operational efficiency in the risk management process ......» bcbs paper dated january 2013 » 14...

Operational Efficiency in the Risk Management Process:

Data, Systems and Procedures

Charles Stewart

Originally presented at the IIF MENA CRO Forum | May 14th, 2013 | Dubai UAE

» Evolving demands of regulators necessitate investment

» Inevitable consequences

– Increased costs

– Undermined profitability

– Pressure on growth

Operational efficiency; strategic imperative or unrealistic utopia?

Operational Efficiency in the Risk Management Process | Moody’s Analytics | 2

» Do you know what “bets” you / 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-making


» 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”


Strategy &

Policy

Portfolio

Management

Tra

ns

ac

tio

n

Ma

na

gem

en

t

Ba

lan

ce

Sh

ee

t

Ma

na

gem

en

t

Performance

Management

By tackling the basics, what are they trying to achieve?

5

» “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 better

sales tools as strategic priorities

» The goal of single-platform commercial lending is to provide a unified depository of

information. 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 theme


Best Practice =

Transforming data into information, into business intelligence…

DATA MANAGEMENT

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» 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 more

informed origination decisions, based on risk appetite and the risk-adjusted performance

of 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 origination


Commercial Loan Origination; Value & Drivers

Source: CEB TowerGroup FSI Technology Survey, 2012- 2013

» 47% of commercial banks affirm that Commercial Loan Origination technology provides

high or very high value to their company

» Value Drivers:


Note: dotted arrow = inputs to origination process

solid arrow = outputs from origination process

Source: CEB TowerGroup Commercial Banking

Straight-through processing in commercial lending


CustomerAcquisition

• Pre-deal credit analysis

• Credit skills training

Credit Modelling

• PD, LGD and EAD model development, validation and calibration

• Appropriate model development governance

• Policies and procedures for overriding credit model outputs

Credit Assessment

• Credit analysis capabilities

• Development and review of credit policies

• Setting of credit risk appetites

• Benchmarking of client portfolios

Pricing

• Development of risk based pricing methodologies, tools and policies

CreditApproval

• Individual credit file reviews

• Determining limits setting frameworks, policies and procedures

Post-sanction

Fulfilment

• Assessment of credit risk documentation

• Adherence to conditions precedent

• Policy reviews on documents and condition precedent process

Monitoring & Review

• Assessment of problem debt identification activities and policies

• Review of loan loss provisioning policies and procedures

• Review and enhancement of credit risk Management Information


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?

Loan

Origination

Credit

Assessment

Portfolio

Management

Feedback loop

Feedback loopFeedback loop

OVERALL


Credit Process: Loan Origination

Client requests a

lending facility

Submitted to Front

Line

Conduct Initial

Assessment

Initial

Assessment

Results

Credit Declined

INPUTS

· Qualitative and quantitative

factors i.e. size of

company, profitability,

security, reputation

· Cash flow modeling and

forecasting

Conduct Second

Assessment

Accepted

Second

Assessment

Results

Rejected

INPUTS

· Financials

· Product mix

· Revenue drivers

· Budget

· Pricing acceptance

· Meeting with senior

officials

Contact Credit

Department for Credit

Assessment

Accepted

Appeal

Process

Rejected

Decision to

proceed with Credit

Assessment

No

Yes

Credit Department

reviews Front Line

Assessment

LOAN ORIGINATION

» Have you

documented your

workflow, a process

that gives you a

chance to stand

back and assess

shortcomings?


Credit Process: Credit Assessment

Credit Department

begins Credit

Assessment

Non-Financial

CorporatesFinancial

Institutions

External rating

agency rating

Mapped to

Sanlam’s internal

20-point scale

Mapped to EDF

via internal

mapping table

OUTPUTS

· Internal rating

· Mapped EDF

External rating

agency sovereign

rating

Determine if group

exposure or

guarantor

RiskAnalyst

Large Corporate

Fundamental Analysis Model

Complete

customer

information

INPUTS

· Years in

business

· Industry

· Firm Type

(public/private)

Select peer group

Spread financials

· Group subsidiary: input financials for each counterparty

separately

· Group parent: input group/consolidated financials

· Guarantor: input financials for counterparty and guarantor

separately

INPUTS

· Audited financial

statements up to 6

months old

· Interim financials if

audited > 6 months old

Point-in-Time EDF

input

RiskCalc South Africa

EDFCreditEdge EDF

Private

(Unlisted firms)

Public

(Listed firms)

INPUTS

· 7 financial ratios

based on spread

financials

INPUTS

· Market Value

of Assets

· Asset Volatility

· Default Point

Adjustments made to

financials by credit analyst

(e.g. Fair value items,

shareholder loans)

