More Related Content Similar to Bara ERM v2 (20) Bara ERM v21. © Oliver Wyman | SIN-ZAK05401-017
ENTERPRISE RISK MANAGEMENT – TOWARDS
SHAREHOLDER VALUE CREATION
DECEMBER 2016
Eric M. Pascal, CPA, CMA, CFA, ACMA, FRM, CGMA
Partner
Finance and Risk
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3. Agenda
1. Introduction
2. Why risk-adjusted analyses is an important part of ERM
3. Setting the Risk Appetite statement
4. Embed Risk Appetite in Annual planning
5. Necessary central capabilities
6. Closing remarks
5. 44© Oliver Wyman | SIN-ZAK05401-017
A best practice Enterprise Risk Management (ERM) planning and allocation
framework in our view incorporates the following four elements
Available capital Current capital requirements (=
capital attribution)
Capital buffer Risk appetite Performance measurment New business allocation
0%
5%
10%
15%
20%
25%
30%
35%
0% 100%
RoE
Share of capital
Asset Mgmt.
Fin. Markets
PF
I F
Lending
PE
Organic
growth
Inorganic
growth
• How much capital is required to cover all
risks?
• How can we attribute capital requirements
to business units?
• What buffer do we need to protect
against adverse economic conditions,
model risks, etc.?
• Is the business plan within our preset
risk appetite
• How can we
understand where it
will be most profitable
to allocate capital to
profit centers?
• How can we budget
capital to achieve a
profitable portfolio with
stable earnings
and efficient use
of capital?
100
40
25
35 35
Corp lending
Fin. Markets
Inv. Banking
Retail
CL
FM
IB
Retail
Acquisition
Risk-adjusted
performance
measurement
Setting risk appetite
Risk measurement
and capital attribution1 2 3
Capital
budgeting
and monitoring4
Illustrative example
6. 55© Oliver Wyman | SIN-ZAK05401-017
The combined economic and regulatory environment means that Banks have
to strive to maximise the efficiency of financial resources
• +200 bps
– Through more coherent approach to
financial resource strategy and balance
sheet management
• +200 bps
– Through effective allocation of financial
resources during planning process
• >+100 bps
– Through clean up of financial
resource consumption
Estimated Return on Equity
uplift potential for average bank
Financial Resource Management levers
• “Strategic balance sheet” that aligns
– Corporate strategy
– Financial resource strategy
– Risk appetite
• Integrated resource planning
– Alignment of funding supply and
asset activity
– Financial resources treated with same rigour
as the P&L
– Central guidance and aggregation
• Dynamic resource deployment
– Clear governance and accountability
– Clear targets and effective
performance management
– Filtering and discipline at origination
Planning
Execution
Strategy
Enterprise risk management has become an integral component of the performance
agenda
7. 66© Oliver Wyman | SIN-ZAK05401-017
Financial performance management has evolved from volume-based to risk-
based metrics
Sales/revenue
Risk
adjusted
return
Return
on capital
Key considerations
for best practice
performance
management
Profits
Returns adjusted for risk
and compared with capital
consumed
Volume Value
Metrics • Sales
• Market share
• Profit margin
• RoE
• Economic Profit (EP)
• Risk Adjusted Return on
Capital (RAROC)
Definition
of “risk”
• Not taken
into account
• Actual risk-costs
(backward looking)
• Forward-looking, cycle-
neutral risk costs
• Simplified versions may be
used at RM or Account
levels
Definition
of “capital”
• Not taken
into account
• Book or regulatory capital • Regulatory or Economic
capital
Periodic view • 1 year • 1 year • 1 year, can be transformed
into NPV view
In Europe the conduct risk agenda means that firms are grappling with aligning financial
measures with behavioural measures of performance
8. 77© Oliver Wyman | SIN-ZAK05401-017
Strategic
Planning Risk Appetite
Financial
Resource
Management
Compensation
and reward
Performance
management
Shareholderalignment
Strategy
Performance metrics
Operating decisions
Vision
Overarching vision/ mission of
the organization
How the vision will
be achieved – including performance
targets and risk appetite
Articulating the strategy in concrete
terms and consistent metrics down
through the organisation
Embedding performance metrics
into key management processes
Aligning business decision-
making processes with the
key management processes
Risk-adjusted performance management (RAPM) frameworks have the goal
of cascading a consistent message through the organisation
Management processes
9. 88© Oliver Wyman | SIN-ZAK05401-017
Economic measures of value are designed to align with shareholder interests
Volume
Revenue
Profit
Returns
(e.g. ROC)
RAROC
Economic
Profit
Increasinginformation
Increasing alignment with shareholder value
Captures activity growth
+ average sales price
+ expenses and tax
+ capital
+ risk-adjustment
+ cost of capital
Value-based metricsSpectrum and “evolution” of financial performance metrics
10. 99© Oliver Wyman | SIN-ZAK05401-017
There are many other levers Risk has to help align the business plan to
shareholder value creation
