risk_intelligence_wp by yvtong


									Risk Management Intelligence

Improving Recovery and Profits
Using Risk Intelligence

     When it rains, it pours. And recently, with such situations as the debt crisis in
     Argentina, the collapse of the telecom sector, and the all-round weakened economic
     environment, corporate default rates have risen across the world—causing a
     considerable adverse affect on the profitability of financial institutions.

     The answer to the profitability issue is both simple and complex—with the key being
     adherence to good credit practices. In a slower economic environment, banks can only
     improve profits and outperform peer groups by demonstrating that they can effectively
     handle credit risk problems and maintain transparent credit policies. In doing so, they
     can free up capital and improve shareholder value.

     The challenge of controlling credit risk under the deluge of current problems, however,
     is exacerbated as banks also prepare themselves to meet the requirements of the new
     Basel Capital Accord (Basel II). An update of “The 1988 Accord,”Basel II has been
     established by the Basel Committee on Banking Supervision to give banks general
     policy guidelines and recommendations for best practices in managing credit market
     and operational risk. The new accord is clearly designed to reward banks that take the
     time to upgrade their risk management and information systems to meet the accord’s
      complex reporting requirements.

     Banks that succeed—by applying such solutions as business intelligence (BI)—will
     benefit by lowering costly capital reserves, whereby positioning themselves to take
     advantage of new opportunities to increase shareholder value. Alternatively, those
     that fail to meet the more stringent requirements will lose their competitive edge
     and end up facing eroding market share, missed business opportunities, and loss
     of valuable customers.

                                                                     R I S K MANAG E M E NT I NTE LLI G E N CE   1
     The Challenges of a Credit Risk Manager

                        Current risk management tools range from Excel spreadsheets to various third-party
                        solutions throughout the organization to sophisticated proprietary internal models. In
                        many organizations, a more modern risk infrastructure is required to deal with the chal-
                        lenges that credit risk managers face. These challenges include:

                          Consolidation of information. Credit risk managers must pull together information from
                        multiple systems and countries that is held in many databases and formats (Excel, flat
                        files, scripts). This information then needs to be pumped into an enterprise risk ware-
                        house or data mart in near-real time.

                                                    Calculation of the exposure. By applying a credit risk model,
                                                  credit risk managers can detect and prioritize credit risks early
    Portfolio risk management reporting           on. The steps to doing this include checking data consistency,
is a critical but often overlooked element in     applying a proprietary in-house or third-party risk model that
[the risk management] process. For risks to       gives clear competitive advantage, and calculating the firm’s
be understood, they must be acknowledged          exposure by region, sector, or product.
  and communicated. A clear strategy for
 disseminating and using the information             Analysis of the results. Credit risk managers must identify,
 generated by a sophisticated portfolio risk      track, and monitor any problem loans and conduct time-series
     management system is essential.”             analyses to detect changes (by client, industry, or region). With
          — PricewaterhouseCoopers                the results of analyses, they can then drill down further to find
                                                  and fix problem loans.

                          Access to and distribution of data. Business executives demand reports and analysis of
                        the data for more business insight to efficiently manage day-to-day operations and their
                        bottom line. Regulators call for greater quantification and control over credit portfolios.
                        Customers and shareholders want reassurance that returns are not being compromised at
                        the expense of misunderstood risk. Therefore, credit risk managers must create reports
                        and analysis to deliver to each of these groups in a clear and easy-to-read format.


With these as the challenges, it’s important to look at how successful banks are handling
their risk management reporting needs. One solution with proven success, as previously
mentioned, is business intelligence (BI). BI provides an ability to access, analyze, and share
risk intelligence information in an easy-to-use, intuitive way that aids business decision

                                                                   R I S K MANAG E M E NT I NTE LLI G E N CE   3
    Using Risk Intelligence to Improve Recovery

                       Financial institutions are looking for ways to increase shareholder value through better
                       understanding and use of risk information. Having the right information, at the right
                       time, and in a format that drives business decisions is key to the development of a suc-
                       cessful enterprise risk management strategy. By receiving risk information in near-real
                       time, business users can incorporate it into all aspects of the decision-making process,
                       transforming passive buy-and-hold strategies into profitable credit risk driven business

