Operational Efficiency in the Risk Management Process


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Operational efficiency; strategic imperative or unrealistic utopia?

» Evolving demands of regulators necessitate investment
» Inevitable consequences
– Increased costs
– Undermined profitability
– Pressure on growth

Published in: Economy & Finance, Business
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  • Banks are investing considerable resources in meeting the evolving demands of regulators. These demands are increasing the cost base, operationally and in terms of capital costs. All this undermines historical levels of profitability, and as the dust settles and banks focus again on growth, operational efficiency will be an area for close scrutiny. This session will look to explore these issues, focusing on one illustrative aspect of day-to-day activity, namely corporate (SME) credit origination and related workflow, and linking these to wider enterprise risk management.
  • The regulatory perspective is in large part a “top down” perspective… about how well the organisation is managed and the governance around that
  • The Basel Committee on Banking Supervision (BCBS) has drawn up 14 Principles to strengthen banks’ risk data aggregation capabilities and internal risk reporting practices. Whilst focused on Global Systematically Important Banks (G-SIB’s or SIFIs) the principles espouse best practice. To the extent that this is not evident from the BIS paper, in our dialogue with regulators they have confirmed that such best practice will increasingly be expected of all market participants.The Principles apply to the data that is critical to enable a the bank to manage the risks it faces. They refer to all types of data including reference and transaction data. These Principles are categorized under four key themes The quuestion is, what is the best approach for addressing them? Reactive / top down, or proactive, bottom up?- Raises the bar on the standard of information required for strong risk management of the enterprise
  • So turningthis on itshead, what do youwant to deliverwithbetterbottom up data flows?
  • To achieve sector-wide productivity improvement, banks need to embrace the changes already seen in other industries, such as automotive, starting with simplified businesses – reflecting customers’ needs – streamlined operating models with strategic sourcing and digitized processes. An entirely new culture of full process transparency and control needs to be established. The time is right for a giant leapforward, with economic pressure and technological potential creating the conditions for change. (P33)- From McKinsey Private Banking Survey 2012: Middle East: Attractive but increasingly competitive. In late 2009, the same local and regional private banks started reviewing their cost structures and focusing on improving efficiency, particularly in the middle and back office. The impact of such programs brought cost margins down from 47 bp in 2009 to 40 bp in 2010, although they have since crept up again in line with revenue margins.
  • Data does not equate to information, i.e. the ability to manage and use the data in a meaningful way. Intelligence is then the next level…
  • Retail is ten years ahead of Corporate… why let them have all the fun!
  • Business Case: one internal business case concluded that for every 1 dollar spent on the system, Bank X would get a return of 3 dollars
  • Link to e.g. oil industry “cracker”; the Risk Cracker = IA, Monitoring, Control and, if necessary, Recovery….
  • So if you are going to do this, how to start?[Historical] silos are a fact of life… how to break these down? Time and motion studies Process Maps etc.
  • Some of you are already doing this Some of you have other priorities How do you prioritise? e.g. does it matter how large you are? (Large organisations have more scope for efficiency, but even for small organisations, this can be a quicker path to profitability and also makes them more scalable….)
  • Ultimately impacts the share price… investor re-ratings, etc.. Puts peers under pressure!
  • This is inevitable evolution…
  • Operational Efficiency in the Risk Management Process

    1. 1. Operational Efficiency in the Risk Management Process:Data, Systems and ProceduresCharles StewartOriginally presented at the IIF MENA CRO Forum | May 14th, 2013 | Dubai, UAE
    2. 2. » Evolving demands of regulators necessitate investment» Inevitable consequences– Increased costs– Undermined profitability– Pressure on growthOperational efficiency: strategic imperative or unrealistic utopia?Operational Efficiency in the Risk Management Process | Moody’s Analytics | 2
