Making strides in financial services risk management
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20 Mai 2011 |
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ERNST & YOUNG S.R.L. |
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Website
www.ey.com
Executive summary
The financial services industry is very aware of the lessons of the crisis: the importance of managing liquidity; the need to strengthen and institutionalize an appropriate risk culture; and the imperative to always be prepared for the unexpected. Accordingly, boards and senior management have a host of initiatives underway to elevate and strengthen risk overnance principles, practices and systems.
In 2008, The Institute of International Finance (IIF) issued a broad set of principles of conduct and sound practice recommendations to provide guidance and support to the industry as it corrects course and continues to navigate through the evolving economic, market and regulatory environment (see appendix for list of recommendations). In March 2009, the IIF asked Ernst & Young to conduct a survey of financial executives to identify gaps and barriers faced by firms as they worked to implement the recommendations. This contributed to the update of the recommendations in 2009. In 2010, the IIF once again asked Ernst & Young to carry out a survey of the changes to risk management practices, and this report, Making strides in financial services risk management, presents the findings from this latest research.
“During the crisis, we probably learned more about risk in our company than we had in the previous 10 years. I’m sure everyone felt the same way.”
In the 2009 study we found that firms had made progress with a variety of initiatives to improve risk governance. In almost all cases, firms reported board- and CEO-sponsored top-down, firmwide assessments to identify gaps against recommendations from the IIF, as well as the guidelines from the Senior Supervisors Group, the Counterparty Risk Management Group and the Basel Committee on Banking Supervision. Based on these gap analyses, areas for improvement had been targeted and prioritized, a number of improvements had already been realized, and plans were being developed to effect others, with resources mobilized and deployed to implement initiatives. Areas being addressed ranged from reinforcement of specific risk governance practices and processes to a complete overhaul of enterprise-wide philosophies, frameworks, methodologies and systems to manage risk.
This year’s study found organizations in various stages of progress against the plans developed in 2008 and 2009. Without a doubt, firms continue to recognize the shortfalls in past practices and are committed to driving and sustaining change. The firms surveyed reported clear progress in strengthening risk management practices in line with recommendations from the IIF and the regulatory guidelines. However, despite significant advancement on many fronts, the reform programs are a considerable way from completion. Many improvements, if they are to prove durable, require deep cultural transformation and significant investment in management time, people and finances to successfully execute and institutionalize. As one executive summed up, “This is a long-term journey and we are in it for the long haul.”
PROGRESS AGAINST RECOMMENDATIONS
Across the board, firms have embraced the IIF’s principles, and the process of achieving compliance against recommendations is well underway with virtually 100% of the respondents reporting progress against goals. Not surprisingly, the firms in North America — specifically the US — and Europe that sustained the most substantial losses in the crisis were the most highly motivated to launch aggressive change programs and timelines, and as a consequence, reported more rapid progress towards compliance. Firms in a number of countries, including Australia, Canada, and Japan as well as those in Latin America, which were significantly affected by previous periods of stress in the early 1990s and 2002, felt they had already revised and strengthened risk governance practices and had fewer gaps to tackle. In addition, all firms, even in the affected countries, found that there were a number of areas where they were already fully compliant with many of the IIF recommendations, and due to the nature and range of businesses across institutions, not all recommendations are applicable to all organizations.
The study collected firms’ views of progress across a number of key areas of risk management: culture; roles and responsibilities; compensation; liquidity risk; capital management; risk appetite; stress testing; and transparency, data and systems. Improvements were reported in governance, liquidity, capital management and stress testing. Compensation reform is underway but more needs to be done, and risk appetite is being addressed, but no one interviewed believes they are near completion. And all agreed that shifting the risk culture and upgrading processes and systems to enhance internal transparency are multiple-year initiatives.
AREAS OF GREATEST PROGRESS
Roles and responsibilities. Risk governance is perhaps the most significant area of change. There was strong agreement that effectively managing risk across the enterprise requires both top-down oversight and bottom-up involvement. Many firms have conducted a reassessment of the roles and responsibilities of all key professionals — from board members to business unit heads and their teams — to re-evaluate, clarify and articulate expectations for risk management. Firms reported that boards are more actively engaged and involved in risk policy setting and governance, and are spending more focused, higher-quality time on risk issues. In addition, the responsibilities and influence of Chief Risk Officers (CROs) have been elevated and strengthened with most CROs now actively participating in business strategy and planning.
