How to Develop a Strong Risk Culture

7/30/2019 How to Develop a Strong Risk Culture

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How to Develop a Strong Risk Culture within

Financial Institutions Leveraging on anEconomic Capital Framework and BASEL III

By Aurle M. Houngbedji, Ph.D.GARP Chapter Meeting

Washington DC, December 19, 2011


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Biography

Dr. Aurle M. Houngbedji is a Senior Risk Management Officer at the International Finance Corporation (IFC), a

member of the World Bank Group in Washington DC. He is responsible for developing new methodologies for

modeling Economic Capital (EC) and its applications for strategic business decision making and portfolio riskmanagement.

Prior to joining the World Bank Group in January 2005, Dr. Houngbedji was a Quantitative Analyst in the Capital

Markets Department at AmTrust Bank. He was responsible for developing mortgage pipeline hedging models; risk

based pricing models, delinquency analysis models, valuation models for the banks loans, servicing assets, and other

hedging instruments and assets.

His research interests include economic capital management, risk strategy, risk culture, credit risk modeling, Monte

Carlo simulation methods, Mortgage Backed Securities (MBS) risk management and pricing financial derivatives.

Dr. Houngbedji is an industry expert and professional lecturer of risk management. He is an adjunct professor of risk

management & quantitative finance, in the McDonough school of business at Georgetown University, and the Johns

Hopkins Carey Business School.

Dr. Houngbedji holds a Ph.D in Mathematical Finance from the University of Pittsburgh; he is a certified Financial RiskManager from both the Global Association of Risk Professionals (GARP) and the Professional Risk Managers

International Association (PRMIA).

Dr. Houngbedji is a Charter Member of Risk Who's Who Society.

Dr. Houngbedji is the regional director for the GARP Washington DC Chapter.


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DisclaimerThe views expressed in this presentation are mine and only

mine and do not reflect in any way those of the IFCs

Integrated Risk Management Department.


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Agenda

Definition of risk culture

Why a strong risk culture in a financial institution?

Key Elements of a strong risk culture

How to develop a strong risk culture in a bank?

How can Economic Capital and BASEL III help?

Conclusion

4


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Definition of Risk Culture

The norms of behavior for individuals and groups within abank that determine the collective ability to identify and

understand, openly discuss and act on the banks current

and future risks*

* Source: IIF & McKinsey, December 2009

A system of values and behaviors present throughout a

bank that shape risk decisions


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Why A Strong Risk Culture? (1/3) A Strong Risk culture is:

Critical to a successful risk management

Centered on human judgment and human interaction in day-to-day business

decisions

Powerful offensive and defensive tool, and must take into account holistically

all material risk related interactions that happen inside the bank

Significant shift in mindsets, policies, processes, making risk everyones

business

Last line of defense in market stressed situations

A recent IIF/EY industry survey indicated that 92%*of firmsinterviewed reported an increase in senior management attention on

strengthening the risk culture

* Source: IIF and Ernst & Young: Making strides in financial services risk management, 2011


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Why A Strong Risk Culture? (2/3) A strong risk culture reinforces

Clear and well communicated risk strategy and risk appetite

High standards of analytical rigor & information sharing across bank

Rapid escalation of threats and concerns

Example:

During the 2008 global crisis, most of existing risk management

frameworks became unreliable, major banks experienced numerous

limit breaches in several business lines

Few banks were able to properly identify, escalade, address riskspromptly, effectively because of their strong risk culture


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Why A Strong Risk Culture? (3/3)

A strong risk culture Helps ensure that the focus on risk-based decision

making becomes sustainable over time

Critical to ensure that doing the right thing wins over

doing whatever it takes

Influences the decisions of management and staff

A fundamental building block of strong ERM practices


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Key Elements of Strong Risk Culture (1/9)

Strong support from the Board & Management

Accountability and Ownership

Risk Transparency

Communication & Training Risk-Adjusted Return on Capital Optimization

Partnership & Collaboration

Strong Integrated Risk Management Framework


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A strong risk culture requires Full support of the board and senior management Setting the stage for the culture change

Establishing the vision and firm wide rules and guidelines

related to risks Clearly defines roles and responsibilities

Strengthen and clarify roles and responsibilities of the:

Board

Senior management team (CEO, CFO, CRO)

Business units leaders


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Accountability & Ownership

Management & Board have to set risk appetite

Engage management and business leaders in franc

dialogue on risk implications of business strategies

Adhere to clear communication and understandingof business expectations, performance

measurements and compensation implications

Consider risk in the hiring, compensation, promotion

process

Enhance risk awareness through training


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Adhere to the three lines of defense model

1st line: Management

Ownership,

Accountability, andresponsibility for risk

Business leaders,

operation groups adopt

strategies to identify

business opportunities

and optimize return oncapital and create value

2nd line: Risk Oversight Risk &

Compliance Functions

Corporate Risk ManagementGroup, independently work

with all business lines

Establish & recommend risk

management policies,

infrastructure, & processes

Provides the framework andinfrastructure to facilitate risk

management

3rd line: Corporate Audit Group

Independent assessment by

internal & external auditorsMonitors the effectiveness of

operational functions, reliability

of financial reporting,

compliance with policies &

regulations

Governance : Board & Risk Committee



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Risk Transparency

Ensure that risk positions are consistent with risk

appetite and are well understood by risk takers

Improve risk reporting, risk dashboard, stress testing

framework, back testing process and risk analytics

Create risk advisory/discussion/forum/ at senior

management level to step up the firm wide riskdiscussions


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Strong Communication & Training Communicate risk appetite across the institution fora better understanding of risks pursued by risk

takers at the bank

Develop a good stakeholder management process byimproving quality and timeliness of risk information