    3. 3. » Do you know what “bets” you or your people are making?- Can you afford the consequences if those bets are incorrect?» Do boundaries reflect strategy, risk appetite, product markets, and clients?» Are current exposures within established limits and boundaries?» Is the risk / reward ratio appropriate?» Can you isolate the unusual, unintended, unacceptable risks?» Do the right people discuss, monitor and manage the risks?» Is there a holistic approach to data management and stress testing?Better-informed & more timely decision-makingOperational Efficiency in the Risk Management Process | Moody’s Analytics | 3
    4. 4. » BCBS paper dated January 2013» 14 principles to strengthen risk data management– Overarching governance and infrastructure– Risk data aggregation capabilities– Risk reporting capabilities– Supervisory review, tools and cooperation» Raises the bar» Applies globally?» Top down or bottom up?– Foundations for good data management» Implications for day to day activity?– Regulatory box ticking?– Extract value from an investment in change?“Principles for effective risk data aggregation and risk reporting”Operational Efficiency in the Risk Management Process | Moody’s Analytics | 4
    5. 5. Strategy &PolicyPortfolioManagementTransactionManagementBalanceSheetManagementPerformanceManagementBy tackling the basics, what are they trying to achieve?5
    6. 6. » “Accelerate economic transformation”– Capital efficiency – significant room for improvement– Revenues – finding pockets of growth– Costs – an irrefutable case for industrialization“Banks need to embrace the changes already seen in other industries, such as automotive,including business simplification, streamlined operating models, and lean process optimization.”2nd McKinsey Annual Review on the banking industry (October 2012)» Two-thirds of financial executives cite improving client experience and creating bettersales tools as strategic priorities» The goal of single-platform commercial lending is to provide a unified depository ofinformation. This improves the efficiency and performance of all lending business units,which ultimately increases customer satisfaction across the entire credit lifecycle.Source: CEB, Commercial Banking Leadership Council,TowerGroup Commercial Banking (Apr 2013)A common themeOperational Efficiency in the Risk Management Process | Moody’s Analytics | 6
    7. 7. Best Practice =Transforming data into information, into business intelligence…DATA MANAGEMENT7
    8. 8. » Investment in commercial loan systems has lagged investment in retail loan systems» Huge scope for commercial underwriting processes to be more efficient» Banks are rethinking the way they manage counterparty risk data; how to make moreinformed origination decisions, based on risk appetite and the risk-adjusted performanceof their overall portfolio» “Real-time” risk-based pricing capabilities, to reflect the overall portfolio= system for measuring and analyzing risk-adjusted return on capital (RAROC)Making this real; e.g. commercial lending originationOperational Efficiency in the Risk Management Process | Moody’s Analytics | 8
    9. 9. Commercial Loan Origination; Value & DriversSource: CEB TowerGroup FSI Technology Survey, 2012- 2013» 47% of commercial banks affirm that Commercial Loan Origination technology provideshigh or very high value to their company» Value Drivers:Operational Efficiency in the Risk Management Process | Moody’s Analytics | 9
    10. 10. Note: dotted arrow = inputs to origination processsolid arrow = outputs from origination processSource: CEB TowerGroup Commercial BankingStraight-through processing in commercial lendingOperational Efficiency in the Risk Management Process | Moody’s Analytics | 10
    11. 11. CustomerAcquisition• Pre-deal creditanalysis• Credit skillstrainingCreditModelling• PD, LGD andEAD modeldevelopment,validation andcalibration• Appropriatemodeldevelopmentgovernance• Policies andprocedures foroverridingcredit modeloutputsCreditAssessment• Credit analysiscapabilities• Developmentand review ofcreditpolicies• Setting ofcredit riskappetites• Benchmarkingof clientportfoliosPricing• Developmentof risk basedpricingmethodologies,tools andpoliciesCreditApproval• Individual creditfile reviews• Determininglimits settingframeworks,policies andproceduresPost-sanctionFulfilment• Assessment ofcredit riskdocumentation• Adherence toconditionsprecedent• Policyreviews ondocuments andconditionprecedentprocessMonitoring& Review• Assessment ofproblem debtidentificationactivities andpolicies• Review of loanlossprovisioningpolicies andprocedures• Review andenhancementof credit riskManagementInformationOperational Efficiency in the Risk Management Process | Moody’s Analytics | 11
    12. 12. Credit Process: Overall» Breakdown the silos in the bank and make sure the different parts work together…– Are they are all part of the same workflow?LoanOriginationCreditAssessmentPortfolioManagementFeedback loopFeedback loopFeedback loopOVERALLOperational Efficiency in the Risk Management Process | Moody’s Analytics | 12
