Does your business have a comprehensive risk management strategy? These days risk management must respond to an environment of continual regulatory change and ever more demanding expectations.

It’s imperative for brands to develop world-class risk management strategies that identify and manage risk before it negatively impacts their business.

Risk Management. Operating in the New Normal.

Financial institutions continue to make progress in many areas of risk management. Boards of directors are devoting more time to risk management. Prevailing practice now includes having a chief risk officer position and an enterprise risk management program.

If your business is considering revamping their existing risk management strategy or you’re in need of creating one, below is a list of important steps to consider.

1. Appoint a Risk Management Council

Before you start developing a strategy, you must appoint a risk management council that will be responsible for reviewing, identifying, and managing loss exposures. This council should be comprised of employees within various departments in your company. They should all be aware of their role in the prevention of risk and be held accountable for making their teams aware of risk management best practices.

2. Conduct a Risk Assessment

Now that you’ve appointed a risk management council, you need to make a list of all the potential risks that could impact your business.

3. Prioritize Your List of Risks

After you’ve identified a list of risks, you need to perform a risk assessment to determine the likelihood that they will happen and the impact they would have on your business as a whole. Once you’ve done this, you can better prioritize risks into two columns—high-risks and low-risks.

4. Track and Monitor Risks

Now that you’ve identified and prioritized your risks, it’s time to track and monitor the risks. For example, a contractor with a satisfactory performance record to date could experience financial or operational difficulties that negatively impact that contractor’s ability to perform. For this reason, it’s important that you keep ahead of risks by continually monitoring things like your suppliers, competitors, and industry trends.

5. Regularly Evaluate Your Risk Management Plan

It’s important that you regularly evaluate and update your risk management plan every quarter. Ask yourself the following questions: Is there appropriate monitoring of the risk management process to ensure it continues to function properly? Are there adequate processes to ensure risks are appropriately identified? Are department heads doing a good job in informing their team of risks and how to prevent them?

The tidal wave of regulatory developments created by the global financial crisis shows no signs of abating, especially for large institutions. Surveys show that increasing regulatory requirements and expectations are extremely challenging for most institutions.

Thus, implementing a risk management strategy is more critical than ever before to your company’s success.

Resources:

Contact Harrison, Stone & Associates at 212.687.3030.
Follow @rpharrisonstone

Over the past five years, the financial services industry has witnessed dramatic shifts in the regulatory landscape. As a result of economic crises around the globe, financial institutions are subject to new and complex regulatory mandates. Here are some of the primary considerations for bank management.

Capital management is at the heart of most of these initiatives. Financial regulations have been evolving at an unprecedented pace across all segments of the industry as a result of these various initiatives:

• Stress testing requirements under the Dodd-Frank Wall Street Reform and Consumer Protection Act
• Comprehensive Capital Analysis and Review (CCAR) exercises conducted by the Federal Reserve Board
• Implementation of Basel II and Basel III regulatory capital frameworks

Capital reform will ultimately create a paradigm shift for many banking organizations as they reevaluate business models, core product and service offerings, and revenue sources. The effort usually requires months to plan and years to fully implement, requiring real changes to business models, operations, and governance.

Liquidity
The global financial crisis of 2007–2008 highlighted the fact that even well-capitalized banks can fail. This finding prompted a new focus on bank liquidity, and resulted in both international and domestic efforts to introduce a new liquidity framework, including measures and disclosures

Comprehensive Capital Analysis and Review
The Federal Reserve published final CCAR rules in November of 2011. They apply to bank holding companies with average total consolidated assets of US$50 billion.

Difficult and costly, CCAR implementation requires extra costs in infrastructure, data and analytics, system connectivity solutions, and human capital. Banks subject to CCAR requirements must produce specific information beginning early January every year: projected annual income statement, balance sheet, and capital ratios; stress test scenarios, forecasts, comprehensive capital plan and asset data.

Data, Systems, and Infrastructure
The high cost of managing data is a constant concern for management, especially those in the financial services industry where a complex regulatory environment continues to puts pressure on operating margins.

Over the coming years financial institutions will continue to struggle with massive regulatory change and adapt to doing business in the post financial crisis environment.

To learn more –

Download the Capital Management Services 32-page report by KPMG,
the global audit, tax, and consulting firm.

CCAR and DFAST Stress Testing Survey Insights
from Moody’s –

In 2015 Fed regulators intend to heighten expectations for the largest and most complex Bank Holding Companies . This is not surprising given the fact that these are the BHC’s with the largest potential impact on the U.S. financial system.

With the complexities of regulatory requirements, large banks are anticipating a major increase in their spending on stress testing. They generally estimate $10m per year in operating costs, with an additional technology cost of $30-$50m.

These were just a few of the insights gleaned from a recent survey of 39 CCAR and DFAST banks during roundtable discussions conducted by Moody’s Analytics.

Three major themes emerged from the series of stress testing discussions:

1. Management judgment versus quantitative modeling: There is uncertainty on when to build a model for a process that has traditionally been forecasted using management judgment.

2. Data: There is a pressing need to better manage the data used in the stress tests, including auditing, augmenting, and aggregating that data.