Examples include:
• Drive the articulation of Risk Appetite
– Ensure no surprises to shareholders – go/ no go areas
– Set limits on the volatility of earnings – helping provide a smooth and stable earnings stream
– Risk appetite consideration of all new business opportunities
• Holistic stress and scenario testing
– Understand the interconnected drivers and magnitude of stress events
– Help identify early warning indicators and mitigate the impact of stress scenarios
– Identify new risks through reverse stress testing
• Comparison of Economic vs. Regulatory risk
– Where simple regulatory measures used, help identify the underlying risk drivers
12. 1111© Oliver Wyman | SIN-ZAK05401-017
RAROC =
Revenues – Operating Costs – Expected Loss
Economic or Regulatory Capital
Credit risk
• Rating tools
• Default definition
• BIS II
• Allocating credit risk
• LGD, EAD
• Portfolio model
Market risk
• Metrics
• BIS II
• Calibration of tools
Operational risk
• Review existing
framework
• BIS II developments
• Methodology must
ensure confidence in
RAROC measure
Other risks
• IRRBB risk
• Business risk
• Liquidity risk
• Metrics
• Cross selling
• Allocation of revenue
• Consistent data
• Cost allocation
• Funding costs
• Average losses
• Substitutes for actual
losses and provisions
RAROC and Economic Profit are core components of a risk-adjusted
performance framework
EP = Revenues – Operating Costs – Expected Loss – charge for Economic or Regulatory Capital
13. 1212© Oliver Wyman | SIN-ZAK05401-017
In a resource constrained world, banks need to more actively manage risk-
return, right from portfolio level…
Example of a peer ASEAN bank “2020 project”
Shift in profit pools by fully charging for resources
23%
30%
4%
9%
23%
23%
27%
17%
15%
5%
3%
6%
5% 9%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Accounting profits Economic profit*
Transaction Bkg FIG Treasury
Corporate SME, Commercial Private banking
Retail
• Shifts in profit pools when fully charged for
capital and liquidity
• An ‘Economic profit’ view for annual planning
process would result in a different ‘resource
prioritisation’ vis-a-vis an ‘Accounting profit’
view
• RAROC, RoRWA and other related
metrics exhibit similar impact
• Shareholder value contribution for Corporate
banking and Treasury lower (22%) than what
was considered during the planning process
(42%)
• Boost for fee and deposit related businesses
(retail, private banking, transaction banking)
* Economic profit reflects charging for capital and liquidity costs to the accounting profits. In Addition, Expected loss is considered instead of accounting provisions
14. 1313© Oliver Wyman | SIN-ZAK05401-017
…down to the customer and RM level
Revenue vs. risk-adjusted view of customers for Commercial banking
-500
-300
-100
100
300
500
700
900
-100 400 900 1,400 1,900
Revs (000s)
EP (000s)
Avg. Revenue/
customer
Avg. EP/
customer
“Sustain and Improve”
(Continue focus)
“Grow accounts”
(Target/invest)
“Restructure accounts”
(Cross sell/re-price)
“Review accounts”
(Replace/exit)
Example of a peer ASEAN bank “Portfolio performance review” project
• Customers traditionally considered
high value (high revenues) but actually
destroying shareholder value
• Need to review accounts – either
restructure or exit accounts
15. 1414© Oliver Wyman | SIN-ZAK05401-017
As business mix shifts, it is important to continue testing the relevance of
performance metrics – most remain mainly in the lending based space
Type of business Typical businesses covered Example performance metric Comments
Lending Based
“standard”
Consumer banking (mortgage,
cards, personal loans)
Commercial and Corporate
Banking (trade and non-trade
loans)
• Economic Profit (EP)
• RoRWA,
• RAROC
• Significant credit risk taken
• Risk adjusted metrics considered as primary
performance metric
Multi-year asset-
based lending
Project Finance, IPRE • SVA (discounted EP) • Significant credit risk taken
• Risk-adjusted metric need to reflect multi-year
‘value-add’
Trading Based Rates, FX, FX Option, Fixed
income, Cross market
• EP
• Total Returns
• Significant market risk taken
• Principal-based: requires capital commitments
• Combination of risk adjusted and profitability
measures
Success Based Strategic investments; Treasury
trading balance sheet
• SVA (discounted EP)
• Single year RAROC /
RoRWA
• Equity Investments
• PE like multi-year businesses
Fee Based Investment banking
Asset Management
Private Banking
• Earning’s volatility and
its drivers
• Shadow reports of EP /
RoRWA / RAROC
• Incorporating “Earnings volatility” as a metric
to adjust for risk
• Commission/margin based businesses
• Flow products require short-term principal risk
• Low capital consumption
Cascading is based on cash-flow and value driver models alongside RoRWA and other classic
risk-adjusted performance metrics
16. 1515© Oliver Wyman | SIN-ZAK05401-017
The existing capabilities of many banks fall short for strategic decision
support in a resource constrained world
Siloed, fragmented approach across bank functions and planning exercises (e.g.