Capital management. Many firms reported that they have reassessed their capital structure across all of the businesses to more appropriately analyze the costs of capital and determine how those costs are calculated and allocated to each business to more accurately reflect risk.
Liquidity risk. Liquidity management continues to be a major focus for the industry and regulators. Firms have learned the lessons of the crisis and highlighted that they have revised approaches to strengthen the management and control of liquidity risk. Changes reported ranged from fundamental shifts in philosophy and governance — particularly for firms most impacted by the crisis — to more tactical efforts to refine specific areas where more progress still needs to be made.
Stress testing. Firms have made considerable progress in the development and strategic use of stress testing. New, more sophisticated methodologies, models and systems are being put in place to provide a more holistic view of potential risks and their impact on the organization. However, there is still work to be done to establish a consistent enterprise-wide approach to stress testing.
- 83% increased board oversight of risk
- 93% implemented new stress testing, but most firms continue to see significant challenges
- 89% strengthened the role of the CRO
- 65% made adjustments to allocating capital across business units
- 92% changed approaches to liquidity risk management, and 82% instituted more rigorous internal pricing
AREAS WHERE MORE PROGRESS STILL NEEDS TO BE MADE
Compensation. In response to regulatory guidance, the majority of firms surveyed have made revisions to their governance, metrics, measurements, systems and reporting processes to better align pay to risk-adjusted performance,but progress still needs to be made on several fronts.
Culture. Shifting the organizational culture to instill a mindset of awareness and ownership of risk is a challenging task requiring a significant commitment of senior management time to establish policies and monitor progress, and substantial investment in processes and systems to support fundamental change. Executives interviewed understand the need to strengthen the culture and most have a host of initiatives underway to institutionalize comprehensive, consistent and collaborative approaches to risk. All agree that cultural change is a multiple-year journey, and there is still much to be done.
Risk appetite. Risk appetite, identified by both the industry and the regulators as a high priority, is very much a work in progress for most all of the 62 firms who participated in this year’s study. Interest and motivation is high to tackle the topic. While many firms reported progress in developing, articulating and enforcing a risk appetite framework, there is still no clear industry consensus on sound practices, particularly in linking risk appetite to business decisions. Many are looking for guidance from regulators and the identification of sound practices by the IIF to assist in this area.
Internal transparency, data and systems. Improving internal transparency of information is another significant area of focus for both the industry and the regulators. Most participants said they face major challenges extracting and aggregating appropriate data from multiple siloed systems and applications, which translates into fragmented management information on the degree of risk facing the organization. Many firms have already undertaken significant IT projects to address these challenges. These projects, however, require multiyear investments of management time, people and finances to further improve the processes and IT systems to support more effective risk management.
- 78% revised compensation schemes, but only 40% are close to completion of initial changes
- 92% increased attention on risk culture, but only 23% report a significant shift
- 96% increased focus on risk appetite, but only 25% report a link to business decisions
- 59% enhanced risk transparency, but only 26% have as yet made significant changes
CHALLENGES
While the executives interviewed remain committed to their plans to improve risk management, competition for senior management time and attention is high across a number of fronts:
• Recovering from the crisis. Almost 50% the firms surveyed indicated their firms were severely impacted by the crisis (see Exhibit 1). The challenges for the senior teams in those firms most severely jolted by the crisis have been intense, requiring dedicated front-line fire fighting to stem losses, clean up distressed assets and assess the longer-term damages. Thirty-two percent of respondents reported that they are still working to recover from the crisis; and while a majority (65%) indicated that they are essentially “back to business” (see Exhibit 2), many cautioned that doing business in the post-crisis world is a “completely new ball game” requiring caution, judgment and an immense amount of senior management focus.
• Navigating the still-fluid economy. While most agree that the downturn is behind us, and the economy is showing signs of recovery in most parts of the world, many are still apprehensive about the continued volatility of the markets. More than 33% of interviewees cited “fluid market factors” as one of their top areas of concern, and many agreed that the uncertain market environment is making business planning and decision making — both short and longer term — extremely difficult. Volatility and uncertainty have increased since the survey was conducted because of the political unrest in the Middle East and the tragic earthquake and aftermath in Japan.
