enterprise risk management: balancing threats and profitability (credit union conference...
DESCRIPTION
Enterprise risk management is not just a process credit unions utilize to mitigate and manage the negative consequences of normal business operations, it is a practice of balancing risk and profitability. By understanding and managing the critical uncertainties that affect day-to-day business, credit unions can execute the proper strategies to achieve their performance goals in a post-financial crisis era. In this 2011 NAFCU Annual Conference session you learn how to apply ERM to your corporate strategies, assure management that risks are properly identified and balance risk management and business objectives. Presented by Radu Miclaus, Senior Analytics Solution Architect, SAS Institute, Inc. More info at http://www.nafcu.org/sasTRANSCRIPT
National Association of Federal Credit Unions l www.nafcu.org
Enterprise Risk
Management: Balancing
Threats and Profitability
Presented by
Radu Miclaus
SAS Institute, Inc.
National Association of Federal Credit Unions l www.nafcu.org
“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
National Association of Federal Credit Unions l www.nafcu.org
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
National Association of Federal Credit Unions l www.nafcu.org
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)
National Association of Federal Credit Unions l www.nafcu.org
ERM Reflects the Paradigm Shift
• Fragmented
• Ad hoc
• Narrowly focused
• Integrated
• Continuous
• Broadly focused
Old Paradigm New Paradigm
Key: Level of Sophistication
National Association of Federal Credit Unions l www.nafcu.org
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
National Association of Federal Credit Unions l www.nafcu.org
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
National Association of Federal Credit Unions l www.nafcu.org
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)
National Association of Federal Credit Unions l www.nafcu.org
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
National Association of Federal Credit Unions l www.nafcu.org
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
National Association of Federal Credit Unions l www.nafcu.org
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
National Association of Federal Credit Unions l www.nafcu.org
Market
People
• Business Analysts
• Investment Background
• Statistical Background (novice-expert)
Technology
• Forecasting
• Simulation (VaR)
• Performance Reporting (multidimensional)
Processes
• Performance Monitoring
• Asset allocation based on risk profile
• Stress Testing
• Healthy Capital Structure
National Association of Federal Credit Unions l www.nafcu.org
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
National Association of Federal Credit Unions l www.nafcu.org
Operational
People
• Business Analysts/ Risk Managers
• Business Unit experience
Technology
• Integrated data collection and process management
• Performance Reporting (multidimensional)
• Simulation (VaR)
Processes
• Centralized Approach
• Awareness and Mitigation Action
• Outcome Simulation
• Healthy Capital Structure
National Association of Federal Credit Unions l www.nafcu.org
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
National Association of Federal Credit Unions l www.nafcu.org
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
National Association of Federal Credit Unions l www.nafcu.org
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
National Association of Federal Credit Unions l www.nafcu.org
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
National Association of Federal Credit Unions l www.nafcu.org
Final Thought….
Analytics
Business Acumen
Goal Achievement
• Awareness • Expectations
• Decisions • Executions
National Association of Federal Credit Unions l www.nafcu.org
Any Questions?
(919) 780-8193