Risk/Finance/Strategy; Holding/Countries/BUs)
Disconnected budgeting/strategic planning/RAS/ICAAP exercises; often using
inconsistent assumptions and resulting in inconsistent/contradictory projections
Resistance to embed risk-adjusted measures in decision making (at all levels from planning
down to pricing)
Low transparency: Lack of understanding of outputs from complex risk models and their
underlying drivers
Limited capabilities to quickly forecast results for alternate economic or strategic scenarios
- resulting in strategic decisions making based on “gut-feeling”
Organization/
approach
Capabilities
Budgeting vs.
Strategy vs.
RAS vs. ICAAP
Embedding risk
Transparency
Whilst under much less regulatory pressure, ASEAN leaders are catching up with global
developments in anticipation of a potential downturn
17. 1616© Oliver Wyman | SIN-ZAK05401-017
Industrial
Offices
Residential
development
Others
Retail
Mixeduse
Vacantland
Uncoded
-10%
0%
10%
20%
30%
40%
0% 20% 40% 60% 80% 100%
SegmentRAROCMay08
Drill down – management often use ‘feed-starve’ charts to depict value
creation and for a focus point for senior challenge
Retail
Offices
Mixeduse
Industrial
Residentialdevelopment
Others
Uncoded
Vacantland
0%
5%
10%
15%
20%
25%
30%
0% 20% 40% 60% 80% 100%
SegmentRAROC
% of Segment Ecap
CoE = 15.0%
Retail
Mixeduse
Offices
Others
Residential
development
Industrial
Vacantland
0%
10%
20%
30%
40%
0% 20% 40% 60% 80% 100%
SegmentRAROCMay08
Offices
Residential
development
Retail
Mixeduse
Others
Industrial
Vacantland
Uncoded
-5%
0%
5%
10%
15%
20%
25%
30%
35%
0% 20% 40% 60% 80% 100%
SegmentRAROCMay08
Region 1
Region 2
Region 3
Property finance RAROC vs. capital consumption
(all regions)
18. 1717© Oliver Wyman | SIN-ZAK05401-017
Case study: Effective risk-based centralised challenge process adding 20%
to planned EP
Plan optimisationOpportunity evaluationProfit pool analysis
1 2 3
-50
0
50
100
150
2010 2015 2020
Economic Profit Cost of Capital
Expected loss Cost
Regional profit pools
Region X Banking Revenues 2010–2020E ($BN)
Existing Business profit pools
Economic Profit by Business Line
Resource availability
Financial targets
Performance Risk
appetite
Valuation Resource
generation/
consumption
Portfolio rebalancing
Economic profit Cost of Capital Tax Expected Loss Cost
0%
20%
40%
60%
80%
100%
Wealth &
Asset
Mgmt.Deposits
Corporate
Banking
Business
Banking
SME
Card
Consumer
Finance Private
Bank
Mortgages
Result
• Planned EP increased by 20%
• NSFR improved by 7%
• Clear optimisation targets tailored by business
against Volumes, Price, Risk & Costs
Capital re-allocation by BU for 2013
Capital by BU (BN)
Current Capital Capital 2013 (initial proposal)
Capital 2013 (optimised)
0
1
2
3
4
5
6
Business
Banking
Corporate
Banking
SME
Deposits
Wealth&
AssetMgmt.
