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5 reasons why spreadsheet based risk management systems don’t work


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5 reasons why spreadsheet based risk management systems don’t work

  1. 1. 5 reasons why Spreadsheet based Risk Management Systems Don’t Work Whitepaper Should Commodity Trading and Processing companies continue using spreadsheets for managing their Risks? What are they losing if they do so? 2013 Risk Edge Solutions P Ltd.
  2. 2. Whitepaper ©Copyright 2013 The prevalence of spreadsheets in managing various functions of business is very high today. And so is the prevalence of errors in most of them! Research has shown that almost 94% of the spreadsheets in use today contain errors. In fact, this issue has gained enough prominence over the past 5 years that there is now a term for that - Spreadsheet Risk Management. Obviously we find it ironical that many organizations use spreadsheets to manage their risks! This has been further confirmed recently by both the Switzerland-based Basel Committee on Banking Supervisioni (BCBS) and UK’s Financial Services Authorityii (FSA). However, even assuming that there are no errors in your spreadsheets (a HUGE assumption), here are the top 5 reasons why you should look beyond spreadsheets when it comes to managing risks on your portfolio: 1. Data Management Spreadsheets typically require you to input your transactions, price data, even volatilities and correlations manually, in the format that is pre-specified. The result is not only massive amounts of time spent by the entire team on preparing that data, but also not checking for any errors in the data or data integrity. Frauds often perpetrate from such loopholes, where a trader (or a colluding operations person) changes his positions before the data is given for risk calculation. Besides, lack of audit ensures that these frauds never come to light till it’s too big to be ignored and only then does everyone notices the elephant in the room! 2. Analysis and Simulations The spreadsheets typically just take in the data, and spew out the results which are incomprehensible to a non-geeky business head. Not only does this create gaps between the Risk Function and the Business Function, it also ensures that analysis of that data is another humongous effort, which, by the time it’s done, is already outdated and no decisions can be based on them. Storing daily data in usable format to create trends of exposures and risks, by portfolio / positions is another critical area where spreadsheets completely fail. Moreover, due to all the time required for data preparation and data analysis, simulations or scenario analysis done on your portfolios are fewer, rarely compared and analyzed and almost never stored for future reference. All of this plays its part in breaking the Risk Process which should really be seamlessly integrated across the organization.
  3. 3. Whitepaper ©Copyright 2013 3. Scalability & Flexibility Even systems that are spreadsheet based, like the ones that run various add-ins for valuation and risk calculation, can rarely be changed to suit your changing business requirements (some that can be changed, need significant efforts for even minor changes). Moreover, as your number of transactions increase over a few months, spreadsheets slow down significantly and are always at a risk of crashing. Such flexibility and scalability issues cannot be carried for long by even smaller organizations (sub-$ 200mn sales), and will soon result in risk division being rendered as a redundant expense. 4. Process Automation Given the issues in data management and analysis, the Risk Process can never be completely automated within a spreadsheet. The automation of data integrity check, automation of various control and monitoring processes, automating reconciliations with the source systems, etc. are also critical areas of concern which are never usually addressed by spreadsheets. Besides, tons of spreadsheets in the network, some of which are interlinked with each other, ensure that even whatever automation is there, is never really in control of the organization. 5. Responsive / Active Risk Management With the complexity involved in running Risk processes with a spreadsheet, there is added disadvantage of passive response to risk management. Your favorite reports are almost never mailed to you at the end-of-day and the alerts generated on various limit breaches are never notified to the respective user automatically. This puts the entire onus on operating and understanding the risk numbers on different users (Finance, Trade, Operations, Risk Management, etc.) thereby significantly increasing the risk of missing a critical risk-area of the portfolio. While one is inclined to also consider the extremely low-cost associated with such spreadsheet solutions, but when we stack up all the disadvantages of such systems, we can clearly see that spreadsheet based solutions not only add little value to your Risk Management Process, they even give you a false sense of security of running an efficient Risk Function. While on one hand they reduce your costs of procuring a risk solution, they significantly increase your costs of internal risk management (people required to do data / report generation work) and costs of reducing risks on your portfolio.
  4. 4. Whitepaper ©Copyright 2013 i Consultative Document - Principles for effective risk data aggregation and risk reporting ( ii Solvency II: internal model approval process (and) data review findings (