Better Risk Management for Improved Business Decision Making
Posted: 22 October 2010 | Source: SAS
The recent turbulence in financial markets has made risk management an increasingly critical part of the decision-making process in financial institutions. An integrated approach to risk management is crucial for enabling organizations to consolidate exposures, measure risk and perform stress tests across all lines of business. However, the ability to measure risk comprehensively is not sufficient. A significant step is the execution of policies based on comprehensive risk measurements the business process. This includes risk methodologies tied to economic capital management, pricing and performance measurement – ensuring that risk is integrated and consistent with business strategies.
The necessity of an integrated data infrastructure to support methodology capabilities and consistent policies is well-understood. However, its actual implementation is far from trivial. The situation is further complicated by the fact that efficient policies require an integrated data foundation and comprehensive methodology capabilities as a prerequisite for establishing effective policies.
Efficient risk-based policies for continuously managing a firm’s risk and return profile and capital are key for the long-term success of financial institutions. Transparency of risk and value-based business processes is critical for investors, rating agencies and regulators. The recent distress in financial markets has placed greater emphasis on a financial institution’s ability to demonstrate a comprehensive approach to viewing firmwide exposures and risk. In a series of papers, the Senior Supervisors Group, 2008; Financial Stability Board, October and November 2009; Institute of International Finance, 2008; and Basel Committee, December 2009 and earlier papers throughout 2008 and 2009, point to the deficiencies of many financial institutions’ risk management practices and the concrete actions that need to be taken.
Some of the key issues – as outlined by the Financial Stability Forum of national and international financial regulators – revolve around the integration of risks, the measurement of risk, and the lack of constant challenges to accepted methods in light of changing market conditions. Similarly, the Senior Supervisors Group report concludes that strong governance and value-based performance management were probably the dominant differences between the firms that performed poorly and the ones that performed well. The December 2009 Basel Committee consultative document on principles for sound stress testing practices and supervision also highlights the weaknesses in infrastructure that limited the ability of banks to identify and aggregate exposures across the bank. This weakness limits the effectiveness of risk management tools – including stress testing.