Transcript Implementation of a Model Integrated Risk Management

Integrated Risk architecture:
Implementation Issues
FICCI - IBA conference on “Global Banking – paradigm shift”
on October 5th 2005
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What is Integrated Risk Management
2
Components for implementing IRM
3
Challenges in Implementing IRM
2
Three key imperatives for Bank’s Management

Growth
Capital
Adequacy
Profitabilit
y
Differing requirements
from various
stakeholders
 Employees
 Borrowers
 Regulators
 Credit Rating
agencies
 Counterparty
banks
 Depositors
 Investors
IRM can assist in managing the three objectives proactively
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Maintenance of Regulatory/ Economic
Capital is crucial to business continuity

Economic Capital is the financial cushion that a bank uses to absorb
unexpected losses. The purpose of economic capital is to provide
confidence to claim holders such as depositors, creditors and other
stakeholders.

The development of of sophisticated risk measurement tools offers banks
the capability to calculate economic capital.

The proposed New Basel Capital Accord is a major move towards
aligning regulatory capital to economic capital.
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Profitability Analysis – Bank ABC
Profitability Analysis
Average Assets
Interest Income
Interest Expenses
Net Interest Margin
Other Income
Less: Provisions
Total Contribution
Contribution (LKR Mn)
Total Contribution
Operating Expenses
Share of Profit from subsidiaries
PBT
Tax
PAT
Credit
Investments
51840
35064
7.9%
3.6%
4.3%
1.9%
1.3%
4.9%
2548
8.5%
3.6%
4.9%
1.3%
0.0%
6.3%
2204
Others
10597

1.5%
3.6%
-2.1%

-2.1%
-226
4526
3975
197
749
70
679
• What is the capital required for different business lines?
• What is the return provided by different business lines on
capital invested?
• What is the expected impact of NPAs/ revaluation? Where
should we grow?
• Are we generating enough internal capital to support growth?
Investments offer the
highest contribution
p.c.age on assets
 Which segment
leads to high
interest earnings?
The credit function has
the largest contribution
towards fixed expenses
 Which credit
segment
contributes the
highest?
 What is the position
after allocating
costs?
 Am I properly
pricing for expected
Losses?
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Risk Exposures – Bank ABC
Liabilities
Assets
Deposits from customers
Deposits from Banks
Total Deposits
Borrowings
Group balances payable
Deferred Tax Liability
Tax Payable
Other Liabilities
Subordinated Debentures
Total Liabilities
Shareholders Equity
Share Capital
Permanent Reserve Fund
Reserves
Total Equity
Total Liabilities & Equity
Credit Risk
31/12/2003
77312
188
77500
10923
397
0
26
4887
520
94253
Cash & Short Term Funds
Balances with Central Banks
T Bills and other eligible securities
Placement with and loans to other banks
Bills of Exchange
Loans & Advances
Lease Rentals receivable within one year
Lease Rentals receivable after One year
Dealing Securities
Equity & others
Bonds
Investment Securities
Investment Properties
Investments in Subsidiaries & Associates
Accrued Intt
Cheques Purchased
Other Assets
Other Assets
Group balances receivable
Property Plant & Equipment
Total Assets
1082
609
4056
5747
100000
Market Risk
31/12/2003
1739
3305
5756
10987
2493
44222
96
72
587
916
17664
18580
804
1667
1073
2979
3331
7382
503
1807
100000
Liquidity Risk
The bank runs asset liability mismatches due differing maturity profiles and lending and borrowing
rates for credit, investments, deposits and subordinated debentures.
Borrowing/ Lending/ Investing in Foreign Currency gives rise to foreign exchange risk
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How does this affect us?
Increasing Complexity & Size
Current Environment

Credit Risk: Simple credit products
(loans normally backed by
collateral, few products)

Market Risk: Simple market risk
products (dealing in g-sec/ limited
corporate bond market/ limited FX
market)

Operational Risk: Not a major
concern
Future Environment

Credit Risk:
 Credit Derivatives
 Project Finance

Market Risk:
 Multiple currencies
 Investments in securities across
countries
 Investments in corporate bonds
 Swaps/ Options other
derivatives

