Composite indicators

transcript

Enter Presentation Title Here

Composite Indicators

Senior Management ReportingLondon

January 17th & 18th, 2006

Charles Taylor

Director, Operational Risk

Agenda

Basic Concepts

Transforming Individual KRIs

Creating a Composite Indicator

Senior Management Reporting

Agenda

Basic Concepts

The Basic Problem

Combining apples and oranges

Combining things in a way that will highlight what senior management needs to focus on

KRIs & Management LevelsBasic Concepts

Location KRI Type Management Level

Local Individual Lower/Mid-Level

Organization Composite Mid-Level/Senior

KRIs & Management LevelsBasic Concepts

Location KRI Type Management Level

Local Individual Lower/Mid-Level Transformation – apples to apples

Aggregation – flagging what should be flagged

Organization Composite Mid-Level/Senior

Individual KRI ThresholdsBasic Concepts

Junior management is managing the risk; no mid-level attention required

Junior management is managing the risk; mid-level management should monitor the indicator

Management should escalate from junior to mid-level management

Composite KRI ThresholdsBasic Concepts

Mid-level (or junior) management is managing the risk; no senior attention required

Mid-level management is managing the risk; senior management should monitor the indicator

Management should escalate from mid-level to senior management

Ranges of Individual KRIsBasic Concepts

Low Low Exected High HighUnderlying KRIs Red Yellow /Target Yellow Red

L1 L0 E H0 H1

Staff Turnover (%) 1 3 8 14 20Staff Training Days (days/year) 4 8 15 na na

L1 L0 E H0 H1

L0L1 H1H0E

L1 L0 E H0 H1

L0L1 H1H0E

Typically, KRIs go: red-yellow-green-yellow-red or red-yellow-green or green-yellow-red

Basic Concepts

Individual KRIs

Staff Turnover

1 5 9 13 17 21 25 29 33 37 41 45

Months

Training

10121416

1 5 9 13 17 21 25 29 33 37 41 45

Months

Basic Concepts

Individual KRIs

Staff Turnover

1 5 9 13 17 21 25 29 33 37 41 45

Months

Training

10121416

1 5 9 13 17 21 25 29 33 37 41 45

Months

The ranges and measures are very different before we transform the KRIs

Basic Concepts

Individual KRIs

Staff Turnover

1 5 9 13 17 21 25 29 33 37 41 45

Months

Training

10121416

1 5 9 13 17 21 25 29 33 37 41 45

Months

The thresholds are very different too

Agenda

Basic Concepts

Transformation to T-ValueTransforming Individual KRIs

KRI L0L1 H1H0

The graphic presentation of the transformation

Transformation to T-ValueTransforming Individual KRIs

KRI L0L1

The graphic presentation of the transformation for a red-yellow-green KRI

Transformation to T-ValuesTransforming Individual KRIs

T = 1 when L0< KRI < H0

T = (KRI + L1 – 2*L0 )/ (L1 – L0) when KRI < L0

T = (KRI + H1 – 2*H0)/(H1 – H0) when KRI > H0.

The algebraic presentation of the transformation

Individual KRIs: T-ValuesTransforming Individual KRIs

Staff Turnover T-value

1 5 9 13 17 21 25 29 33 37 41 45

Months

Training T-Value

13 17 21 25 29 33 37 41 45

Months

The transformed ranges and measures are now the same

1 5 9 13 17 21 25 29 33 37 41 45

Months

Training T-Value

13 17 21 25 29 33 37 41 45

Months

And so are the thresholds

1 5 9 13 17 21 25 29 33 37 41 45

Months

Training T-Value

13 17 21 25 29 33 37 41 45

Months

Does this work really? Three ranges of months are red in the two graphs …

Individual KRIsTransforming Individual KRIs

Staff Turnover

1 5 9 13 17 21 25 29 33 37 41 45

Months

Training

10121416

1 5 9 13 17 21 25 29 33 37 41 45

Months

… exactly as they were for the untransformed KRIs. So it does work!

