This document discusses the creation and use of composite indicators for senior management reporting on operational risk. Individual key risk indicators (KRIs) are first transformed into common T-value metrics to allow for aggregation. Composite indicators are then created by combining related T-values through multiplication or unrelated ones through taking the maximum. Weights and thresholds can be adjusted to reflect management's risk appetite. The resulting composite indicators are presented on a single-page summary to highlight areas requiring senior management's attention, such as a particular business growing too rapidly.

1. 1
Enter Presentation Title Here
Composite Indicators
&
Senior Management Reporting
London
January 17th & 18th, 2006
Charles Taylor
Director, Operational Risk

2. 2
Agenda
Basic Concepts
Transforming Individual KRIs
Creating a Composite Indicator
Senior Management Reporting

3. 3
Agenda
Basic Concepts
Transforming Individual KRIs
Creating a Composite Indicator
Senior Management Reporting

4. 4
The Basic Problem
Combining apples and oranges
Combining things in a way that will
highlight what senior management needs to
focus on

5. 5
KRIs & Management Levels
Basic Concepts
Location KRI Type Management Level
Local Individual Lower/Mid-Level
Organization Composite Mid-Level/Senior

6. 6
KRIs & Management Levels
Basic Concepts
Location KRI Type Management Level
Local Individual Lower/Mid-Level
Transformation – apples to apples
Aggregation – flagging what should be flagged
Organization Composite Mid-Level/Senior

7. 7
Individual KRI Thresholds
Basic Concepts
Junior management is managing the risk; no mid-level
attention required
Junior management is managing the risk; mid-level
management should monitor the indicator
Management should escalate from junior to mid-level
management

8. 8
Composite KRI Thresholds
Basic Concepts
Mid-level (or junior) management is managing the risk;
no senior attention required
Mid-level management is managing the risk; senior
management should monitor the indicator
Management should escalate from mid-level to senior
management

9. 9
Ranges of Individual KRIs
Basic Concepts
Low Low Exected High High
Underlying KRIs Red Yellow /Target Yellow Red
L1 L0 E H0 H1
Staff Turnover (%) 1 3 8 14 20
Staff Training Days (days/year) 4 8 15 na na

10. 10
Ranges of Individual KRIs
Basic Concepts
Low Low Exected High High
Underlying KRIs Red Yellow /Target Yellow Red
L1 L0 E H0 H1
Staff Turnover (%) 1 3 8 14 20
Staff Training Days (days/year) 4 8 15 na na
L0L1 H1H0E

11. 11
Ranges of Individual KRIs
Basic Concepts
Low Low Exected High High
Underlying KRIs Red Yellow /Target Yellow Red
L1 L0 E H0 H1
Staff Turnover (%) 1 3 8 14 20
Staff Training Days (days/year) 4 8 15 na na
L0L1 H1H0E
Typically, KRIs go:
red-yellow-green-yellow-red or
red-yellow-green or
green-yellow-red

12. 12
Basic Concepts
Individual KRIs
Staff Turnover
0
5
10
15
20
25
1
5
9
13
17
21
25
29
33
37
41
45
Months
Percent
Training
0
2
4
6
8
10
12
14
16
1
5
9
13
17
21
25
29
33
37
41
45
Months
Averagedaysinlast12
mos

13. 13
Basic Concepts
Individual KRIs
Staff Turnover
0
5
10
15
20
25
1
5
9
13
17
21
25
29
33
37
41
45
Months
Percent
Training
0
2
4
6
8
10
12
14
16
1
5
9
13
17
21
25
29
33
37
41
45
Months
Averagedaysinlast12
mos
The ranges and measures are very different before we
transform the KRIs

14. 14
Basic Concepts
Individual KRIs
Staff Turnover
0
5
10
15
20
25
1
5
9
13
17
21
25
29
33
37
41
45
Months
Percent
Training
0
2
4
6
8
10
12
14
16
1
5
9
13
17
21
25
29
33
37
41
45
Months
Averagedaysinlast12
mos
The thresholds are very different too

15. 15
Agenda
Basic Concepts
Transforming Individual KRIs
Creating a Composite Indicator
Senior Management Reporting

16. 16
Transformation to T-Value
Transforming Individual KRIs
T-Value
KRIL0L1 H1H0
1
2
The graphic presentation of the transformation

17. 17
Transformation to T-Value
Transforming Individual KRIs
T-Value
KRIL0L1
1
2
The graphic presentation of the transformation for a red-yellow-green KRI

18. 18
Transformation to T-Values
Transforming Individual KRIs
T = 1 when L0< KRI < H0
T = (KRI + L1 – 2*L0 )/ (L1 – L0) when KRI < L0
T = (KRI + H1 – 2*H0)/(H1 – H0) when KRI > H0.
The algebraic presentation of the transformation

19. 19
Individual KRIs: T-Values
Transforming Individual KRIs
Staff Turnover T-value
0.0
0.5
1.0
1.5
2.0
2.5
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
Training T-Value
0.0
0.5
1.0
1.5
2.0
2.5
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
The transformed ranges and measures are now the same