    13. 13. Credit Process: Loan OriginationClient requests alending facilitySubmitted to FrontLineConduct InitialAssessmentInitialAssessmentResultsCredit DeclinedINPUTSQualitative and quantitativefactors i.e. size ofcompany, profitability,security, reputationCash flow modeling andforecastingConduct SecondAssessmentAcceptedSecondAssessmentResultsRejectedINPUTSFinancialsProduct mixRevenue driversBudgetPricing acceptanceMeeting with seniorofficialsContact CreditDepartment for CreditAssessmentAcceptedAppealProcessRejectedDecision toproceed with CreditAssessmentNoYesCredit Departmentreviews Front LineAssessmentLOAN ORIGINATION» Have youdocumented yourworkflow, a processthat gives you achance to standback and assessshortcomings?Operational Efficiency in the Risk Management Process | Moody’s Analytics | 13
    14. 14. Credit Process: Credit AssessmentCredit Departmentbegins CreditAssessmentNon-FinancialCorporatesFinancialInstitutionsExternal ratingagency ratingMapped toSanlam’s internal20-point scaleMapped to EDFvia internalmapping tableOUTPUTSInternal ratingMapped EDFExternal ratingagency sovereignratingDetermine if groupexposure orguarantorRiskAnalystLarge CorporateFundamental Analysis ModelCompletecustomerinformationINPUTSYears inbusinessIndustryFirm Type(public/private)Select peer groupSpread financialsGroup subsidiary: input financials for each counterpartyseparatelyGroup parent: input group/consolidated financialsGuarantor: input financials for counterparty and guarantorseparatelyINPUTSAudited financialstatements up to 6months oldInterim financials ifaudited > 6 months oldPoint-in-Time EDFinputRiskCalc South AfricaEDFCreditEdge EDFPrivate(Unlisted firms)Public(Listed firms)INPUTS7 financial ratiosbased on spreadfinancialsINPUTSMarket Valueof AssetsAsset VolatilityDefault PointAdjustments made tofinancials by credit analyst(e.g. Fair value items,shareholder loans)CREDIT ASSESSMENT STEP A: Determine internal obligor ratingIdentify ClientTypeSovereign/ParastatalsGroup exposure(i.e. parent)Guarantor CounterpartyProceed toSTEP BContinuewith STEP AProvide responsesto qualitativefactorsINPUTSCustomer powerDiversification ofproductsManagement qualityRisk appetiteOUTPUTSRiskAnalyst rating on1 to 10 internal scalePoint-in-Time EDFProcess RiskAnalystassessmentmethodologyMultiply internalrating by 2FINAL OUTPUTSFinal rating on 1 to20 internal scalePoint-in-Time EDFSIDE NOTENational scale if exposureto South African companydenominated in RandsGlobal scale if exposure tointernational companiesCREDIT ASSESSMENT STEP A CONTINUED: Determineinternal obligor ratingLDG ProcessFacility RatingsProcessUnsecuredFacility / SecuredFacilityLGD = 50% forSenior Debt*LGD = 75% forSubordinated DebtEligible FinancialCollateralEligible IRBCollateralEligible FinancialCollateralCashGoldBB- Sov debt/BBB-IssuersEquities Main IndexCollectiveInvestmentSchemesEligible IRB CollateralReceivablesReal EstateOtherOUTPUTAggregate LGD = weighted LGD for eachpart of the exposureUnsecuredFacilitySecuredFacilityStarting point =internal obligorrating from Step ASubordinateddebt / HybridinstrumentsFacility RatingAdjustmentsbased oncollateralNotch downwardbased on internalobligor ratingNotch upwardbased oncollateral andhaircut policyOUTPUTFacility RatingCREDIT ASSESSMENT STEP B: Determine LGD and Facility RatingFront Line or Credit Departmentfills in form and sends to CPMRiskFrontierINPUTSNominal AmountEDF1TenorLGD2SpreadOUTPUTRORAC calculationCPM enters required informationinto RiskFrontierMultiple runs basedon scenariosprovided byFront LineOutput file provided to FrontLine and Credit DepartmentCredit analyst collects all therequired informationINPUTSSummary Screen fromRiskAnalyst3EDF1RORAC4Other: SWOT analysis,covenants, research oncompany, market infoCredit Analyst completes creditapplication in CAPExposureExposure up to R55 millionSub-committee for approvalSCM transaction > R110 millionSIM transactions > R750 millionInternal rating worse than 10Econ cap/MTM > 7.5%Econ cap portfolio utilisation > 5%Econ cap amount > R15 millionNegative equityNominal loan amount + interest > 10% of equityplus all other exceptionsCentral Credit Committee forapprovalDecisionApproved RejectedDeal added to overall portfoliofor portfolio managementpurposesINPUTSCredit application from Step DMemo from Front LineCREDIT ASSESSMENT STEP C: Determine RORACCREDIT ASSESSMENT STEP D: Preparing Credit ApplicationCREDIT ASSESSMENT STEP E: Approval ProcessCredit DeclinedOperational Efficiency in the Risk Management Process | Moody’s Analytics | 14
    15. 15. Credit Process: Portfolio ManagementDeal added to overall portfoliofor portfolio managementpurposesCPM performs regularstress testingReportingEconomic Capitalcalculated at portfoliolevel by CPM groupRiskFrontierOUTPUTDaily Economiccapital Excel reportProvided to Front LineUsed as Early Warningsignal to make effectivechanges to the creditINPUTSCreditEdgeEDFRiskCalc EDFMapped EDFINPUTS3 Scenarios:50% EDF100% EDF200% EDFResults provided toCCC and ALaRMCoCPMALaRMCoCCCCreditAdministration andReporting DeptCCCREPORT EXAMPLESMonthly EDFmapping to ratingEDF Trend AnalysisEDFs for SA Listedcompanies, SCC,SCMRisk/Return AnalysisPipeline Deals, etc.Annual Reviewsconducted for existingcreditsDecision No changeInternal ratingor LGD changeINPUTSEDFsKnown crediteventsInform CPM so itcan be changed inportfolio informationPORTFOLIO MANAGEMENTRepeat CreditAssessmentOperational Efficiency in the Risk Management Process | Moody’s Analytics | 15
