Guest post from Pedro Masetto, Senior Risk Specialist to North America, IBM Risk Analytics
Financial institutions and regulators around the world believed they were on the brink of discovering the “holy grail” to integrated risk management with the adoption of the Basel III guidelines after most of the G20 endorsed it back in 2010.
Many organizations perceived those changes as an opportunity to up its Enterprise Risk and Capital Management programs and address risk aggregation and economic capital concerns.
Over the past 30 months, I’ve had the opportunity to interact with more than 50 of the 100 largest internationally active banks and collect detailed risk analytics, business and technical requirements from them. Moreover, in conversations with heads of risk, IT, and Basel program managers, I’ve been able to review a variety of full fledge economic capital (EC) and enterprise risk management programs.
Across the board, my research and clients’ experience tell me that said grail is still proving elusive.
Most of the firms have made significant progress in creating an enterprise information platform while developing an integrated view of risk. Thus, they are improving the management of both banking and trading book exposures and their ability to measure, price and aggregate risks.
More specifically, banks have been looking at integrated EC approaches to determine their capital needs in order to protect its value vis-à-vis an understanding of the correlation among risk factors driving unexpected losses.
Additionally, many companies have also been pushing towards creating a more robust risk management infrastructure in lieu of having to demonstrate, to their corresponding regulators, an appropriate Internal Capital Adequacy Assessment Process (ICAAP) and its ability to evaluate and deal with systemic risk within the global financial system.
In spite of that progress, a large number of those institutions are still muddling through capital and earnings pressures derived from significant loan losses and sharp declining values of selected securities portfolios.
This is especially true after Basel III introduced a “leverage ratio” requiring that firms further explain their capital requirements by means of comparing Tier 1 capital against “total exposure” without reference to risk-weighted assets.
In addition to the new liquidity ratios, there are also explicit trading book capital requirements (market and counterparty credit risk) with taxing consequences on business analytics, data and technology.
With all these challenges what should organizations do?
A handful of organizations have decided to invest in creating a flexible analytical framework to pull together risk and compliance data from multiple systems.
The objective is simple: find ways of safeguarding profitability under stressed conditions, as well as remaining within risk limits through portfolio optimization under current and stressed scenarios.
Under this heuristic approach, firms have created options to achieve desired levels of risk and returns by keeping within their risk-appetite limits and constraints.
By using an analytical approach, these organizations have been able to alter the weightings of any desired asset groupings and recalculate individual risk results, typically leveraging the consistency of historical approaches, which includes full economic capital, revenue, funds-transfer-pricing (FTP) and risk adjusted return on capital (RAROC).
This is significant because identifying and capturing risks from across the enterprise in a single grid-like environment creates a structured methodical process that involves frequent, if not constant, communication among risk analytics, IT and the lines of business.
Banks in this grouping are finding this type of approach reasonable and acceptable as many of them have to rely on expert judgment to supplement risk aggregation and economic capital calibration approaches due to an overwhelming lack of historical time-series data.
Overall, firms have found that business units are more willing to engage in such communications because it enables businesses to funnel-up the risk they see regularly, if not on a daily basis, and thus achieve a more comprehensive view of its risk return profile.
The resulting item involves creating action plans that are then presented to Risk Management Committees who are able to explain to their regulators the ways in which risks are managed across the enterprise.
While several banks have made significant progress in creating single views of risk through integrated, flexible risks aggregation frameworks, a large number of firms are still a long distance from the “holy grail” target.
For more information:
· Learn more about IBM Risk Management solutions: Algorithmics & IBM OpenPages