3. Getting more out of the stress testing exercise: With the amount of time, effort, and money being spent on stress testing, banks would clearly like to use the results for multiple purposes. For most banks, stress testing is still about regulatory compliance, rather than improving their business decisions and risk practices.

The larger banks all agreed that it is hard to determine what to do first, given the multiple regulations in multiple jurisdictions.

Improving infrastructure is desired, but the way forward is not always clear. Banks often lack well-defined roadmaps for longer term projects . The time pressure makes it difficult for them to move beyond regulatory compliance and leverage their stress testing investments to help run their businesses.

Priorities for 2015 Stress Testing

• Across 30 different banks, large and small, credit modeling was the top priority for improvement.
• Large and small banks ranked infrastructure, data, and process/workflow as important items.
• Documentation is becoming a top priority. Regulators are asking for more details and clearer explanations.

Fed Wants More Details and Better Documentation
Capital plans and model methodologies still lack detail, noted a member of the Federal Reserve Bank who spoke at the CCAR roundtable.

Most important, the overall emphasis will continue to shift from quantitative stress test results to qualitative capital plans. The Fed anticipates that there will be fewer quantitative failures during next year’s stress testing than qualitative failures, which was also the story in 2014.

Regulators have indicated they would like to see banks use stress testing for other purposes, like risk appetite definition, limits, and general risk management, but banks have indicated there is still a long way to go before they incorporate stress testing into these areas of their business.

In conclusion, Moody’s anticipates that investments in data, modeling, scenario design, and infrastructure will accelerate as banks seek to deliver more efficient and consistent responses to regulators and to maximize returns on their stress testing expenditures.

How has your approach to capital planning changed in light of today’s regulatory and financial environment?

For many years enterprise risk management was more of a concept than a reality. Now all that has changed.

Enterprise risk management programs have been implemented by organisations of all sizes, with Treasury central to this process. The current regulatory environment requires banks to hold capital not just on their current portfolio. Now they are also required to plan capital for the next three years.

Post 2008 Financial Crisis

Banks must now carefully identify the way their businesses, projected revenues, losses, reserves and capital levels will evolve under adverse macroeconomic scenarios. Regulators around the world have consistently increased the level of regulatory capital required.

To be successful, banks need both an infrastructure and a process for identifying businesses that create long-term value. The system must also be equipped to restructure businesses that are inefficiently managed but have growth potential. The data demands of this process are very high – and they straddle the two domains of risk and finance that have traditionally worked independently of each other.

It’s a delicate balancing act – maximizing growth and profitability while managing risk and ensuring compliance with regulatory agencies.

This paper offers banks a capital management approach that involves long-term capital planning and efficient capital allocation. Learn why banks use enterprise stress testing to bridge the domains of risk and finance. Download the PDF paper below …

CAPITAL MANAGEMENT FOR BANKING

Staying on top of CCAR Fed requirements? Contact Harrison, Stone & Associates at 212.687.3030.

A recent abstract using empirical data, various methodologies and relevant news articles by De Nederlandsche Bank concludes that there is “only weak evidence that stress tests after 2009 affected equity returns of large US banks”.

Equity returns were only affected by the disclosure of the stress test results in 2012 and only for non-gap banks, according to their findings.

Stress tests are an important tool for banking supervisors. Thus, it’s important to consider their effects on stock and credit markets.

The Dutch bank’s abstract quantifies the market reactions of US stress tests performed after the start of the financial crisis by considering their effects on stock returns, CDS spreads, systematic risk, and systemic risk.

US stress tests considered are:
1) Supervisory Capital Assessment Program (SCAP) of the 19 largest Bank Holding Companies (BHCs).

2) Comprehensive Capital Analysis and Review (CCAR) program which assesses the capital planning processes and capital adequacy of banks.

3) Dodd-Frank Act Stress Test (DFAST) stems from the Dodd-Frank Act and requires assessing how bank capital levels would fare in stressful scenarios.

Preventing Crisis

The Federal Reserve stress tests are designed to prevent a repeat of the 2008 financial crisis, when the banking system teetered near collapse and the U.S. created a $700 billion taxpayer-funded bailout program. Firms in this year’s tests must describe what would happen to capital ratios, revenue and loss rates on various assets in dire scenarios described by the Fed.

Referring to post-crisis stress tests former Federal Reserve chairman Ben Bernanke stated last year:

“Even outside of a period of crisis, the disclosure of stress test results and assessments provides valuable information to market participants and the public, enhances transparency, and promotes market discipline.”

The Dutch working paper agrees.

“We have concluded that stress tests have produced valuable information for market participants and can play a role in mitigating bank opacity. Our findings indicate that post-crisis stress tests affected the CDS market strongly but had less impact on bank stock returns.”

The researchers add that their findings suggest that stress tests are a useful tool in mitigating risk in stock and credit markets.

Read the whole report here. Click below to download the “Banking Stress Test Effects on Returns and Risks” pdf:

Staying on top of CCAR Fed requirements? Contact Harrison, Stone & Associates at 212.687.3030.