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
Operational Efficiency in the Risk Management Process | Moody’s Analytics | 3
» 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”
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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?
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» “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
Operational Efficiency in the Risk Management Process | Moody’s Analytics | 6
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
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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:
Operational Efficiency in the Risk Management Process | Moody’s Analytics | 9
Note: dotted arrow = inputs to origination process
solid arrow = outputs from origination process
Source: CEB TowerGroup Commercial Banking
Straight-through processing in commercial lending
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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
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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
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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?
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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
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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
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Constraints?
Benefits?
Unrealistic?
Inevitable?
Operational efficiency; strategic imperative or unrealistic utopia?
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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:
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» 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
» 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
» 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:
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» A superior customer experience
» Faster response times
» More efficient decisions
» Up-to-date information about the application status and risk-based pricing
» Consistent standards of credit analysis
» Reduced opportunities for human error
Workflow – benefits… Customer:
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» 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
» Faster and more efficient decisions
» Scalability of data storage resources
» Operational efficiencies
» Business Case (MA client example): for every “dollar” spent …a return of three…
Workflow – benefits… IT Department:
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Conclusions?
» Constraints?
– Plenty
» Benefits?
– Outweigh the constraints
» Unrealistic?
– Many are already doing it… No!
» Inevitable?
– Regulatory pressure, competitive pressure, shareholder pressure…. Yes!
Operational Efficiency in the Risk Management Process | Moody’s Analytics | 22
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
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
www.moodys.com
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