Risk
Today's financial institutions operate in highly competitive, complex and interconnected capital markets. Their ability to tackle risks across various geographies, jurisdictions (and hence regulatory environments), business units and asset classes is of enormous importance for their financial solvency and profitability. An inability to manage the risks involved can cause lasting damage to the entire financial sector with severe repercussions for the global economy, as the collapse of major financial institutions during the recent crisis vividly demonstrated.
In brief
Globalization, shifting regulations and increasing complexity of financial instruments pose unprecedented challenges to the financial services industry. Companies are uncertain about the inherent risks in their organizational structure, asset allocation, investment decisions and sources of funding. They are also unsure about the exposure arising from these risks.
The crisis has shown how inadequately risks are managed at present, even by major financial institutions. We believe that the industry is moving toward a new paradigm of holistic, forward-looking management of risk, liquidity and capital.
To address and overcome the uncertainties due to financial risks, we work with international clients from both the banking and insurance sector on a wide range of areas, outlined below.
Strategic business planning, controlling and reporting
- Linking ex-post financials and ex-ante risk figures to strategic bank decisions (e.g. about liquidity)
- Integrating strategic decisions into the controlling framework
- Creating a basis for internal/external reporting and communication
Advanced risk modeling
- Quantifying the interactions between different types of risk
- Quantifying the interdependencies between banking risks and macro-economic variables
- Calculating results for a wide range of stress scenarios
Integrated liquidity management
- Managing liquidity and capital in an integrated approach
- Planning funding and contingency requirements
- Designing funds transfer pricing mechanisms
Active credit portfolio management
- Simultaneous forecasting and active steering of capital demand driven by the bank's risk exposure and capital supply
- Taking into account the perspective of the regulatory authority, rating agencies and the company itself
Capital planning and management
- Designing and setting up an active credit portfolio management function to manage risk and return simultaneously
- Overcoming cluster risks in the credit portfolio
Our team of experts has in-depth experience of all types of risk topics that financial institutions face in today's demanding environment. They are summarized in the figure below.
Sample projects
The following sample projects illustrate some of our international experience in the Risk Segment.
Developing credit-risk models for the retail SME segment of a leading universal bank in Hong Kong (including mainland China)
Background
A leading universal bank in Hong Kong wished to introduce an internal ratings-based (IRB) approach. This would allow it to assess the creditworthiness of its counterparties and so measure the capital requirements for credit risk more accurately. We were engaged to model two of the main components of this approach: the loss given this default (LGD) as a share of the exposure outstanding at default (EAD) and EAD itself.
Approach
Our approach was to assign a sample of defaulting customers to different risk segments (e.g. product classes) and estimate a number of parameters based on these clusters, such as the probability of cure, restructuring and liquidation, the collateral recovery rate and other recoveries. On the basis of these parameters we derived the LGD. We then calculated the EAD by estimating the credit conversion factor (CCF), which indicates the share of granted credit lines that will probably be drawn by the counterparty at any one time and adds the outstanding exposure to it.
Results
The resulting expected loss forecasts constitute the basis for the capital requirements for credit risk. Accordingly, the approach had to be approved by the Hong Kong Monetary Authority (HKMA). Approval was granted.
Scoping and designing a holistic bank-planning model for a German public-sector bank
Background
A large German public-sector bank asked us for an overall bank-planning approach so that it could integrate its various existing planning processes for capital (adequacy), funding, new business, P&L, balance-sheet structure and risk.
Approach
We first scoped and later developed a detailed holistic model that reflected the bank's situation and captured the interactions between risk, return, capital and liquidity. By implementing our Excel-based prototype, the bank could simulate the effects on its key regulatory and steering indicators (e.g. Tier 1 & 2 capital ratio, RoE) for different strategic decisions and stress scenarios.
Results
The new holistic bank-planning approach is quicker (fewer departments are involved), more consistent (the departments share a common understanding) and more agile (the number of scenarios and strategies tested is greater) than the previous planning processes. It is an effective tool for strategic value optimization in the bank.
Redesigning the treasury function of a new direct bank
Background
We were engaged to review the treasury function of a new Austrian bank and derive an action plan for resolving problems related to the strategic goals.
Approach
We reviewed all the dimensions of the treasury in terms of the business units and functions involved, which included strategy, organizational setup, systems, quantitative models, processes and interfaces, as well as roles and responsibilities. We then derived an action plan based on this assessment. Furthermore we drew up a treasury policy laying down mandatory guidelines, roles and responsibilities for all employees.
Results
We delivered a report on the gaps that needed to be closed before launching the bank. This report included a detailed action plan for overcoming the obstacles and ensuring the timely entry into operation of the treasury function.