CREDIT ASSESSMENT STEP A: Determine internal obligor rating

Identify Client

Type

Sovereign/

Parastatals

Group exposure

(i.e. parent)Guarantor Counterparty

Proceed to

STEP BContinue

with STEP A

Provide responses

to qualitative

factors

INPUTS

· Customer power

· Diversification of

products

· Management quality

· Risk appetite

OUTPUTS

· RiskAnalyst rating on

1 to 10 internal scale

· Point-in-Time EDF

Process RiskAnalyst

assessment

methodology

Multiply internal

rating by 2

FINAL OUTPUTS

· Final rating on 1 to

20 internal scale

· Point-in-Time EDF

SIDE NOTE

· National scale if exposure

to South African company

denominated in Rands

· Global scale if exposure to

international companies

CREDIT ASSESSMENT STEP A CONTINUED: Determine

internal obligor rating

LDG ProcessFacility Ratings

Process

Unsecured

Facility / Secured

Facility

· LGD = 50% for

Senior Debt*

· LGD = 75% for

Subordinated Debt

· Eligible Financial

Collateral

· Eligible IRB

Collateral

Eligible Financial

Collateral

· Cash

· Gold

· BB- Sov debt/BBB-

Issuers

· Equities Main Index

· Collective

Investment

Schemes

Eligible IRB Collateral

· Receivables

· Real Estate

· Other

OUTPUT

Aggregate LGD = weighted LGD for each

part of the exposure

Unsecured

Facility

Secured

Facility

Starting point =

internal obligor

rating from Step A

Subordinated

debt / Hybrid

instruments

Facility Rating

Adjustments

based on

collateral

Notch downward

based on internal

obligor rating

Notch upward

based on

collateral and

haircut policy

OUTPUT

Facility Rating

CREDIT ASSESSMENT STEP B: Determine LGD and Facility Rating

Front Line or Credit Department

fills in form and sends to CPM

RiskFrontier

INPUTS

· Nominal Amount

· EDF1

· Tenor

· LGD2

· Spread

OUTPUT

RORAC calculation

CPM enters required information

into RiskFrontier

Multiple runs based

on scenarios

provided by

Front Line

Output file provided to Front

Line and Credit Department

Credit analyst collects all the

required information

INPUTS

· Summary Screen from

RiskAnalyst3

· EDF1

· RORAC4

· Other: SWOT analysis,

covenants, research on

company, market info

Credit Analyst completes credit

application in CAP

Exposure· Exposure up to R55 million

Sub-committee for approval

· SCM transaction > R110 million

· SIM transactions > R750 million

· Internal rating worse than 10

· Econ cap/MTM > 7.5%

· Econ cap portfolio utilisation > 5%

· Econ cap amount > R15 million

· Negative equity

· Nominal loan amount + interest > 10% of equity

· plus all other exceptions

Central Credit Committee for

approval

Decision

Approved Rejected

Deal added to overall portfolio

for portfolio management

purposes

INPUTS

· Credit application from Step D

· Memo from Front Line

CREDIT ASSESSMENT STEP C: Determine RORAC

CREDIT ASSESSMENT STEP D: Preparing Credit Application

CREDIT ASSESSMENT STEP E: Approval Process

Credit Declined


Credit Process: Portfolio Management

Deal added to overall portfolio

for portfolio management

purposes

CPM performs regular

stress testingReporting

Economic Capital

calculated at portfolio

level by CPM group

RiskFrontier

OUTPUT

Daily Economic

capital Excel report

Provided to Front Line

Used as Early Warning

signal to make effective

changes to the credit

INPUTS

· CreditEdge

EDF

· RiskCalc EDF

· Mapped EDF

INPUTS

3 Scenarios:

· 50% EDF

· 100% EDF

· 200% EDF

Results provided to

CCC and ALaRMCoCPM

· ALaRMCo

· CCC

Credit

Administration and

Reporting Dept

· CCC

REPORT EXAMPLES

· Monthly EDF

mapping to rating

· EDF Trend Analysis

· EDFs for SA Listed

companies, SCC,

SCM

· Risk/Return Analysis

· Pipeline Deals, etc.

Annual Reviews

conducted for existing

credits

Decision No changeInternal rating

or LGD change

INPUTS

· EDFs

· Known credit

events

Inform CPM so it

can be changed in

portfolio information

PORTFOLIO MANAGEMENT

Repeat Credit

Assessment


Constraints?

Benefits?

Unrealistic?

Inevitable?

Operational efficiency; strategic imperative or unrealistic utopia?


Covenant Tracking

Counterparty Management

Financial Spreading

Limits Checking

Back Office

Probability of Default

Product Proposal & Pricing

Loss Given Default

Financial & Risk Data

Mart

Benefits

Standardize your process with straight-through processing

Reduce redundancies and costly mistakes

Reduce application-to-approval cycle

time

Win more deals that reflect risk

tolerance

Improve customer satisfaction

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» 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 Value

Added (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) – an

opportunity to enable lower cost expansion or cost reductions

» Competitive advantage

Workflow – benefits… Business Line:


» 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



» More consistent accuracy of data

» Reduced calculation times



» 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) – an

opportunity to enable lower cost expansion or cost reductions

Workflow – benefits… Risk Department:


» A superior customer experience

» Faster response times

» More efficient decisions

» Up-to-date information about the application status and risk-based pricing



Workflow – benefits… Customer:


» 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


» Scalability of data storage resources


» Business Case (MA client example): for every “dollar” spent …a return of three…

Workflow – benefits… IT Department:


Conclusions?

» Constraints?

– Plenty

» Benefits?

– Outweigh the constraints

» Unrealistic?

– Many are already doing it… No!

» Inevitable?

– Regulatory pressure, competitive pressure, shareholder pressure…. Yes!


Contacts

Charles Stewart

Senior Director

Moody's Analytics

One Canada Square

Canary Wharf

London E14 5FA

+44 (0) 20.7772.1341 direct

+44 (0) 7736.868976 mobile

[email protected]

www.moodys.com

Wael Jadallah (& team)

Director

Moody's Analytics

Dubai International Financial Centre

Gate Precinct Building 3, Level 3

P. O. Box 506845

Dubai, UAE

+971 (0) 4237 9545 direct

+971 (0) 50 104 4218 mobile

+971 (0) 4237 9655 fax

[email protected]

www.moodys.com

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operational efficiency in the risk management process ......» bcbs paper dated january 2013 » 14...

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