikel J., Six Sigma: A Breakthrough Strategy for Profitability, Quality Progress, May 1998 14
  • Process Sigma Advantages The Sigma Scale provides a common metric for comparison The Sigma Scale provides a common metric for comparison that includes the customer requirement and the degree of that includes the customer requirement and the degree of variation. Addresses multiple occurrences. variation. Addresses multiple occurrences. PROCESS PERFORMANCE Call servicing 32 seconds ASA vs goal of 35 Billing 98% accuracy, on time, right location Accounts Receivable 33 days average aging vs goal of 40 Customer Service 82% rated 4 or 5 responsiveness 15
  • The Antecedents of Six Sigma • Six Sigma is the latest and most powerful in a long line of process management and process improvement methods, e.g.: – – – – Guilds The Scientific Method Quality Circles TQM • Six Sigma has built on these ideas and added powerful tools • It is specially useful for transactional processes 16
  • Sound Practices in Operational Risk Management Principle 1 The board of directors should be aware of the major aspects of the bank’s operational risks as a distinct risk category that should be managed, and it should approve and periodically review the bank’s operational risk management framework. The framework should provide a firm-wide definition of operational risk and lay down the principles of how operational risk is to be identified, assessed, monitored, and controlled/mitigated. Source: Sound Practices for the Management & Supervision of Operational Risk (Basel Committee – July 2002) 17
  • Sound Practices in Operational Risk Management Principle 2 The board of directors should ensure that the bank’s operational risk management framework is subject to effective and comprehensive internal audit by operationally independent, appropriately trained and competent staff. The internal audit function should not be directly responsible for operational risk management. Source: Sound Practices for the Management & Supervision of Operational Risk (Basel Committee – July 2002) 18
  • Sound Practices in Operational Risk Management Principle 3 Senior management should have responsibility for implementing the operational risk management framework approved by the board of directors. The framework should be implemented throughout the whole banking organization, and all levels of staff should understand their responsibilities with respect to operational risk management. Senior management should also have responsibility for developing policies, processes and procedures for managing operational risk in all of the bank’s products, activities, processes and systems. Source: Sound Practices for the Management & Supervision of Operational Risk (Basel Committee – July 2002) 19
  • Sound Practices in Operational Risk Management Principle 4 Banks should identify and assess the operational risk inherent in all material products, activities, processes and systems. Banks should also ensure that before new products, activities, processes and systems are introduced or undertaken, the operational risk inherent in them is subject to adequate assessment procedures. Source: Sound Practices for the Management & Supervision of Operational Risk (Basel Committee – July 2002) 20
  • Sound Practices in Operational Risk Management Principle 5 Banks should implement a process to regularly monitor operational risk profiles and material exposure to losses. There should be regular reporting of pertinent information to senior management and the board of directors that supports the proactive management of operational risk. Source: Sound Practices for the Management & Supervision of Operational Risk (Basel Committee – July 2002) 21
  • The 6σ Process Key Risk Indicators (Dashboards) Establish Controls Operational Risk Assessment & Analysis Project Selection Measurement System Validation SIPOC New Process Capability New Process Pilot Capability Baseline IMPROVE Measurement System Validation New Policies & Procedures Process Specifications Process Risk Mapping Confirm Impact Correlation Analysis Identify Key Risk Drivers 22
  • Monitoring & Updating SP C An a ly si s & E & C Li n es   es s Co nt Ca pa ro l bi lit y ss Ch ar ts pi ng ap M  Pr oc e A RI M Risk Solutions     Operational Risk Definition & Analysis us in Risk Profiling    B Quantification & Modelling     1 Identification & Risk Mapping     Le ve l Creating Management Awareness An al ys i s Operational Risk Management Framework O Level 2 & Activity Groups Mapping 6σ to Operational Risk Framework Natural Linkage to Operational Risk Management Framework ••Natural Linkage to Operational Risk Management Framework Operates at Level 1, Level 2 and Activity Group Level (All Business Lines) ••Operates at Level 1, Level 2 and Activity Group Level (All Business Lines) Linked to All Products, Activities, Processes, and Systems ••Linked to All Products, Activities, Processes, and Systems DMAIC Employed to Improve Existing Policies, Procedures, and ••DMAIC Employed to Improve Existing Policies, Procedures, and Processes….DFSS Leveraged to Design New Ones Processes….DFSS Leveraged to Design New Ones