                       Business intelligence can help improve recovery and control and aid risk transparency by
                       enabling risk officers and business executives to:

                          Access and consolidate data from disparate systems
                          Identify risks early
                          Respond quickly to swift and unexpected market events
                          Identify, track, and monitor critical risks over time
                          Gain business insight with increased breadth of risk reports and depth of analyses
                          Free up capital and prepare for Basel II

                       Access and Consolidate Data from Disparate Systems

                       A prerequisite to the credit risk management process is obtaining good position and mar-
                       ket data. Position information is usually maintained in spreadsheets and disparate systems
                       across the enterprise, while market data is obtained from various feeds, external providers,
                       and internal databases. In many banks, data collection is a laborious, time-consuming
                       process riddled with data inconsistencies and requiring manual intervention to fix errors.

                       The challenge is how best to manage the timely acquisition of information from heteroge-
                       neous systems. Some specific data management issues include:

                         Timing the capture of information from various position-keeping systems
                         Transforming the various data representations into a consistent format that can be used
                       by the risk engine(s)
                         Eliminating the need to re-key duplicate trade information
                         Reducing or eliminating manual errors

                                                                      IMPROVING REOVERY

Business intelligence tools designed specifically for data management enable the rapid
extraction, transformation, and loading of data from disparate systems. The data collected
is prepared for detailed analytics in a proprietary risk model. By consolidating market data
and position information into a central repository, information can be viewed, managed,
and accessed in a consistent, predictable manner without impacting the host systems.
Additionally, personnel can be alerted to data errors/inconsistencies as soon as they occur.

Identify Risks Early

Credit and audit departments are constantly looking for signs of any counterparty distress
and assessing the bank’s exposure level to these parties. Essentially, the earlier that risky
counterparties can be identified, the sooner steps can be taken to mitigate the counterpar-
ties’overall risk to the bank.

By responding early to a risky counterparty, the bank can reduce its exposure to an indi-
vidual or group of counterparties and thus maximize recovery amounts or adjust risk-
based premiums on future deals. Such an early identification program also helps banks
align risk information with their everyday business practices to better serve the bank and,
ultimately, its shareholders.

                                                                              With an early indication of potential
                                                                              losses corrective measures can be taken
                                                                              in time and recovery values can be
                                                                              raised significantly.

                                                                  R I S K MANAG E M E NT I NTE LLI G E N CE   5
    Success with Business Objects:
                       Credit Risk Indicators (CRIs) at Dresdner Bank
                       Dresdner Bank is one of the leading banking groups in Europe with over 1,170 branch
                       offices and more than 50,000 employees in over 70 countries. Driven by the need for bet-
                       ter control over credit risk exposure and mounting credit losses in a tougher economic
                       environment, the audit department within Dresdner Bank had been looking to replace its
                       legacy systems—which had been in place since the 1980s—to improve business processes
                       and address the following market developments:

                         Increased recovery of commercial loans
                         Basel II requirements for credit risk
                         Regulatory requirements of the German Federal Agency
                         for Oversight of Financial Services

                       Dresdner Bank, in partnership with Accenture, used a modern credit risk infrastructure
                       incorporating business intelligence to meet its information and reporting needs for its
                       audit department. The innovative credit risk indicator (CRI) solution, which was imple-
                       mented in under eight months, was developed as an early warning system to potential
                       counterparty credit risk. With the old audit systems, it took 50-60 man days to gather
                       information and conduct analyses on just 30% of the bank’s counterparties. With the new
                       CRI solution, 100% of the accounts could be processed in a matter of minutes, allowing
                       for a precise and accurate picture of the bank’s risk exposure at any time.

                       The use of BI also gives Dresdner’s audit department a complete and timely 360-degree
                       view into customer activities. Branch oversight and comparison reports are easily generat-
                       ed and distributed to help drive strategic business decisions. And the early identification
                       of risks allows for premiums to be corrected and adjusted faster on a deal-by-deal basis.

                       Looking forward, the audit department also plans to integrate systems from other busi-
                       ness units and other subsidiary companies and intends to use this CRI information as a
                       basis for the bank’s Basel II initiatives.