1 5 9 13 17 21 25 29 33 37 41 45

Months

Training T-Value

13 17 21 25 29 33 37 41 45

Months

So, now we can combine “apples” to “apples.”

Agenda

Basic Concepts

Senior Management Focus

Are many small things going slightly wrong in (one or related) area(s)? Are any things going gravely wrong in any (unrelated but similar) areas?

Basic DistinctionsCreating a Composite Indicator

Related indicators reflect factors that compound one another in their influence on a common underlying risk

Eg: staff turnover and training

Unrelated indicators reflect factors that do not impact one another

Eg: staff turnover in London and staff turnover in Sydney

Basic PrinciplesCreating a Composite Indicator

Related T-Values indicators we combine by “multiplying” them:

NB: green x green = green, because 1 x 1 = 1. yellow x yellow can equal yellow or red, because yellows on average between 1 and square root 2 multiply to less than 2, and yellows on average above square root 2 multiply to more than 2

Unrelated T-Values we combine by taking the “maximum”:

NB: then the combined indicators tells us if anything really serious is happening in any of the covered areas

RefinementsCreating a Composite Indicator

We should be able to:

Weight the influence of different individual KRIs differently

adjustable weights for each T-Value

Adjust the overall composite indicator to reflect how closely and how soon senior management wants to be alerted to issues – their appetite for risk. (We want “red” to be “higher” for senior management than for middle management: how much higher?)

scaling parameters that affect the thresholds up and down and the sensitivity of the composite to changes in the weighted underlying T-Values

Individual KRIs: T-ValuesCreating a Composite Indicator

1 5 9 13 17 21 25 29 33 37 41 45

Months

Training T-Value

13 17 21 25 29 33 37 41 45

Months

The two component individual KRIs …

Aggregation FormulaeCreating a Composite Indicator

Related I = max [1, a * [T(1)w(1) * T(2)w(2)]b]

Unrelated I = max [1, a * max [T(1)w(1), T(2)w(2)]b]

where I = composite indicatorT(i) = the ith individual KRIw(i) = the ith KRI weight, Σw(i) = 1, i = 1,2a and b = “appetite” parameters

It is straightforward to generalize to more than 2 indicators

Staff Quality IndexCreating a Composite Indicator

1 4 7 10 13 16 19 22 25 28 31 34 37 40 43 46

Months

lues Turnover

Training

a = 0.2b = 1.2w(1) = 2w(2) = 2

... And the Composite Staff Quality Index (SQI)

Adjusting Appetite and WeightsCreating a Composite Indicator

1 5 9 13 17 21 25 29 33 37 41 45

Months

lue a = 0.2

b = 1.2w(1) = 2w(2) = 2

1 5 9 13 17 21 25 29 33 37 41 45

Months

lue a = 0.2

b = 0.9w(1) = 2w(2) = 2

6 – 8, 19, 23 - 24 6 - 8

1 5 9 13 17 21 25 29 33 37 41 45

Months

a = 0.2b = 0.6

w(1) = 5w(2) = 1

7 - 10

Agenda

Basic Concepts

The One-Page SummarySenior Management Reporting

Staff Quality Index ___ Audit Issue Management Index ___

Business Continuity Index ___ Failed Customer Interactions Index ___

Information Security Index ___ Information Technology Index ___

Operational Losses ___Process Breaks Index ___

Profitability Index ___Policy Exceptions Index ___

Regulatory Index ___Change Management Index ___

EuropeNorth AmericaAsia

Trading and Sales Payments and Settlement Retail BankingBrokerage

Maybe the trading and sales business in North America is growing too fast? Drill down and see…

Enter Presentation Title Here

Composite Indicators

Senior Management ReportingLondon

January 17th & 18th, 2006

Charles Taylor

Director, Operational Risk