6038 5401 raj murdia_presentation
DESCRIPTION
Integrated Balance Sheet ManagementTRANSCRIPT
Page 2
Overview
► Regulatory reform, changes in Board risk appetite and shifts in the competitive landscape have significantly increased the complexity of balance sheet management.
► Traditional ALM focusing on interest rate risk in the banking book and capital attribution is evolving to dynamic balance sheet management, driving strategic business and risk management decisions at the highest levels in financial services organizations.
► Future state strategic balance sheet management will drive:
► Fundamental changes in the operating models of financial services organizations
► Rationalization and enhancements in data, technology and reporting
► Enhanced analytics to support balance sheet optimization and strategic planning given multiple binding constraints
► Implementation is complex, requiring sponsorship by the Board and executive management, as well as cross-functional participation from Finance, Risk and business lines.
Page 3
Traditional balance sheet management and current challenges
This document contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither Ernst & Young LLP nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this document. On any specific matter, reference should be made to the appropriate advisor.
Page 4
Traditional balance sheet management
► Performed by corporate treasury with a focus on the banking book.
► Objective to fund plans delivered by business lines and manage associated IRR and FX risks.
► Input, rather than the driver of strategic plans
► Product pricing and performance management do not capture all liquidity risks and costs, particularly contingent risks.
► Data lacks sufficient granularity and frequency to meet emerging regulatory expectations.
► Silo-based governance, organization, risk analytics, data and technology infrastructure.
Long-Term
Funding
Trading Book Short-term
Funding
Banking Book
Core Capital (Including Retained
Earnings)
CR
CR
MR
LR
IRRBB
LR
MR LR
Operating models in many organizations make it difficult to provide the Board and senior management with a holistic view of the balance sheet. Silo-risk analysis can fail to capture inter-dependencies across risk categories and may not fully test the resilience of a bank’s balance sheet.
Page 5
Traditional planning model
Strategic planning in many organizations does not allow sufficient two-way flow of information between functions and focuses on aggregation of inputs, rather than dynamic analysis and optimization.
Management Committee, Board of Directors
Risk Management
Asset Liability Committee
Inte
rest R
ate
Ris
k
Liq
uid
ity R
isk
Cre
dit R
isk
Opera
tional R
isk
Oth
er
Ma
teria
l R
isks
Fu
nd
ing
Inve
stm
en
t P
ort
folio
Mg
mt.
Ma
teria
l R
isk A
sse
ssm
en
t Capital
Planning
Stress
Testing
B/S Forecast I/S Forecast
Enterprise Risk Committee
Treasury Planning
Lines of Business
Fu
nd
s T
ran
sfe
r P
ricin
g
Page 6
Regulatory considerations for balance sheet management The Regulatory reform landscape is complex and dynamic. Interrelated regulatory requirements impact functional areas across the organization.
Balance Sheet Management
FDIC IDI Rule and
DFA 165(d) resolution
plans
Basel “2.5” trading
book capital
CCAR – stress
testing and capital plans
US SIFI Enhanced prudential standards
NPR
SR 10-1 Interagency
guidance IRR
SR 11-7 Interagency
guidance Model Risk
Basel III, SR10-6, RN
10-57 on Funding, Liquidity
Risk
Funding & Liquidity
Management
Cash Management
Operations & Technology
Capital Management
Capital Markets
Investment Management
Finance
ALM & Hedging
Capital Management
Enterprise Risk/CRO Credit Risk
Market Risk
Internal Audit
Lines of Business
Financial Planning
Living Will
Page 7
Gap to crisis
Capital and liquidity ratios
time
Stress buffer
Recovery zone
Resolution
Failure threshold
Crisis threshold (capital or liquidity event)
Lower end of operating range
Current Capital/liquidity ratios
Upper end of operating range
Stress testing Analyze potential impact of stress scenarios and risk mitigation options
Further stress testing Identify potential crisis/failure scenarios; demonstrate strength of capital/liquidity position
Recovery plan Plan for potential recovery actions to address severe stresses
Resolution plan Support efficient legal entity resolution activities after failure
Risk appetite calibration The amount of risk that the firm is willing to accept given target capital/liquidity position
Risk capacity analysis The maximum amount of risk that can be borne given current capital/liquidity levels
Business Planning requirements
Risk appetite inputs
Living will
Target operating range
Increasing scope for analysis and decision making
Business decisions need to be evaluated and their implications considered not only in BAU or Stress scenarios, but in the extreme stress (Recovery and Resolution) scenarios as well.
