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Guillermo Kopp, TowerGroup
Guillermo Kopp, TowerGroup
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Basel II Converges With Business Performance

Risk management will influence business decisions; banking needs a model automation framework; and it's time to automate, according to Guillermo Kopp.

Responding to public and regulatory scrutiny of accountability and corporate performance, business executives at leading banks are emphasizing sound management practices to restore trust. Compliance deadlines have mobilized all sectors in the banking industry toward a comprehensive framework of controls, transparency and professional discipline stemming from Basel II and other financial, accounting and privacy regulations around the world.

Risk Management Will Influence Business Decisions

This year, financial services institutions (FSIs) are investing an estimated $51 billion globally in IT solutions for risk and compliance. However, TowerGroup finds that 30 percent of these IT investments may be considered wasteful. Given their tactical compliance purpose, many risk and compliance solutions are duplicated over multiple functional silos or are applied to inefficient legacy technology systems. IT inefficiencies also result in manual business operations that involve exception processing, workarounds, reconcilements, day-to-day losses and adjustments.

Consequently, a pervasive "multiplier effect" augments these IT inefficiencies by overburdening the surrounding business processes, and FSIs are finding ways to save big on an estimated $71 billion in operational expenses. Much of this large expense base has been buried in the economic capital reserves that bank executives must set aside to conduct business. Basel II introduces a convergent framework of risk management and controls that will encourage banks to invest wisely in IT and improve the efficiency of their business operations. Banks that adopt effective enterprise risk management platforms will reap business benefits that go well beyond regulatory compliance.

Most bank CEOs consider lagging efficiency ratios a top concern. As banks look for structural transformations to improve efficiency, Basel II adds one more reason to introduce deeper changes: The financial performance of diverse lines of business and products will be determined by their level of risk. A risk-weighted analysis of business performance will prompt banks to focus on core competencies and restructure or divest those activities that burden their convergent regulatory and economic capital reserves. In the increasingly interconnected universe of financial services, creditworthy customers are likely to balk at paying a premium for bank inefficiencies. These lower-risk customers may stray from long-standing banking relationships and shop around for more competitive products and services. With a holistic combination of credit, market and operational risk factors, the adoption of Basel II performance measurements will advance specialization and efficiency in the banking business.

Banking Needs a Model Automation Framework

Capital reserves, supervision and market discipline are Basel II's three risk management pillars. A cohesive technology platform building on these pillars will prove instrumental in integrating the risk and compliance needs across the enterprise. By adopting integrated IT solutions, banks may attain more business agility through:

  • Introducing transparent business performance indicators that factor in a holistic risk profile
  • Implementing effective controls that reduce credit and operational losses
  • Simplifying business processes that improve efficiency ratios
The time has finally arrived for banks to leverage tactical efforts in regulatory reporting, risk analytics, quantitative studies and internal controls for strategic business gains. Winners will promote the best risk management and control practices, bring straight-through processing paths to the banking operations, and introduce advanced measurement models that integrate financial, risk and operational performance. Regulators as well as rating agencies are also becoming more sensitive to these evolving risk management capabilities. Besides catering to many internal management and regulatory compliance needs, adopting advanced risk models will influence mainstream business decisions. These models will transcend the primary attention of risk managers and compliance officers. At the same time, line-of-business heads convert standard risk metrics into meaningful parameters to weigh the alternatives in their product and services offerings.

It Is Time to Automate!

The industry is now at the implementation phase of Basel II. Few banks have the perspective and resources to experiment and establish their own enterprise risk management models that include this new field of operational risk. Notwithstanding their attention to business continuity and reputational risk matters, most banks have still to inscribe operational risk procedures in the broader picture of business management and operational efficiency. Not only may banks improve their operational efficiency by streamlining business processes, but they also can tap important benefits in operational resilience, responsiveness and flexibility to innovate. By adopting automation models for integrated business and risk management, proactive banks may derive significant returns from a concerted enterprise approach.

These integrated automation models typically include the following components:

  • Straight-through origination processes that simplify and accelerate the credit process
  • Business process management tools that boost operational flexibility and business ownership
  • Dynamic limits and real-time controls that reduce credit and operational losses
  • Streamlined business processes that improve efficiency ratios
  • Modular core systems that integrate with enterprise risk and compliance utilities
  • Holistic data models and integration that map all transactions and risk types
  • A knowledge base with standard definitions and risk indicators that set performance baselines
  • Comprehensive business performance dashboards and enterprise reporting functions
  • Loss databases that capture in full detail various transaction types and risk events
  • Business rules engines that interact with risk analytics and automate exception handling
While a complete set of automation tools is still in the works, banks should establish a Basel II road map and implement the components listed above. The complexity of a full implementation should not be underestimated, and banks should start automating sooner rather than later. Internationally active banks should adopt these emerging global industry standards and automation platforms and enrich them with a right combination of appropriate local and regulatory controls.

Guillermo Kopp is vice president, financial services strategies and IT investments, at TowerGroup (Needham, Mass.).

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