Using Holistic Information on Risk to Enhance Business Strategies

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2 Using Holistic Information on Risk to Enhance Business Strategies Sponsored by:

3 Introduction Business and risk have always been seen to go hand-in-hand. The higher the risk, the higher the return. The recovery period, over the last five years since the global recession, has become even more difficult to navigate due to distress in the Eurozone and fiscal tightening around the world. Many organisations have had to scale back on their high risk policies and attempt to stabilise their portfolios. As such, the need for banks to strengthen their risk management framework has become vital. In the period before the global meltdown of financial markets, most organisations had structured themselves into disparate silos, especially within Risk, which led to less than satisfactory collaboration. It undermined the status of Risk in the organisational hierarchy and, most notably, it obscured the true risk profile of the financial institution. This approach also undermined the development of the organisation as a whole, as different divisions were implementing systems and operational processes which did not complement each other. Furthermore, as the information available to senior managers on the risks of business strategies was insufficient, a false sense of security was fostered, which, in turn, could lead to sub-optimal business decisions being taken. To mitigate this situation, financial institutions need to work towards fully integrated infrastructures that provide a holistic view of the risks faced by the organisation at every point in time. When up-to-date information on risks can be obtained, firms will inevitably find it easier to react promptly to changing market conditions and strengthen their forecasts of future market conditions. However, an integrated infrastructure in itself is not sufficient; there is a need for sophisticated analytical techniques and strong lines of communication between different departments so that senior managers can remain cognisant of the risk profile of the firm at all times. To this end, solutions that are available include interactive risk dashboards that can be tailored and adjusted to individual requirements and allow for on-demand risk analysis, and the Extract Transform Load (ETL) model, which ensures that all personnel are making decisions based on the same set of data. This report, based on a survey of 59 banking professionals from 30 identifiable institutions, explores the degree of collaboration between Risk and the Front Office to ensure optimum decision-making and the processes through which this collaboration is being achieved. Of the institutions that could be identified, 22 are based in, 5 in, 2 in and 1 in Africa. The analysis is broken down into the following sections: Enterprise Data Management Risk Analysis and Reporting Monitoring Frequency Enterprise View of Risk Collaboration between Risk Management and the Front Office Stress Testing 2

4 Enterprise Data Management Given the increasing correlation between market and credit risk, it is vital that banks generate a more holistic view of the risks that each part of their business is exposed to. Aggregation of high-quality data from several sources is a prerequisite if sound risk management is to be implemented within a bank or financial institution. Consistency of data is therefore an intrinsic element in this process. As can be seen in Figure 1, just under half of the banks surveyed for this report, 48%, work with data which is globally consistent across all of the asset classes that they trade in. Given the persistence of silos within banks, this figure is perhaps not surprising. What is of much greater concern is the fact that 14% of the banks surveyed continue to work with differing data sets across the various regions in which they are present and the asset classes they trade. Breaking the analysis down by region, as illustrated in Figure 2, it is clear that efforts to make data consistent across the enterprise are least mature among n banks, with almost 60% of respondents not being able to obtain data that is globally consistent. Although the greatest proportion of Asia Pacific banks work with consistent data across all regions and asset classes, a quarter of these banks are still working with different data sets. Figure 1: Consistency of data across the enterprise (All Responses) 15% 14% 48% 8% 15% Data is globally consistent Data is consistent across all asset classes but not all geographies Data is consistent across all asset classes but not all geographies Data is not consistent at all Other 3

5 Figure 2: Consistency of data across the enterprise (By Region) Data is globally consistent Data is consistent across all asset classes but not all geographies Data is consistent across all geographies, but not asset classes Data is not consistent at all High quality data is what all strategic decision-making is based upon and to ensure that the best and most appropriate business decisions for the firm are made. Therefore, it is vital that executives within the institution base the decisions they make on the same data. There are two principal methods being adopted by banks to attempt to ensure that employees work with the same numbers. The first method is the Extract Transform Load (ETL) model, while the second is adoption of a single central database from which every employee can access the same data. As can be seen in Figure 3, over half of respondents that selected that their data is globally consistent are from banks that employ a single central database to ensure all personnel make decisions based on the same data. Although ETL is the most popular method by a small margin, it is used by only 23% of respondents that use consistent data throughout the enterprise. Figure 3: Methods to ensure all personnel make decisions based on the same data (All Responses) 14% 4% 36% 14% 32% Extraction, Transformation & Loading (ETL) A single central golden source database Requests to be made to an Enterprise Data Management team Data Virtualisation / Federation Other 4