Page 8
Funding and liquidity strategies to address LCR binding constraint:
Overlay capital considerations:
Illustrative example: liquidity and capital considerations
► Strategy 3 may be the lowest-cost strategy today to achieve LCR compliance, but requires significant debt issuance, indicates a low risk-appetite as leverage ratio becomes binding and weak return profile to the shareholder
► Strategy 1 and Strategy 2 reduce risk-weighted assets but at the expense of negative carry
Strategy 1: shift investment portfolio mix Strategy 2: shift asset mix Strategy 3: balance sheet expansion
► Increase level 1 securities and reduce LCR level 1 non-eligible securities
► Increase level 1 securities and decrease loans
► Increase level 1 securities and issue 3-year long-term debt to fund the security purchase
Investment portfolio security yield:
3.1% Yield on loan portfolio: 4.5% 3-year note coupon (treasury + 130-160 bps)
1.6%–1.9%
5-year treasury rate: 0.6% 5-year treasury rate: 0.6% 5-year treasury rate: 0.6%
Investment shift impact: 250 bps Asset shift impact: 390 bps Negative carry on level 1 assets
100 bps– 130 bps
► More complex situations would involve decisions between disparate portfolios across the entire balance sheet; e.g., investing in mortgage loans vs. leveraged leases
Page 9
Need for a new strategic balance sheet management operating model
This document contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither Ernst & Young LLP nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this document. On any specific matter, reference should be made to the appropriate advisor.
Page 10
Capital planning Liquidity forecasting
Stress tests RRP Stress tests CFP
Risk profile: how much risk are we exposed to? Risk appetite: what risks should we take?
Credit Market
Operational
Liquidity
Reputational
New business and product approval
Measuring risk-based returns
Risk within strategic planning
Board-approved risk appetite
Internal controls
Data and IT capabilities
Enterprise risk profile
• Enterprise-wide view of risk
• Emerging risk identification
Regulatory constraints
• Minimum capital and liquidity ratios
• Other prudential requirements
Linkage of risk-taking and regulatory requirements with strategic goals
• Challenging business environment
• Leverage ratio vs. risk based capital (RBC) continuum – risk-return reward, size of balance sheet
• Focus on counter-cyclicality and tight underwriting
• Trade-off between higher liquidity requirement, earnings, leverage and RWA
Aggregation
Concentrations
Correlation
Risk capacity: how much risk can we take?
Internal risk-based view of capital and liquidity
Regulatory minimum capital and liquidity
Integrated balance sheet analysis
Enhanced balance sheet analytics and decision making
Resilience constraints
• Internal operating range for risk and capital
• Contingency and recovery options
Optimizing balance sheet strategies considering regulatory constraints, risk appetite and business objectives requires integrated and dynamic analysis.
Page 11
New operating model Enhanced governance, functional, data and infrastructure capabilities
Board of directors and board-level risk committees ► Establish risk appetite and responsibility for risk governance and approval (e.g., approval of capital plan, establishment of liquidity risk
tolerance) ► Active and interventionist role for the board-level risk committee with respect to the oversight of management risk-taking
Risk functions (CRO) ► Capabilities to support enhanced reqmts. for:
► Enterprise risk monitoring, aggregation and reporting capabilities and risk committee reporting
► Liquidity risk monitoring and reporting ► Daily counterparty exposure identification, calculation
and monitoring; monthly counterparty exposure reporting
► Capital and liquidity stress testing
Finance functions (CFO) ► Capabilities to support enhanced requirements for:
► Liquidity management requirements — detailed cash flow projections, monthly stress testing, contingency funding plan; liquidity monitoring against limits including intraday liquidity and collateral, formal documentation of assumptions
► Formal review of liquidity management effectiveness ► Increased regulatory reporting expectations — daily cash flow,
monthly reports on single counterparty exposures ► Capital plan and stress testing
Data management and IT infrastructure ► Build sustainable data provisioning and underlying architecture to support enhanced capabilities ► Significantly increase the granularity and timeliness of reporting (e.g., legal entity, daily). Develop single “golden” sources of data at
enterprise level. Focus on aggregation (inc. aggregate counterparty positions) and finance and risk data reconciliation
Executive management and business strategy ► Strategic analysis on the viability of certain products and activities against regulatory and market constraints ► Active role in investment decisions supporting regulatory spend (e.g., prioritization, first-mover advantage) ► Enterprise-level governance over implementation/transformation projects and workstreams
Liquidity risk management
CP exposure monitoring
Stress testing
Capital and funding plans
Lines of business ► Shaping business strategy and implementation approach related to addressing the financial reform agenda ► Ability to assess businesses against multiple constraints — multiple risk-based capital ratios, liquidity ratio, leverage ratio — and business
performance metrics
Audit — Effectiveness of reform projects. Impact on audit universe, new business models and risk/compliance processes
Enterprise compliance — Ability to manage as an integrated, firm-wide management discipline
Page 12
The Scorecard approach for more complex tradeoffs across entire balance sheet
VS.