Private
Banking.
Card
Consumer
Finance
Mortgages
Invest Scale back
20. 1919© Oliver Wyman | SIN-ZAK05401-017
Banks should set their capital targets based on their Risk Appetite and
strategic needs
Tier 1 + Tier 2
Minimum
Pillar 1
requirements
Pillar 2
add ons
Buffers
Strategic
Downturn
Minimum
regulatory
requirements
Average of peer group
Target
required
capital
• Outside-in target setting demands
judgemental application of benchmark
analyses to take into account the “signalling”
effect to external stakeholders (e.g. analysts,
investors, regulator)
• Conducted through benchmarking with a
group of peer banks
• Inside-out analysis provides an
analytics-based target, subject to
analytical assumptions
• Based on stress tests for credit, market and
other loss in income
Outside-in
benchmarking
Capital
target
Inside-out analysis
21. 2020© Oliver Wyman | SIN-ZAK05401-017
Risk Appetite is fundamentally about articulating, governing and cascading
an overall risk tolerance into operational actions/controls…
FHC-level risk
indicators
FHC-level risk metrics
Business-level and risk
metrics and limits
FHC
-level risk
tolerance
• Key measure of risk levels which serve as levers
that can be used to manage the risk profile of the
bank/holding company across risk types
• Key measures to be monitored that provide early
warning if the risk appetite may be breached
• Explicit limits and guidance provide to business
and risk managers cascaded from the desired
risk profile for the bank/holding company
• “Inviolate” limits given a choice, particularly if
the risk appetite has been communicated to
the public
Note: FHC = Financial Holding Company, or Group
22. 2121© Oliver Wyman | SIN-ZAK05401-017
…which needs to be inter-linked with the institution’s strategic goals
Strategy
Risk
appetite
RoE
Profitability/
Efficiency
Asset
growth
Revenue
growth
Market share/
penetration
Solvency
Liquidity
Business mix
Franchise
Earnings
volatility
Requirements
• What do you need to achieve your strategy?
• What outcomes would not be acceptable?
Limitations
• How do these constrain the business plan?
• What do we need to track/stress test?
23. 2222© Oliver Wyman | SIN-ZAK05401-017
When setting targets, banks consider different definitions of capital…
Regulatory capital Agency driven capital Economic capital Actual capital
Definition • Amount of capital required to
protect the Group against
statutory insolvency over a
one-year time-frame
• Amount of capital the rating
agencies expect in order to feel
comfortable giving a
“AA” rating
• Amount of capital required to
protect the Group against
economic insolvency over a
one-year time-frame
• Amount of equity capital or
Embedded Value actually held
to protect the Group against
economic and statutory
insolvency over a one-year
time-frame
Purpose • Designed to protect policy
holders and creditors
• Acts as a floor, which triggers
takeover by the regulators
• Designed to test and
communicate capital adequacy
warranting the target debt rating
based on the rating agency
metrics and models
• Designed to be a tool
for management
• Designed to communicate
accounting solvency
and profitability to
outside constituents
Measurement • Based on undifferentiated rules
of thumb that do not reflect the
real economic risks of the
business and usually based on
(relatively) public information
• Based on relatively
undifferentiated rules of
thumb (bank), and/or simple
models (insurance)
• Not formulaic – other factors
such as quality of management
and likelihood of Government
bail-out are also considered
• Reflects real risks taken in the
sense of unexpected
movements in the value of
assets and liabilities and on the
confidence interval
management wishes to tolerate
• Accounting result; expanded
definition includes
hidden reserves
Bare minimum capital
you must have
Capital you are
expected to have
Capital you ought to have Capital you actually have
Economic capital provides an internal measure of risk-based capital requirements
and hence forms an important component of ICAAP
24. 2323© Oliver Wyman | SIN-ZAK05401-017
…as well as its internal strategic objectives
Range of strategic objectives
Option for
aggressive growth
Strategic objective Relevance under stress Further considerations/notes
Survival:
Batten down the hatches,
i.e. keep buffer for survival
Under a stress scenario, the bank may
also want to have this buffer for
idiosyncratic events e.g. single
name events
N/A
Dividend:
Ensure that the bank can
pay a dividend without
restrictions from regulators
Under a stress scenario, the bank may