Operational Risk:
 Increasingly important with
complex systems and
processes, operations across
time zones and markets
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RAROC - Base for Integrated Risk Management

RAROC allows a bank to take a comprehensive
risk view and forms the base for IRM
Risk-adjusted
After tax income
1.75%
Risk-adjusted
Net income
1750
RAROC
22%
Risk-adjusted
income
5.60 %
Risk-adjusted
Net income
2.20%
Income
6.10 %
Expected
Loss 0.50 %
Costs
3.40 %
Net Tax
0.45%
Average
Lending assets
100,000
Total capital
8000
Credit Risk Capital
4.40 %
Total capital
8.0 %
Market Risk Capital
1.60 %
Operational Risk Capital 2.00 %

RAROC could be carried out for the bank as a
whole or a business segment.
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Integrated Risk Management in a Bank
What is Integrated Risk Management?
Organisation
•Measure, monitor and manage all the
risks across the bank.
Structure
•Bank wide integrated risk
management infrastructure in terms of
people, policies and systems
Integrated
Risk
Manageme
nt
Compliance
•Common and consistent risk
measurement and quantification
methodologies across all risk
categories
•Aggregation of risks and estimation of
economic capital to assist in risk/
return decision making
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Perceived advantages of IRM

Facilitates strategic value creation

Key to regulatory compliance

Mechanism for efficient allocation of economic capital

Enables bank to maximise returns

Lower capital costs

Better decision making due to scenario analysis

Risk adjusted pricing

Loss reduction due to understanding of correlations

Elimination of unwanted exposures
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1
What is Integrated Risk Management
2
Components for implementing IRM
3
Challenges in Implementing IRM
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IRM Implementation – Important Facets
Policy
Risk Models
Performance
Measurment
Aggregation
Risk
Policy
Centralised
risk function
(analytics and
management)
Quantification
MIS
Controls on
Risk takers
Risk-adjusted
performance
measurement
Risk reporting
New product
assessment
IT Infrastructure
Risk Communication and Control
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1
What is Integrated Risk Management
2
Components for implementing IRM
3
Challenges in Implementing IRM
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IRM Challenges – identification of gaps in
existing risk management practices
Reviewing and improving existing

Information Technology Systems

Risk Analytics

Organisation Structure
Basel II
Credit Risk
Market Risk

Risk Management Policies

Management Information Systems

Top Management Oversight

Processes and Systems
Operational Risk
Beyond Basel II
ALM
Business Risk
Reputation Risk
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IRM Challenges - measurement of risks

Credit Risk
 Probability of Default
 Loss Given Default
 Exposure at Default

Market Risk
 Trading Book (VaR)
 Interest Rate Risk on Banking Book

Operational Risk (evolving)
Requires collection of data over time, development of measurement
models, back testing of models
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IRM Challenges – Risk Aggregation
Business Line 2
Business Line 1
Retail Pool
Corporate II
Corporate I
Equity Risk
Interest Rate Risk
Foreign Exchange Risk
Commodity Risk
Correlations
across
Asset classes
Correlations
Across
Companies
Correlations
across
Businesses
MARKET RISK
CAPITAL
CREDIT RISK
OPERATIONAL
RISK
RISK
CATEGORY
RISK SILO
Correlations among risk silos
OVERALL ECONOMIC CAPITAL
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IRM Challenges - modelling of correlations
across risk categories & risk silos


Modelling correlations requires data and is not easy
Fat tails in credit risk create problems
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IRM Challenges - Improving IT systems







Internal risk scoring models for credit
Portfolio Management Models
Models for estimating VaR for Market risk
Operational Risk databases
Asset Liability Management System
Data warehouse having interfaces for
 Analytical
 Modelling
 Reporting
Options for developing Risk Management Systems
 In-house
 Off-the-shelf
Sizeable investments in IT infrastructure required for implementing Basel II
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Thank you
CRISIL Investment & Risk Management Services
CRISIL Limited
[email protected]
Ph.no: 91 22 56537371
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