Business Model
Asset Liability
Management
Regulatory Capital
Market and
Shareholder View
Loss Rates
+
1 +
Risk (Volatility and
Correlation)
PPE and NIAT
MORTGAGE SERVICING RIGHTS
PPE/OS = $X, NIAT/OS = $X (seasoned)
Short Payback
± Basel 1: 100% RW
Basel 2: Low given asset quality
Liabilities easily hedged with
balance guarantee swaps +
+
-
+
- Basel 3: Punitive treatment (only 10%
allowed vs. 90% earlier)
High RoE
Short Payback
- Daily hedging using TBAs etc.
Hedging and Acct. operationally demanding
Natural alignment and natural hedge
with origination
Considered inferior collateral loans
Very Low: <1% (Through-the-Cycle)
+ Low volatility
Imperfect correlation with other assets
- Considered risky due to volatility
“Free” money
MtM volatility flows through earnings ±
SCORECARD
N/A
Natural hedge with HFI Portfolio
High volatility ±
2
1
2
4
3
4
PRIME AUTO ASSETS
Ra
nk
-o
rdere
d
+ RoE and Economic
Profit
High: X% Average (post-hedge): Y% ± 3
Liquidity / Impact
on LCR, NSFR + Short dated; Relatively easy to sell
Impact on LCR using stable funding: X% - Illiquid, difficult to dispose
Impact on LCR using stable funding: X% 5
Qu
an
tita
tive
Q
uali
tati
ve
±
► Balanced Scorecard articulates goals and constraints and provides transparency and objectivity in decision making.
► Forms the basis for tradeoff decisions, allocating B/S and setting targets at high level LoB segments
► Composed of a few critical and meaningful metrics that do not change too frequently
Illustrative example
Page 13
Traceability to validate treasury infrastructure
Target operating model (TOM)
Outlines key functional components and processes
Business requirements (BRD)
Describes the functional and non-functional requirements
Balance sheet
Granular logical chart of accounts
Data groupings
Logical grouping for data requirements
Reporting requirements
Describes management and regulatory requirements considering target state for reporting
Product hierarchy
Groups charts of accounts in platform to optimize system functionalities (e.g., dimensions)
Data requirements
Consolidates the data elements needed to produce management and regulatory reporting
Solution design
End-to-end solution design (sourcing to reporting)
Logical data model
End-to-end solution design (sourcing to reporting)
Data dictionary
Description for product and data elements
Business rules
Outlines functional and technical rules
Business drivers
1. How do I know that business requirements are complete and at the right granularity?
2. How do key business inputs translate into technical delivery and can actually produce intended results?
3. How do I think about balance sheet management, capital, funding and liquidity in a structured way?
4. How do I ensure complete balance sheet and product coverage?
Traceability benefits
1. Clear auditabillity from regulatory requirements to solution implementation
2. A structured approach to phasing business benefits
3. Comprehensive balance sheet and product coverage
4. Clear mapping to delivery inputs (e.g., data model, interfaces, testing)
Page 14
Traceability example
1. Business requirement: Automated reporting solution capable of producing the Fed 4G Report
2. Reporting line item: 9.10 Cash Balance at Federal Reserve
3. Business rule Product Code = Interest Earning Balance with Other Banks OR Non Interest Earning Balance with Other Banks AND Party Long Name = Central bank AND …
5. SQL to fulfill Line 9.10 SELECT: Balance Amount FROM: Position Fact, Instrument Dimension, Party Dimension, Purpose Dimension WHERE (Instrument Dimension.Product Code = Interest Earning Balance with Other Banks OR Non-Interest Earning Balance with Other Banks) AND …
4. Data definition Product Code Party Long Name Balance Amount
Business/regulatory needs Demonstrated linkage to reporting solutions
Business requirements and data requirements are not enough; traceability formally documents the mapping of requirements to infrastructure and the reports generated by treasury.