still want to maintain ability for
dividend payment
• Dependent on dividend pay-out ratio
External rating:
Look relatively better than
other banks in the market
Under a stress scenario, the bank may
want to benefit from a “flight to
safety” effect
• Hygiene factor for certain parts of
the business
• Dependence on
internationalization strategy
• Delta in funding costs by rating grade
Growth:
Support organic growth
Under stress, there may be
opportunities to grow as the bank
emerges from stress scenario
• Given range of potential objectives,
this requirement under stress may
place onerous demands on
capital requirementsGrowth:
Support inorganic growth
(M&A opportunities)
Under a stress scenario, there may be
opportunistic transactions to benefit
from low valuations
Survival
25. 2424© Oliver Wyman | SIN-ZAK05401-017
Stress testing typically plays an important role in informing capital targets and
buffer levels
Credit Risk Credit Risk
ALM
Pillar 1 Minimum Capital as
of specific balance sheet date
(Credit, Market and Operational risk)
Pillar 2 – Defining
Minimum Capital Level to
Propose to Regulator
Market risk
Credit
Concentration
Broader stress testing to guide
“cushion” (and manage
regulator and rating agency)
• Identify major loss scenarios, that could impair
capital base
Market risk
Operational risk Operational risk
Other
Often no extra capital required,
unless risks larger than for
competitors/benchmark
Capital adequacy Role of stress testing
“Cushion”
• Compare Pillar 1 requirements with actual
magnitude of Pillar 1 risks at the bank, using
Economic Capital
• Determine relative importance of non-Pillar 1 risks
to Pillar 1 risks and benchmark to peer banks
– Judge if Pillar 1 capital is enough
– Judge if other risks require more attention than
at other banks
The trend globally is to define capital targets both under stress and business-as-
usual circumstances
26. 2525© Oliver Wyman | SIN-ZAK05401-017
Client example: Framework for assessing trade-off between growth, return,
external rating and solvency requirements
• What are the Bank’s strategic
objectives with respect to
growth, ability to pay dividends
and external ratings?
• What are the relevant
regulatory considerations, e.g.
– increase in regulatory
minimums
– implementation of capital
conservation buffer (CCB)
• Based on the strategic and
regulatory considerations, what
are the minimum solvency
ratios that the Bank needs to
protect?
– Under BAU
– Under Stress
Implication on
returns
Minimum solvency
ratios required
Bank’s strategic
objectives and regulatory
considerations1 2 3
• Based on the minimum solvency
ratios required to satisfy strategic
and regulatory objectives, how
does this impact overall Group
Return on Equity (RoE)?
• Further, what is the effect of Basel
III liquidity and funding rules on
RoE going forward?
Loop back if needed
Disguised client example
27. 2626© Oliver Wyman | SIN-ZAK05401-017
However, capital targets cannot be set in isolation, because RAS sets multi-
dimensional constraints, within which management needs to optimise returns
Risk Appetite
dimensions
Solvency
Earnings
Liquidity
Franchise
Return
optimisation
space
Concentration
constraints (region,
country, product)
Asset growth
> X%
Funding
constraints
RegCap growth
< XX%
EaR < revenue
Return is optimized within constraints, the tightness of which will
depend on business unit profiles and comfort levels, leaving the
trade-off decisions to business management
X
If BU needs to
release
constraints mid-
plan, they can
request it
provided the
Group approves
This raises key questions
regarding the set of RAS
chosen in terms of
• Comprehensiveness:
Do we have the right set of
statements and metrics covering
all risks that are important to the
Board?
• Consistency:
Can the various targets be
achieved at the same time in
non-stressed conditions?
• Sensitivity to changes in
drivers/ components
How sensitive are individual
RAS to changes in underlying
components? E.g. how will a
capital increase impact my EPS
targets?
• Hierarchy of RA statements:
If we cannot meet all targets in a
stress situation, which one are
we sacrificing first?
Illustrative
28. 2727© Oliver Wyman | SIN-ZAK05401-017
Embedding
into other
processes
(at all
levels of the
organisation)
Senior Management
(i.e. Exec Risk Committee)
Board
Risk Appetite
Sectorexposure
Tradingdesk
Linking to
limit frameworks
BU2 BU3 BU4 BU5 Etc.BU1
Allocate
Group Risk
Appetite to
BU level
Link to limit
frameworks
1
2
3
Linking to annual planning process
– Metrics translated into a planning factor
(e.g. credit exposure, ECap, etc.)