                                              SUCCESS WITH BUSINESS OBJECTS

                                                                     The CRI reporting portal provides a
                                                                     snapshot of a firm’s overall risk levels
                                                                     for quick identification of risk by geog-
                                                                     raphy, by individual exposures, and
                                                                     over selected time periods.

Respond Quickly to Swift and Unexpected Market Events

The ability to respond quickly to unpredictable shifts in the market is critical for
financial institutions to avert potential disaster. Unlike credit risk, which is meas-
ured over longer time horizons (e.g., 1 year), market risk is measured and dealt
with on a daily or intra-daily basis. In particular, when entire sectors of the market
experience swift and unexpected decline, banks must be able to quantify their
exposure and measure its impact on them. Business managers and senior execu-
tives need up-to-the-minute updates to make informed decisions on what actions
to take to protect the firm and manage shareholder expectations. Regulators need
to be updated with regard to the state and financial health of the institution. And
lastly, customers and clients are looking for reassurance that their bank is in con-
trol of the situation and taking the necessary steps to limit exposure

JP Morgan Chase, a leading financial services firm with offices in over 50 coun-
tries, serves more than 30 million customers worldwide. In 1998, the Malaysian
currency crisis occurred, causing a rapid depreciation of that country's monetary
system—which then set off the collapse of its stock market and asset prices.

                                                                   R I S K MANAG E M E NT I NTE LLI G E N CE    7
    Success with Business Objects:
                       JPMorgan Chase
                       While many of JP Morgan Chase’s competitors were scrambling to assess their situation,
                       JPMorgan Chase was able to quickly create and distribute reports that broke out the level
                       of risk for the entire firm by using BI solutions. JP Morgan Chase analysts were able to
                       generate reports on the fly, which could be updated as needed. This allowed JP Morgan
                       Chase to immediately establish the bank’s risk exposure and provide answers to the
                       Federal Reserve’s inquiries. The use of BI solutions replaced Microsoft Access and Excel,
                       which proved to be too technical for business users and were prone to manual errors as
                       results had to be cut and pasted into spreadsheets and emailed for distribution.

                                                    In times of crises, business users can rely on BI tools to collect
        “During the Malaysian currency              information from disparate systems across the enterprise and
       crisis, the Federal Reserve needed to        quickly distribute status reports to internal officers and regula-
         know our level of exposure – and           tory bodies. This information is easily customized and reports
        we were able to get a response out          can be refreshed upon request with minimal effort. What’s
                    immediately.”                   more, business users can be alerted to breaches to risk or
                                                    exposure limits, and then deal with problems on an exception
        —James Chai, VP of front and middle office
               for securities and treasury          basis. This allows business units to maintain complete control
                                                    over an otherwise volatile situation.

                                            SUCCESS WITH BUSINESS OBJECTS

Identify, Track, and Monitor Critical Risks over Time

With so much activity occurring simultaneously across business units and physical geog-
raphies, risk managers need automation tools that help them monitor and manage prob-
lems in both areas. For instance, alerts can be used to monitor exceptions throughout the
organization, from counterparty exposure and value-at-risk (VAR) levels to notional levels
on the trading desk. The benefit of an alert mechanism is that it prompts the user into
action only when corrective action is required.

When investigating problem areas, BI tools let users quickly and easily rework problems
through ad hoc queries and drill down into subsets of data to identify problem sources.
If problems need to be escalated, BI solutions allow reports to be easily customized and
regenerated on the fly. Reports can then be quickly distributed to those who need them
to contain and resolve problems through to a timely resolution. Critical counterparties or
higher risk products can be isolated and tracked separately over time in reports or man-
agement dashboards. In addition, a comparison between present risk exposure and the
plan or trend analysis aids management decision making by highlighting areas that devi-
ate from the agreed management or entity plan in easy-to-understand dials on a man-
agement dashboard.