Page 15
Accountability and governance Treasury data steward establishes governing body, roles and accountabilities and defines data reconciliation strategy
Data provisioning (sourcing) Consolidate data sourcing from LOB by product group through identification of authorized sources, validation and gap closure; elimination of redundancy; and alignment to enterprise data provisioning points
Data standardization, cleansing and storage
► Integrated data model leveraging common data sources for market and security master data
► Scalable data model that supports incremental functional components
► Multiple periods of stored production data for user access
► Controlled management of standard reference data, metadata, reconciliation and data model
Analytics and reporting
► Central function to support internal and external reporting of treasury risk
► Flexibility to compute and/or import contractual, behavioral and stressed cash flows for internal risk or statutory/ regulatory reporting
► Shared stress-testing strategies and scenario analysis capabilities across risk categories
► Multi-dimensional reporting with drill-down capabilities at the most granular level and ability to view risk measures across line of business, legal entities, currencies and counterparties
High-level target state architecture
Traceability
Measurement system
Treasury, risk and finance
users
Data management steward
Upstream accountability of data Policy and standards Reconciliation, testing and attestation
Line of business } Provisioning point
Line of business } Provisioning point
Line of business } Provisioning point
Loans
Debt/hedges
Traded products
Deposits
Off-balance sheet
Treasury data warehouse
Analytical/ calculation engines
Capital
Planning
ALM
Liquidity
Stress testing
Cash flows
Analytics/ reporting framework
Regulatory reporting
MIS tools
Data visualization
Report generation Personnel
Personnel
Personnel
4 3 2 1
1
2 3 3 4 4
Page 16
Program approach and governance A structured approach to defining a target state operating model and implementation road map
Iterative target state development methodology
Strategic architecture
Functional and IT road map
Gap assessment
Business strategy
Conduct applicability assessment of
regulations Tactical
architecture
Inputs
Perform current state assessment
Perform gap assessment
Develop target state
Establish ongoing management operating model
Leading practice considerations and
benchmarking
BAU target operating model
Strategic treasury improvement program governance
Strategic functional and IT
road map
Functional and data requirements
Target operating model
► The creation of a program governance structure provides oversight to planning and implementation activities, including fine-tuning the approach due to regulatory updates and new requirements. It also provides a framework to evaluate tactical initiatives in terms of the planned strategic architecture limiting rework.
Increased clarity of regulations and new regulations
As new requirements emerge or existing ones change, the roadmap and target state will update iteratively throughout this process.
Outputs
Strategic architecture
Interim architecture
Page 17
Benefits of strategic balance sheet management
► Allows better management of the firm in this complex environment with changing competitive and regulatory landscape.
► Facilitates tight integration of key stakeholders, early and all along the decision making process.
► Makes possible dynamic analysis and reporting across risk factors using strategic infrastructure.
► Facilitates optimization across entire balance sheet, considering multiple constraints and strategic goals.
► Enhances alignment of LoB behavior with strategic goals.
► Enhances profitability by optimizing funding and IT costs.
► Enables stronger governance of Balance Sheet decisions and performance evaluation and enhance accountability by clarifying roles and responsibilities.
► Facilitates key supervisory risk management objectives.
Page 18
Ernst & Young
Assurance | Tax | Transactions | Advisory
About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.
Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com.
Ernst & Young LLP is a client-serving member firm of
Ernst & Young Global Limited operating in the US.
© 2012 Ernst & Young LLP. All Rights Reserved.
SCORE No. XXXXXX
1210-1396753
This publication contains information in summary form
and is therefore intended for general guidance only. It is
not intended to be a substitute for detailed research or
the exercise of professional judgment. Neither
Ernst & Young LLP nor any other member of the global
Ernst & Young organization can accept any responsibility
for loss occasioned to any person acting or refraining
from action as a result of any material in this publication.
On any specific matter, reference should be made to the
appropriate advisor.