– Allocated to BUs based on previous
growth projections and management
discretion
– Planning process redesigned to
incorporate risk input and guidance
– Initial Risk Appetite guidance for
each BU communicated through
Budget Guidance
– Taken into account during planning
process, discussions in case of breach
• Linking to existing limit frameworks
– Working closely with respective BUs
(e.g. Corporate, SME, Capital Markets)
to align/develop existing limit
frameworks and monitoring processes
• Embedding into other processes
– For “qualitative” Risk Appetite
statements/metrics (e.g. rating agency
communication, Op. Risk management,
ethical conduct policies, etc.)
1
2
3
Three linking mechanisms for Risk Appetite
To make it all work in practice, capital targets and other RAS need to be
cascaded into an institution’s decision making, processes and governance
frameworks
30. 2929© Oliver Wyman | SIN-ZAK05401-017
To succeed, banks need a consistent framework to make clear risk-return
trade-offs during planning and then embedding this in business execution
Make forward looking
risk-return trade-offs
during planning
Embed risk-return
trade-offs into how the
business executes
Ensure business is
aligned to risk-return
behavior
RAS
Strategic
planning
Budgeting
Scenario planning
Portfolio optimisation
RAS
cascading
Capital
allocation
Allocation framework
RWA optimisation
Liquidity management
Liquidity
charge
Performance management and Incentives
RAPM framework
Compensation models
Processes Analytics
A
B
C
Effectively monitor
performance* Reporting mechanism and framework
MIS
Feedback frameworkD
* Not addressed in detail in this presentation
31. 3030© Oliver Wyman | SIN-ZAK05401-017
How much capital do we need?
What and how
much risk
should we take?
Where should
we place our
strategic bets?
How should we
allocate
resources for
sustainable
growth?
Risk Appetite
(Risk)
Strategic Planning
(Strategy/Finance)
Capital Management
(Finance/Treasury)
This will require a step-change in collaboration between Strategy, Risk,
Finance, and subsequent support from HR
• Best practices articulate a process that ensures that
implications of strategic decisions are informed from a
risk and capital perspective
• Specifically, articulating a trade-off reflections
contribute to ensure that
– Capital adequacy targets are met under certain
strategic scenarios
– Risk-return analysis are considered
– Capital is efficiently allocated
– Risk appetite is not breached and is consistent with
strategic targets
• From an implementation perspective, entities
– Articulate a trade-off debate prior to the
planning exercise
– Account for high level analytical sensitivities to a set
of strategic decisions
– Count with a formalised governance, with clearly
defined leaders and challengers
A. Make forward looking risk-return trade-offs during planning
32. 3131© Oliver Wyman | SIN-ZAK05401-017
Banks have developed integrated annual planning process to embed risk-
return considerations
Example: Peer ASEAN bank
Phase 1
(Aug)
Phase 2
(Sept – Oct)
Phase 3
(Nov – Dec)
Phase 4
(Jan – Mar)
Board
Senior
Management
Finance
Risk
Strategy
Capital
Management
Business Units
/ Legal Entities
HR
Creation of
high-level
SBU and legal
entity plans
C
Budget
creation and
submission
H
Plan
approval
N
Debate and
challenge
G
Capital and
funding
plans
I
Finalized
plans
M
Detailed
RWA
forecasting
J
Iterative process
High level
funding and
capital plan
F
Annual RAS
refresh
A
Annual
strategic
planning
B
Monthly reporting of
EP/RAROC
O
B
Monthly monitoring of
capital, funding
P
B
ICAAPQ
Aggregation
K
Scenario
analysis
D
RWA
forecast
E
Revise
plans
L
Revise
plans
Compensation models
R
A. Make forward looking risk-return trade-offs during planning
33. 3232© Oliver Wyman | SIN-ZAK05401-017
Analytics – Scenario planning
An integrated scenario planning framework allows the bank to analytically
assess trade-offs between capital, funding and P&L
A. Make forward looking risk-return trade-offs during planning
Which bank strategies will
provide an optimal risk-adjusted
return for the bank?2
Are we meeting the internal
(RAS) and external (Regulatory)
constraints in the chosen
‘strategic’ scenario?