6 There are significant regional differences in the methods that are used to ensure all personnel are formulating decisions based on the same data. The majority of an banks are using a single database (closely followed by ETL), whereas an overwhelming majority of n banks are utilising ETL techniques. Expanding on this point further, there is evidence of even wider regional disparities when we note that the greatest proportion of respondents work with data that must be requested from a dedicated Enterprise Data Management (EDM) team. Figure 4: Methods to ensure all personnel make decisions based on the same data (By Region) A single central golden source database Extraction, Transformation & Loading (ETL) Requests to be made to an Enterprise Data Management team Data virtualisation / federation Risk Analysis and Reporting Generating the most up-to-date view of all of the risks faced by a bank is necessary to maintain the most effective risk management strategies. When it comes to creating this summary, 56% of respondents, as can be seen in Figure 5, use a risk dashboard to obtain an up-to-date view of the risks they face on an on-going basis. The issue faced by the majority of these banks, however, is that the dashboards employed are still very rudimentary. Just under a quarter of the respondents that use a dashboard are using a sophisticated interactive utility, whereas over three-quarters are still using a spreadsheet based dashboard. Underscoring the fact that a majority of banks are still utilising manual methods to obtain an up-to date view of risk, over a third of banks are still relying on written reports and presentations. This brings into question how up-to-date these views really are given the amount of time it takes to compile them. 5

7 Figure 5: Methods to obtain an up-to-date summary of risks faced (All Responses) 8% 14% 42% 36% Spread sheet Written reports and presentations Interactive risk dashboard Other Figure 6 shows how widespread the use of manual methods to obtain risk summaries is across the industry, with the issue being most prevalent at banks. Although it is only an banks that have developed or purchased an interactive risk dashboard, spread sheets are still the prevalent format. Figure 6: Methods to obtain an up-to-date summary of risks faced (By Region) Interactive risk dashboard Spread sheet Written reports and presentations When it comes to the frequency at which the information on the risk dashboard is updated, the survey yields some unsettling results. Disturbingly, only 12% of banks update the information on dashboards throughout the day, and only 5% of respondents update information on a real-time basis. At the banks that make updates to the dashboard on either a weekly or monthly basis, it is common practice to maintain spread sheet type dashboards or keep people abreast of the relevant risk data through written reports or presentations. 6

8 This lack of progress, however, is not limited to banks with less sophisticated dashboards. Only 14% of the respondents that use interactive dashboards update the information on a real-time basis. At the institutions of 29% of respondents, the interactive dashboards are updated on an intraday basis, with the remainder updating them on a less frequent basis. Of the banks which selected the other option, over half explained that updates vary depending on the nature of the data in question. In all these instances, the most frequently updated data was done so daily, with other data sets either updated weekly, monthly or even quarterly in some cases. Figure 7: Regularity of updates to dashboard (All Responses) 24% 5% 7% 28% 31% 5% Real-time Intraday Daily Weekly Monthly Other Not a single participant from an bank has access to dashboards where the data is updated more frequently than at the end of each trading day. Although the greatest proportion of dashboards which are updated in real-time are at US banks, though still just 20%, the majority update the dashboards no more frequently than weekly. Figure 8: Regularity of updates to dashboard (By Region) Real-time Intraday Daily Weekly Monthly 7

9 The functionality of the dashboards employed is an important feature as the more sophisticated ones allow risk managers to drill down further into the data they display. However, only 29% of respondents, as illustrated in Figure 9, have access to dashboards that allow risk managers to drill down into any level of detail. Of these respondents, only a quarter can drill down to any level of information that is updated in real-time or on an intraday basis (just 7% of the overall sample). A number of the banks that selected other explained that risk managers can access any level of information but this cannot be done instantaneously or automatically. Either a request has to be made to technicians or the employee must download any additional data required. Figure 9: Ability to drill down to more detail on risk dashboard (All Responses) 10% 27% 34% 29% Yes, but highest level of detail is limited Yes, managers can further access any level of detail No, cannot drill down into further detail Other The greatest proportion of respondents from banks that allow risk managers to drill down to any level of information on demand are from banks. However, as mentioned earlier, this information is not updated on a frequent basis and usually only weekly at best. Figure 10: Ability to drill down to more detail on risk dashboard (By Region) Yes, managers can further access any level of detail Yes, but highest level of detail is limited No, cannot drill down into further detail 8