                                                                           B U S I N E S S PA P E R T I T L E   9
     Success with Business Objects:
                        New York Investment Bank
                        A leading financial services company based in New York is using BI to enhance
                        the reporting capabilities of its in-house market and credit risk management sys-
                        tems. BI provides multiple views of the data, giving business users complete flexi-
                        bility when performing analyses and interrogating risk model results. For instance,
                        when analyzing month-end reports, the ability to drill down into report data
                        helps analysts to identify the underlying factors that drive changes from month to
                        month. Moreover, BI lets banks easily create different risk exposure reports for dif-
                        ferent parties, so that reports and information are relevant to specific departments.
                        Risk exposure reports are prepared for divisions, product lines, or individual coun-
                        tries with the relevant risk data for each entity.

                        Gain Business Insight with Increased Breadth of Risk Reports
                        and Depth of Analyses

                        A complete picture of risk requires the examination of a bank’s credit portfolio
                        through a variety of risk reporting views. Traditional measures such as credit
                        value-at-risk (VAR), marginal risk, and risk/return analyses offer risk managers a
                        base-level understanding of the bank’s credit risk, while rigorous stress testing
                        and analyses provide even greater insight into how a bank’s portfolio would fare
                        against hypothetical or historical credit events.

                        With BI tools, users can analyze and view risk data to help build this more com-
                        plete picture of enterprise risk. The flexibility of a BI framework allows risk man-
                        agers to take existing risk report data one step further by performing supplemen-
                        tary analyses. In addition to standard user-defined, customized, and ad hoc
                        reporting, a flexible BI framework can provide a set of predefined analytics, such
                        as time-series analyses, that risk managers can use to compare the results of
                        reports from different time periods (e.g., past year, past quarter, past month).
                        Predictive analysis, as another example, allows users to project product or behav-
                        ioral trends based on historical time-series information.

                                             SUCCESS WITH BUSINESS OBJECTS

Free Up Capital and Prepare for Basel II

Capital is the lifeblood of most financial institutions, and successful business managers
are those who can leverage precious capital to maximize returns for investors. Banks are
required to hold a significant amount of their working capital in reserve in order to pro-
tect themselves against market or credit losses. As a general rule of thumb, the more risk
a firm is willing to take, the higher the level of economic capital it must maintain to
ensure financial stability. However, with effective information management tools, banks
can take advantage of opportunities to lower their risks, which in turn lowers their capital
reserves without compromising return to investors.

For example, a bank armed with powerful BI tools can analyze and produce status
reports on their loan portfolios in minutes. Through predefined prioritization reports, per-
sonnel can quickly identify high-risk positions and determine a course of action to reduce
risk levels. The outright sale of risky loans is one way to instantly reduce credit exposure
and free up capital. This, in turn, can be re-allocated into vehicles with a lower-risk/high-
er-return profile.

The New Basel Capital Accord or Basel II, as mentioned earlier, is designed to give banks
more flexibility to determine their minimal capital requirements. Under the new accord,
there are two broad categories for reporting: a standardized approach (which approxi-
mates the current capital accord) and an internal ratings-based (IRB) approach (which
gives banks the ability to use their own internal risk measures in calculating their capital

Under the new “IRB foundation”and “IRB advanced”approaches, additional capital relief
is granted to banks in exchange for greater disclosure of their internal risks. However,
most firms currently lack the systems infrastructure to meet these proposed disclose

Business intelligence can help banks prepare for Basel II. As a strategic first step, BI pro-
vides an ideal platform to support the extensive data collection, reporting, and sophisti-
cated analytical requirements proposed by the new accord. By consolidating market,
position, and risk information, banks can easily manage information and audit trails
required by the regulators. As requirements evolve, a BI system will also help banks sys-
tematically address and manage reporting changes, as well as increase visibility into their
own internal market, credit, and operational risks. In the end, this will allow them to take
maximum advantage of capital reduction opportunities.

                                                                  R I S K MANAG E M E NT I NTE LLI G E N CE   11

                         As has been evidenced, financial institutions need to
                         actively control and measure their exposure to risk in a
                         downturn market. They must be able to consolidate
                         information in one place, calculate risk exposure, easily
                         access data, and perform sophisticated analysis on data.
                         In applying the best BI tools, banks today can display
                         results via a management dashboard, gaining more
                         control and improving credit risk transparency in the
                         enterprise—so that they can also successfully address
                         the credit industry challenges of tomorrow.

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