  • Operational Risk Management Using 6σ Operational Risk Internal Measurement Analysis (ORIMA) Business Line Probability Risk of Loss (Exposure Event (PE) Indicator - EI) Loss Given Event Occurs (LGE) Expected Loss (EL) Potential Risk Factors Potential Failure Effects Potential Causes Current Controls 1 Corporate Finance - - - - 0.50 0.10 100 5.00 2 Trading and Sales - - - - - - - - 3 Retail Banking - - - - - - - - 4 Commercial Banking - - - - - - - - 5 Payment and Settlement - - - - - - 6 Agency Services - - - - 7 Asset Management - - - - 8 Retail Brokerage - - - - Business Line Description Six Sigma Focus • Identify Risks • Describe Outcome of Failure • Determine Cause & -Effect • Evaluate Current Controls ORIMA Drills-Down From Top Level ORIMA Drills-Down From Top Level Business Line to the Processes Business Line to the Processes Within Each Activity Group Within Each Activity Group Expected Loss Factors 24
  • Operational Risk Management Using 6σ Methods Operational Risk Internal Measurement Analysis (ORIMA) Expected Loss (EL) 0.10 100 5.00 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Potential Causes Current Controls 1 Corporate Finance - - - - 0.50 2 Trading and Sales - - - - 3 Retail Banking - - - - 4 Commercial Banking - - - 5 Payment and Settlement - - 6 Agency Services - - 7 Asset Management - 8 Retail Brokerage - Business Line Description Key Risk Indicators (Dashboards) Establish Controls Operational Risk Assessment & Analysis Processor Review Measurement System Validation Disclosures Application SIPOC New Process Capability Create approval letter Capability Baseline New Process Pilot Fast Loan Approval IMPROVE Measurement System Validation # of loan processors Process Risk Mapping Confirm Internet capability Identify Key Impact Correlation Process Capability Analysis for Risk Drivers CT_ Approval Enter in System Loan Approval Notify Bank & Customer Prepare Documents Pareto Chart for Loan Amount 120.000 * LSL Mean Sample N StDev (Within) StDev (Overall) Approve Loan Amount * 98.126 530 19.2991 19.5817 Within Disperse Funds Regression Plot 30 50 70 90 + 1327.06 pH**2 Pp PPU PPL Ppk * R-Sq(adj)Observed Performance = 40.0 % PPM < LSL * PPM Quadratic > UB Model * * 60 200 40 20 0 Cpm PLT.YLD. = 68371.0 -*19042.9 pH 150 300 100 * * Overall R-Sq = 42.5 % Capability S = 18.7123 80 400 PPM Total * 133962.26 133962.26 110 130 Exp. "Within" Performance PPM < LSL * PPM > UB PPM Total * * 150 100 I Chart for Approval 170 Exp. "Overall" Performance PPM < LSL * PPM 150 > UB PPM Total Individual Value Enter in System PLT.YLD. Customer Signs Paperwork 100 500 Overall Potential (Within) Capability Cp * CPU * CPL Cpk Environment UB Upper Bound Target YES Machine Analysis Notify Bank Manager & CustomerProcess Data C oun t Review Application Defect Count Percent Cum % 0 1 <$ 60 254 47.9 47.9 ,0 0 0 $1 60 100 Mean=98.13 1 0 7.1 7.2 0 -$ 164 30.9 78.9 50 pH ,00 UCL=156.0 * * 50 7.0 # of underwriters Remote Printing Credit Score Process Specifications NO Easy to understand instructions Loan amount Manager approval Project Selection New Policies & Procedures Receive Loan Application Material - - Potential Failure Effects 100 200 300 400 500 Observation Number The Discipline and Its Approach, The Discipline and Its Approach, Combined With a Rich Set of Analysis Combined With a Rich Set of Analysis Tools, Makes Six Sigma a Perfect Fit Tools, Makes Six Sigma a Perfect Fit for Operational Risk Management for Operational Risk Management LCL=40.23 19 9 ,0 00 $2 ,00 00 29 0-$ 53 10.0 88.9 9 ,0 01 0 $3 0 ,0 00 -$ 4 38 7.2 96.0 99 ,00 2 e rs Oth 21 4.0 100.0 P ercen t Loss Given Event Occurs (LGE) Business Line Probability Risk of Loss (Exposure Event (PE) Indicator - EI) Potential Risk Factors
  • A Way Forward Outside In or Inside Out • Outside In: 1. Review statistics for comparable businesses and identify risk by type 2. Identify the processes that lie behind the risk (hierarchy) 3. Perform risk analysis on the key processes (FMEA) 4. Identify key measures inside and outside of the process 5. Collect data 6. Monitor, using dashboards and control charts. Search for signals 7. Take action as required (DMAIC, Lean, DFSS or other) 26
  • A Way Forward • Inside Out: 1. Inventory all processes 2. Identify those presenting the greatest risk 3. Identify the sub-processes that lie behind the risk (process hierarchy) 4. Perform risk analysis on the key processes and subprocesses (FMEA) 5. Identify key measures inside and outside of the process 6. Collect data 7. Monitor, using dashboards and control charts. Search for signals 8. Take action as required (DMAIC, Lean, DFSS or other) 27
  • Questions? Further Questions / Information: Lori Marin Telephone: 312-381-4420 Email: lori_marin@ars.aon.com 28
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