10 Given that only a minority of banks can update the information in the dashboard in real time, it is not surprising that only 2% of respondents are completely satisfied with the format and functionality of their risk dashboard. An overwhelming majority of respondents, 93%, are in the process of making improvements to risk dashboards. Some of the improvements that a number of banks are making include: Improving the quality of underlying data Increasing the regularity of updates to data Increasing automation Adding detail, allowing for a more granular view of information Making the dashboard more user friendly Figure 11: Satisfaction with format of dashboard (All Responses) 5% 2% 41% 52% Completely satisfied Satisfied, but are still making improvements Not satisfied, but are making improvements Not satisfied, and are not making improvements Although the majority of banks in all regions are currently making improvements to risk dashboards, the respondents from n banks are least likely to be satisfied with the current state of these dashboards. This is to be expected, as 60% of these respondents commented that updates to dashboards are made on either a weekly or monthly basis, and over half cannot drill down to greater detail. 9

11 Figure 12: Satisfaction with format of dashboard (By Region) Completely satisfied Satisfied, but are still making improvements Not satisfied, but are making improvements Not satisfied, and are not making improvements Monitoring Frequency Given the nature of the data being analysed, there is a limited window of opportunity after which the information contained therein becomes out of date and thus useless. 28% of banks believe that financial institutions have less than an hour after any market move before the information and subsequent analysis based on that data is out-of-date. Of the respondents that selected more than 4 hours, a little under two-thirds believe that data has no more than 24 hours before it is out-of-date and thus inaccurate. As can be seen in Figure 14, banks in the region, in sharp contrast to or, generally believe that the window of time is longer than 4 hours. Figure 13: Window of time before analysis is out-of-date (All Responses) 14% 37% 14% 35% 0-30 minutes minutes 1-4 hours More than 4 hours 10

12 Figure 14: Window of time before analysis is out-of-date (By Region) 0-30 minutes minutes 1-4 hours More than 4 hours Given that only 12% of respondents, as illustrated in Figure 15, have access to risk metrics constructed from data updated intraday or in real-time, and that 28% believe data is out-of-date within an hour of market changes, it is a cause for concern that only 21% are able to receive and analyse data within an hour of said market move. 20% of respondents feel that it typically takes longer to receive and analyse information than the period of time it takes for it to be considered out-of-date. Figure 15: Time it takes to receive risk information once market conditions have changed (All Responses) 12% 38% 9% 41% 0-30 minutes minutes 1-4 hours More than 4 hours As Figure 16 makes clear, n and an banks receive data within very similar timeframes. Although none of the respondents from the banks selected that data is typically received and analysed within an hour of market moves, no participant commented that data is received after it is perceived to be out-of-date. 11

13 Figure 16: Time it takes to receive information once markets conditions have changed (By Region) 0-30 minutes minutes 1-4 hours More than 4 hours Enterprise View of Risk For an enterprise to be fully aware of all risk, it needs to be able to view risk based on aggregated, up-to-date data from across the enterprise. This data will be more useful and beneficial to managers and decision makers if the data supplied is a consolidated view of all risk faced. As the following figures demonstrate, the vast majority of business users at banks have the ability to view and analyse a consolidated view of risk. Figure 17: Can business users view and analyse a consolidated view of risk? (All Responses) 22% 78% Yes No 12

14 The respondents from n firms are the least likely to have access to a consolidated view of all risks faced by the institution. Furthermore, those that can view and analyse risk information can only do so for their own business lines. The responses make it clear that data is still held in disparate silos at several n institutions, where, as Figure 2 illustrated, there is also a lack of globally consistent data. Figure 18: Can business users view and analyse a consolidated view of risk? (By Region) Yes No What is important to consider, however, is who is able to view what type of information. Different institutions will have varying policies in place in regard to which personnel will have access to firm-wide data, and which personnel will have access to data that is relevant only to particular business lines. The responses to the survey show that it only a quarter of business users can view enterprise-wide information. Figure 19: Levels at which users can view a consolidated view of risk (All Responses) 25% 75% For the whole enterprise Only for their respective business lines 13

15 Most notably, the results show that n institutions have the greatest limitations in terms of access to data, as none of the respondents from these firms are able to view enterprise-wide information on the risks faced by the institution. While some an and institutions do allow users to access enterprise-wide, consolidated view of risk, they constitute a very low proportion of the overall sample, illustrating that risk management in silos and suboptimal data management are major issues in the financial industry. Figure 20: Levels at which users can view a consolidated view of risk (By Region) For the whole enterprise Only for their respective business lines Collaboration between Risk Management and the Front Office With increased pressure to perform and achieve outstanding results in a ruthlessly competitive environment, the Front Office needs the cross-asset view possessed by Risk to shape business strategy. It is reassuring that an overwhelming majority of respondents selected that Risk managers have some input in determining business strategy, with 34% of respondents stating that the input of risk managers is significant. The Front Office, however, still ultimately determines business strategy at a majority of banks. Only 16% of respondents stated that Risk Managers and the Front Office contribute to business strategy in equal measure. 14