20. 20
Individual KRIs: T-Values
Transforming Individual KRIs
Staff Turnover T-value
0.0
0.5
1.0
1.5
2.0
2.5
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
Training T-Value
0.0
0.5
1.0
1.5
2.0
2.5
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
And so are the thresholds

21. 21
Individual KRIs: T-Values
Transforming Individual KRIs
Staff Turnover T-value
0.0
0.5
1.0
1.5
2.0
2.5
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
Training T-Value
0.0
0.5
1.0
1.5
2.0
2.5
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
Does this work really? Three ranges of
months are red in the two graphs …

22. 22
Individual KRIs
Transforming Individual KRIs
Staff Turnover
0
5
10
15
20
25
1
5
9
13
17
21
25
29
33
37
41
45
Months
Percent
Training
0
2
4
6
8
10
12
14
16
1
5
9
13
17
21
25
29
33
37
41
45
Months
Averagedaysinlast12
mos
… exactly as they were for the
untransformed KRIs. So it does work!

23. 23
Individual KRIs: T-Values
Transforming Individual KRIs
Staff Turnover T-value
0.0
0.5
1.0
1.5
2.0
2.5
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
Training T-Value
0.0
0.5
1.0
1.5
2.0
2.5
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
So, now we can combine “apples” to “apples.”

24. 24
Agenda
Basic Concepts
Transforming Individual KRIs
Creating a Composite Indicator
Senior Management Reporting

25. 25
Senior Management Focus
Are many small things going slightly wrong
in (one or related) area(s)?
Are any things going gravely wrong in any
(unrelated but similar) areas?

26. 26
Basic Distinctions
Creating a Composite Indicator
Related indicators reflect factors that compound one another in
their influence on a common underlying risk
Eg: staff turnover and training
Unrelated indicators reflect factors that do not impact one another
Eg: staff turnover in London and staff turnover in Sydney

27. 27
Basic Principles
Creating a Composite Indicator
Related T-Values indicators we combine by “multiplying” them:
NB: green x green = green, because 1 x 1 = 1.
yellow x yellow can equal yellow or red, because yellows
on average between 1 and square root 2 multiply to less
than 2, and yellows on average above square root 2
multiply to more than 2
Unrelated T-Values we combine by taking the “maximum”:
NB: then the combined indicators tells us if anything really
serious is happening in any of the covered areas

28. 28
Refinements
Creating a Composite Indicator
We should be able to:
Weight the influence of different individual KRIs differently
adjustable weights for each T-Value
Adjust the overall composite indicator to reflect how closely and
how soon senior management wants to be alerted to issues – their
appetite for risk. (We want “red” to be “higher” for senior
management than for middle management: how much higher?)
scaling parameters that affect the thresholds
up and down and the sensitivity of the composite
to changes in the weighted underlying T-Values

29. 29
Individual KRIs: T-Values
Creating a Composite Indicator
Staff Turnover T-value
0.0
0.5
1.0
1.5
2.0
2.5
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
Training T-Value
0.0
0.5
1.0
1.5
2.0
2.5
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
The two component individual KRIs …

30. 30
Aggregation Formulae
Creating a Composite Indicator
Related
I = max [1, a * [T(1)w(1) * T(2)w(2)]b]
Unrelated
I = max [1, a * max [T(1)w(1), T(2)w(2)]b]
where I = composite indicator
T(i) = the ith individual KRI
w(i) = the ith KRI weight, Σw(i) = 1, i = 1,2
a and b = “appetite” parameters
It is straightforward to generalize to
more than 2 indicators

31. 31
Staff Quality Index
Creating a Composite Indicator
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
1
4
7
10
13
16
19
22
25
28
31
34
37
40
43
46
Months
T-Values
Turnover
Training
SQI
a = 0.2
b = 1.2
w(1) = 2
w(2) = 2
... And the Composite Staff Quality Index (SQI)

32. 32
Adjusting Appetite and Weights
Creating a Composite Indicator
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
a = 0.2
b = 1.2
w(1) = 2
w(2) = 2
0.0
0.5
1.0
1.5
2.0
2.5
3.0
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
a = 0.2
b = 0.9
w(1) = 2
w(2) = 2
6 – 8, 19, 23 - 24 6 - 8
0.0
0.5
1.0
1.5
2.0
2.5
3.0
1
5
9
13
17
21
25
29
33
37
41
45
Months
T-Value
a = 0.2
b = 0.6
w(1) = 5
w(2) = 1
7 - 10

33. 33
Agenda
Basic Concepts
Transforming Individual KRIs
Creating a Composite Indicator
Senior Management Reporting

34. 34
The One-Page Summary
Senior Management Reporting
Staff Quality Index ___
Audit Issue Management Index ___
Business Continuity Index ___
Failed Customer Interactions Index ___
Information Security Index ___
Information Technology Index ___
Operational Losses ___
Process Breaks Index ___
Profitability Index ___
Policy Exceptions Index ___
Regulatory Index ___
Change Management Index ___
Europe
North America
Asia
Trading and Sales
Payments and Settlement
Retail Banking
Brokerage
Maybe the trading and sales business in
North America is growing too fast? Drill
down and see…

35. 35
Enter Presentation Title Here
Composite Indicators
&
Senior Management Reporting
London
January 17th & 18th, 2006
Charles Taylor
Director, Operational Risk