    16. 16. Constraints?Benefits?Unrealistic?Inevitable?Operational efficiency; strategic imperative or unrealistic utopia?Operational Efficiency in the Risk Management Process | Moody’s Analytics | 16
    17. 17. CovenantTrackingCounterpartyManagementFinancialSpreadingLimitsCheckingBackOfficeProbabilityof DefaultProductProposal& PricingLoss GivenDefaultFinancial &Risk DataMartBenefitsStandardize your process with straight-through processingReduceredundancies andcostly mistakesReduceapplication-to-approval cycletimeWin more dealsthat reflect risktoleranceImprovecustomersatisfaction17
    18. 18. » Win more deals that reflect your risk tolerance» Improve customer satisfaction by pricing transactions competitively» Faster and more efficient decisions» Consistent standards of credit analysis» More consistent accuracy of data» Reduced calculation times» Reduced opportunities for human error» Operational efficiencies» More efficient deployment of capital» Increased return on equity (ROE), Shareholder Value Added (SVA) and Economic ValueAdded (EVA)» Transparent governance / audit trails» Centrally accessible data; risk data, volumes data, performance data, migration data,point in time data and trend analysis, etc., etc.» Productivity (re volumes of activity undertaken by relationship managers, analysts) – anopportunity to enable lower cost expansion or cost reductions» Competitive advantageWorkflow – benefits… Business Line:Operational Efficiency in the Risk Management Process | Moody’s Analytics | 18
    19. 19. » Improve profit margins by reducing mistakes» Easier enforcement of policies / more control over the loan origination process» Spreading information linked to decision drivers (e.g. exposure, limits, performance,expected loss, policy exceptions) enhances critical business metrics for loan approvals» Faster and more efficient decisions» Consistent standards of credit analysis» More consistent accuracy of data» Reduced calculation times» Reduced opportunities for human error» Operational efficiencies» Transparent governance» Audit trails» Centrally accessible data; risk data, volumes data, performance data, migration data,point in time data and trend analysis, etc., etc.» Productivity (re volumes of activity undertaken by analysts, credit sanctioners) – anopportunity to enable lower cost expansion or cost reductionsWorkflow – benefits… Risk Department:Operational Efficiency in the Risk Management Process | Moody’s Analytics | 19
    20. 20. » A superior customer experience» Faster response times» More efficient decisions» Up-to-date information about the application status and risk-based pricing» Consistent standards of credit analysis» Reduced opportunities for human errorWorkflow – benefits… Customer:Operational Efficiency in the Risk Management Process | Moody’s Analytics | 20
    21. 21. » Helps make the IT vision a reality» Creates efficiencies and reduces redundant systems(e.g. using one process and one Risk Data Warehouse)» Enables policy enforcement» Improves regulatory compliance» Reduces total cost of ownership» Faster and more efficient decisions» Scalability of data storage resources» Operational efficiencies» Business Case (MA client example): for every “dollar” spent …a return of three…Workflow – benefits… IT Department:Operational Efficiency in the Risk Management Process | Moody’s Analytics | 21
    22. 22. Conclusions?» Constraints?– Plenty» Benefits?– Outweigh the constraints» Unrealistic?– Many are already doing it… No!» Inevitable?– Regulatory pressure, competitive pressure, shareholder pressure…. Yes!Operational Efficiency in the Risk Management Process | Moody’s Analytics | 22
    23. 23. ContactsCharles StewartSenior DirectorMoodys AnalyticsOne Canada SquareCanary WharfLondon E14 5FA+44 (0) 20.7772.1341 direct+44 (0) 7736.868976 mobilecharles.stewart@moodys.comwww.moodys.comWael Jadallah (& team)DirectorMoodys AnalyticsDubai International Financial CentreGate Precinct Building 3, Level 3P. O. Box 506845Dubai, UAE+971 (0) 4237 9545 direct+971 (0) 50 104 4218 mobile+971 (0) 4237 9655 faxwael.jadallah@moodys.comwww.moodys.com23
    24. 24. 24Moody’s Analytics provides strategic solutions for measuring and managing risk. Weassemble best practices across credit, economics and financial risk management,helping you compete in an evolving marketplace. In addition to distributing the creditratings and proprietary research of Moody’s Investors Service, we offer quantitativemodels and enterprise risk management software as well as training and professionalservices that are tuned to your business challenges.www.moodys.com24
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