16 Figure 21: Personnel that shape business strategy decisions (All Responses) 16% 3% 47% 34% Risk Managers have an input but the Front Office determines business strategy Risk Managers have a significant input but the Front Office still holds sway over business strategy Risk Managers and Front Office personnel contribute to business strategy in equal measure Business strategy is determined solely by the Front Office Risk Managers have the greatest authority at institutions, with 40% of respondents selecting that Risk Managers and Front Office personnel determine business strategy in equal measure. A further 40% selected that Risk Managers make a significant contribution to business strategy. At an institutions, relative to North American institutions, Risk Managers exercise a notably lower degree of influence on business strategies. Figure 22: Personnel that shape business strategy decisions (By Region) Risk Managers have an input but the Front Office determines business strategy Risk Managers have a significant input but the Front Office still holds sway over ultimate strategy Risk Managers and Front Office personnel contribute to business strategy in equal measure Business strategy is determined solely by the Front Office 15

17 Stress Testing Regulatory bodies have continuously impressed upon banks the need for resilience against tail risk events that have materialised with remarkable consistency over the last five years. As a result, financial institutions need to develop and implement sophisticated stress testing frameworks so that business managers can take mitigating action as soon as a market downturn is witnessed. However, as the responses to the survey show, the ability of firms to conduct portfolio-level stress tests on-demand, as soon as conditions begin to change in the market, leaves a lot to be desired. Less than half of the respondents are able to conduct portfolio-level stress tests on demand for the whole enterprise, while 18% are unable to conduct these stress tests for any product. Unsurprisingly, 90% of the respondents that cannot conduct stress tests on demand even for some products also do not receive updates to data within an hour of market changes. There are no notable differences in these trends across different regions. Figure 23: Ability to conduct timely portfolio-level stress tests on-demand (All Responses) 18% 36% 46% Yes, across all products Yes, but only for some products No The results from the research indicate that firms are using stress testing results most widely for setting limits and determining the risk appetite, with 43% of respondents stating that stress tests are central to this activity. Stress testing is also an important, but generally not critical, factor in determining economic capital and business strategy. 16

18 Figure 24: Usefulness of stress testing (All Responses) Economic capital calculations Setting limits / appetite Business planning Critical Very Useful Useful Once the stress testing framework is in place it is necessary to ensure that business managers are able to understand the implications of stress testing on the firm s overall business strategy and risk appetite. As can be seen in Figure 25, committee meetings are deemed to be the best method to ensure that senior management understand the significance of stress testing. Figure 25: Steps taken to ensure business managers are able to understand stress testing results (All Responses) Written explanatory reports Verbal discussions Committees / meetings / presentations Primary significance Secondary significance Tertiary significance 17

19 Conclusion Although financial institutions are aware that a robust risk management framework is an integral component of successful business strategies, this research indicates that there is room for improvement in the risk management processes at most firms. It is alarming that the approach of risk management in silos is still prevalent, and the use of inconsistent datasets by different functions is also widespread. More than half of the respondents are making use of risk dashboards to obtain up-todate information on the risks faced by the institution. However, these dashboards take the form of spread sheets and written reports at most institutions, which brings into question how up-to-date the information presented in this format really is. Market conditions and the risk profile of the organisation can change within a few minutes, which makes it necessary to have up-to-date risk metrics, based on data updated in near real-time, available to business managers at every instance. As this is not the case at most of the surveyed institutions, the level of satisfaction with the quality of information presented in risk dashboards is understandably very low. Notably, most senior managers at a number of organisations are able to view and analyse a consolidated view of risk only for particular lines, and not for the entire organisation, which can lead to sub-optimal decisions being made during a market event. However, it is encouraging that collaboration between Risk Management teams and the Front Office is slowly showing signs of improvement. Given the crises that financial institutions have faced over the last five years, stress testing has received due attention as a means to assess an institution s resilience against extreme market events. While the importance of stress tests in determining the risk appetite and economic capital has gained currency across the industry, there is still some room for improvement in this area. It is a cause for concern that a vast majority of the surveyed firms cannot conduct portfolio-level stress tests on-demand, which exposes notable weaknesses in the prevailing risk management frameworks. Overall, financial institutions certainly have an express desire to bolster their risk management processes as demanded by the new regulatory environment. The influence of risk management divisions on business strategies has grown markedly in the wake of the financial crisis of However, there is a need to forge stronger relationships between Risk and the Front Office if financial institutions are to regain the confidence of their clients in a post-crisis world. 18