Download - Enterprise Risk Management: Balancing Threats and Profitability (Credit Union Conference Presentation)

National Association of Federal Credit Unions l www.nafcu.org

Enterprise Risk

Management: Balancing

Threats and Profitability

Presented by

Radu Miclaus

SAS Institute, Inc.


“amat victoria curam”

Victory likes careful preparation. (Anonymous)

National Association of Federal Credit Unions l www.nafcu.org 1980s

Credit

Interest Rate

Financial

Risk Management

1990s

Credit

Transactional

Enterprise

Risk Management

Credit

1970s

Credit

Risk Management

Compliance

Op

eratin

g

Liquidity

Ma

rket

Interest Rate

Liquidity

Ma

rket

Strategic

Reputation

Evolution of Industry Best Practices in ERM


Real Measures, Real Dollars

• Reduce Charge-Offs: 1%↑ earnings

• Risk-based Pricing: 1 to 2%↑ earnings

• Streamlined Underwriting Processes: 0.5 to

1%↑ in earnings

• Mitigating Operational Losses: 1 to 2%↑ in

earnings


Regulatory Incentives

• Identifies and measures all material risks

• Relates capital to risk levels (cushion)

• States capital adequacy goals to risk (Management)

• Assesses conformity to our stated risk objectives (Board involvement)


ERM Reflects the Paradigm Shift

• Fragmented

• Ad hoc

• Narrowly focused

• Integrated

• Continuous

• Broadly focused

Old Paradigm New Paradigm

Key: Level of Sophistication


Sophisticated Competitors Create

Competitive Inequality

• “Right” price all members

– Lower pricing on least risky/profitable members

– Higher pricing on most risky members

• Better pricing/servicing to their best members…

• …and to yours


Regulatory versus Economic Capital

•Role of capital

– Institutions should have sufficient capital to protect themselves and their depositors from the risks (credit/market/operational) they are taking.

•Regulatory capital

– Amount of capital an institution should have according to a regulation (for example, Basel I or Basel II)

•Economic capital

– Amount of capital a bank has based on internal modeling strategy and policy

•Types of capital:

• Tier 1: common stock, preferred stock, retained earnings

• Tier 2: revaluation reserves, undisclosed reserves, general provisions, subordinated debt (can vary from country to country)

• Tier 3: specific to market risk


Benefits of Sophistication

• Regulators: Better, Improved CAMEL

ratings

• Ratings Agencies: Cost/Availability of

Funds

• Insurance Companies: Insurance

Premiums and Coverage

(We are judged by our Oversight and Controls)


How Do We Get that Level of

Sophistication?

• Borrow Industry Best Practices

– People

– Technology

– Processes

• Get Public Information

10

National Association of Federal Credit Unions l www.nafcu.org 1980s

Credit

Interest Rate

Financial

Risk Management

1990s

Credit

Transactional

Enterprise

Risk Management

Credit

1970s

Credit

Risk Management

Compliance

Op

eratin

g

Liquidity

Ma

rket

Interest Rate

Liquidity

Ma

rket

Strategic

Reputation

Evolution of Industry Best Practices


Credit

People

• Business Analysts

• Underwriting Background

• Statistical Background (novice-expert)

Technology

• Predictive Modeling

• Simulation (VaR)

• Reporting (multidimensional)

Processes

• Account level risk profiling (credit rating system)

• Loan portfolio level outcome simulation

• Stress Testing

• Healthy Capital Structure


Credit Risk Analytics (Example)

Credit Unit A is aiming to reduce bad credit charge-offs,

and improve the process of reserving and capital

structure.

Acc

ou

nt

• PD, LGD, EAD (Data Mining)

• Credit Scorecards

• Credit Rating (IRB)

Port

folio

• Stress Testing (application and

macroeconomic factors)

• Exposure Simulation (50-th

percentile vs. 99-th percentile)

• Define Policy and Thresholds


Market

People

• Business Analysts

• Investment Background

• Statistical Background (novice-expert)

Technology

• Forecasting


• Performance Reporting (multidimensional)

Processes

• Performance Monitoring

• Asset allocation based on risk profile

• Stress Testing



Market Risk Analytics (Example)

Credit Unit A is aiming to improve portfolio

performance through investment policy in order to

better meet profit goals and buffer capital structure

Inst

rum

ent

• Instrument/Position Level

Exposure Calculation (MTM)

• Pricing functions

• P/L curve/ Surfaces

• Performance Monitoring

Port

folio

• Stress Testing (based on risk

factors- pricing and macro)

• Exposure Simulation (50-th

percentile vs. 99-th percentile)

• Define Investment Policy and

Thresholds


Operational

People

• Business Analysts/ Risk Managers

• Business Unit experience

Technology

• Integrated data collection and process management

• Performance Reporting (multidimensional)


Processes

• Centralized Approach

• Awareness and Mitigation Action

• Outcome Simulation



Operational Risk/ EGRC (Example)

Credit Unit A is aiming to improve the operational environment

through increased awareness of risk pockets and better actions

plans for mitigation and planning

Bu

sin

ess

Un

it

Cap

ital

• Event Modeling at BU level

• Exposure aggregation by BU

and Risk Type

• Capital Allocation

• Centralized data

collection/reporting

• Centralized/Streamline

process management

• Ownership and

Awareness


Not an Initiative or a Culture Change

• It’s a New Way of Life

• It’s a Shift in Thought (not in culture):

Everyone is a risk manager, not just the

CRO

• Nurture the entrepreneurial spirit and take

calculated risks

• It’s both Art and Science

Business Acumen

Analytics

Goal Achievement


Art and Science

“This, ultimately, is what risk management

and decision-making are all about and where

the balance between measurement and gut

becomes the focal point of the whole story.”

--Peter L. Bernstein

Against the Gods:

The Remarkable Story of Risk


NCUA’s Risk Categories and Risk Indicators

CREDIT RISK FACTORS:

Low Medium High

Board and Operational Management Understanding

Fully understands all aspects…

Reasonably understands key aspects…

Does not understand risks…

Etc.

INTEREST RATE RISK FACTORS:

Low Medium High

Board and Operational Management Understanding

Fully understands all aspects…

Reasonably understands key aspects…

Does not understand risks…

Etc.

Art or Science?

From NCUA Letter No.: 02-FCU-09


Final Thought….

Analytics

Business Acumen

Goal Achievement

• Awareness • Expectations

• Decisions • Executions


Any Questions?

[email protected]

(919) 780-8193

mailto:[email protected]



Download - Enterprise Risk Management: Balancing Threats and Profitability (Credit Union Conference Presentation)

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