& interaction with stakeholders

Risk & HR functions can jointly create workshopprograms to increase knowledge and understanding

of risk throughout the banks


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Risk-Adjusted Return on Capital Optimization

Optimize risk-return trade offs at transaction and

portfolio levels

Improve EC and other risk models, allocate capital,

monitor capital usage & performance on capital Improve risk based pricing models and practices

Engage management to put risk at the center of

discussions during periodical strategic planning Consider risk-return as an integral part of decision

making


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Partnership & Collaboration

Improve cooperation and dialogue with risk takers to

enable the pursue of sustainable profitable growth

opportunities

Work proactively with businesses to establish trustand open conversion about risks related issues

Ensure that consistent risk information is shared

with all business lines

Establish risk champions (CRO & Risk Head) for the

firm & major business lines

Share rewards by celebrating success


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Key Elements of Strong Risk culture (9/9)

Strong Integrated Risk Management Framework

Enhance processes, skills, education, models, technologies thatsupport risk management activities

Develop a firm wide models risk management framework

Establish core competency in risk management function

Establish a firm wide IT risk Architecture & central risk database Remove silos and replace by an integrated risk management

framework

Embrace the strategic view of risk management turning it into a

strong competitive advantage

Align risk appetite and strategy

Leverage BASEL III and Economic Capital framework to improve risk

management processes and practices


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How to develop a Strong Risk Culture? Begin a dialogue at management level on risk culture

Create a team to lead the process

Conduct a complete assessment of existing culture

Develop a diagnostic report with a set of tangible

recommendations

Determine what the desired risk culture should look like

Design and implement an action plan based on the

recommendations to build the new risk culture

Communicate changes and secure buy in from allstakeholders

Establish a process to evaluate the changes and make

necessary adjustments


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Risk-Based

Pricing

Performance MeasurementRisk-Based Limits Setting

Concentration ManagementCapital Adequacy

Risk-Based Business

Decision Making

Risk IT Infrastructure, Portfolio Risk Analytics, Stress Testing & Scenario Analysis

Strategic Planning

Risk MeasurementHow Much Risk does and should

Bank have?

Risk ControlHow can Bank control

Unexpected Loss?

Risk/Return OptimizationHow can Bank optimize

Capital Utilization?

Risk Culture, Communication & Training

How can Economic Capital help? Economic capital framework can fully integrate

material risks into the decision making process and

support the implementation of a strong risk culture


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BASEL (2006,2009,2010): Three-Pillar Architecture

Pillar 1

Minimum Capital Requirements

Pillar 2

Supervisory Review Process

Pillar 3

Market Discipline

Capital Requirements for:Credit Risk Standardized Approach

Foundation IRB Approach

Advanced IRB Approach

Market Risk

Standardized Approach

Internal Var Models

Operational Risk Basic Indicator

Standardized Approach

Advanced Measurement ApproachesStrengthen capital requirements

Risk weight of resecuritization Exposures

Market Risk Capital Requirements

Credit Conversion Factor (CCF) for liquidity

facilities

More rigorous credit analysis of externally rated

securitization exposures

Prohibition to use ratings based on self-guarantees

Framework for Banks (ICAAP)

Qualitative Supervisory

EC and Stress testing

Risk oversight, risk concentrations,

off-balance-sheet exposures

Providing incentives for banks to better

manage risk and returns over the long term

Sound compensation practices

Reputational risk

Supervisory Framework

Evaluation of internal

Systems of Banks

Assessment of risk profile

Review of compliance with all regulations

Supervisory measures

Disclosure Requirements for Banks

Transparency for Market

participants concerning

the banks risk position

Increase transparency for

securitizations, off-balance-sheet

exposures and trading

Reduce uncertainties about the

ability to trade in volatile Markets

Pipeline and warehousing risks

with regard to securitization Exposures

Enhances comparability among banks

Global Financial Stability

How can BASEL III help? (1/2) Regulations such as BASEL can drive changes in risk management leading

to culture change


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How can BASEL III help? (2/2) BASEL III addresses jointly capital, leverage, buffer, liquidity

The Internal Capital Adequacy Assessment Process (ICAAP)in pillar 2 is a process to ensure that management:

Identify, measure, aggregate, and monitor adequately the banks risks

Hold adequate internal capital with respect to the bank's risk profile

Use sound risk management systems and develop them further

ICAAP is a key integrated risk management tool

Pillar 2 processes enhance link between banks risk profile,

risk management, risk mitigation systems, and its capital BASEL III and ICAAP implementation can help instill a strong

risk culture in a financial institution


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Conclusion Risk culture has to be at the top of the agenda for senior

management in all banks Financial Institutions need to develop a strong risk culture that is

focused on optimizing well calculated and well understood risk

return trade-offs within a well defined firm wide risk strategy

leading to a consistent value creation for shareholders

Develop a strong risk culture is a journey, a long process of

consistent communication, education, and management

Implementation of EC framework and BASEL III can help instill a

strong risk culture

Some professional risk organizations and financial services

providers can help create a culture of risk awareness within firms,

from entry level to board level, making risk everyones business


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Q&A

Thank You!

Documents

How to Develop a Strong Risk Culture