3
What are the best mitigating
strategies and/or changes in
strategy to each scenario?4
What is the financial impact of
each bank strategy or macro-
economic scenario?1Inputs
Financial statements
• P&L
• Balance sheet
Balance sheet strength
• Capital position
• Funding position
Portfolio snapshot
• Exposure breakdown
• Risks
Key value drivers
• Group-wide
• Major divisions/BUs
Forecasting
Capital adequacy
• Regulatory view
• Economic View
P&L and Balance Sheet
• P&L
• Key B/S items
Funding
• Asset liability gap
• Funding profile
Valuation
• Group-wide
• Key divisions/BUs
External factors
Macro scenarios
• Chief economist
assumptions
• User specified scenarios
Market developments
• Banking sector
• Peers
Internal levers
Strategies
• Group-wide
• Major divisions/BUs
• Products
Levers
• Growth
• Pricing
• Risk
Integrated planning framework… … focused on addressing key
concerns of senior management
34. 3333© Oliver Wyman | SIN-ZAK05401-017
Mitigating actions: attractiveness map
Feasibilityofapplication
Financial Impact
Variable costs5
Δ Credit spreads2
Δ Commissions (unitary)3
Business/Geo mix6-7
Credit deleverage1
Δ Deposits vols4
+
- +
Δ Strategic divestments8
ROE Solvency EP Liquidity
1 Deleverage in
customer loans
2 Increase in
credit spreads
3
Increase in
unitary
commissions
4 Increase in
Retail funding
5 Efficiency ratio
improvements
6 Change in
geographic mix
7 Change in
product mix
8
Strategic
Portfolio
divestments
Analytics – Scenario planning
…enabling impact analyses to support informed board discussions on
portfolio optimisation decisions
IllustrativeA. Make forward looking risk-return trade-offs during planning
35. 3434© Oliver Wyman | SIN-ZAK05401-017
Analytics – Scenario planning
Example: Assessing segment attractiveness under multiple macroeconomic
scenarios
A. Make forward looking risk-return trade-offs during planning
1. Based on Economic Department’s macroeconomic scenarios
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
Consumer
financial services
Credit cards Commercial Corporate Markets Investment
banking
Asset
Management
International
RORWA
Positive Current Base Mild High stress
RRWA under four scenarios
Structurally
attractive
Selective segments
will be attractive
Value preservation
using downside protection
Positive case
• 10 year interest rate peaks
at 8.8%
• Home price inflation slows down to
~ 6% for one year
Base case
• 10 year interest rate peaks
at 9.2%
• Home price inflation slows down
to ~ 0% for one year
Mild stress (1:4)
• 10 year interest rate peaks
at 9.6%
• Home prices drop by 10%
(30% real)
High stress (1:10)
• 10 year interest rate peaks
at 11.3%
• Home prices drop to -20%
(40% real)
Illustrative
36. 3535© Oliver Wyman | SIN-ZAK05401-017
Analytics – Portfolio optimisation
Banks formulate a “fair” account of shareholder value creation across the
portfolio to make business-level strategic decisions
A. Make forward looking risk-return trade-offs during planning Illustrative
Home Loans
Trading
Business Banking
Credit Cards
Imperial
VAF
Retail Deposit
Small businesses
PF Lending
Personal Loans
Corporate Banking
Capital - Banking
Bancassurance &
Wealth
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
55%
60%
65%
(700) (350) - 350 700
Capital production vs. RAROC: Client example
Capital
Producing
Capital
Consuming
Challenge: Gain
margin at expense
of volume
RAROC
Challenge: Maintain
Challenge: Grow
faster
Challenge: Continue
improving returns
37. 3636© Oliver Wyman | SIN-ZAK05401-017
Process
To embed the risk-return considerations in business decision, resources
need to be suitably charged - the level of sophistication may vary by banks
B. Embed into how the business executes
Basis of charge FTP and Capital
charge
FTP, EL and Capital
Charge
FTP, EL, Capital
and Liquidity charge (LCR,
NSFR)
FTP only
Comparison of charging regimes
Charging by risk
types
Pillar 1 RWAs
(Credit, market and
operational)
ECap equivalent
(Internal calculation)
Full regulatory capital
(Pillar 1 and 2)
Pillar 1 RWAs
(Credit only)
Granularity of
charging
Business unit
(e.g. Rates)
Desk
(e.g. Govies)
Trade levelDivision
(e.g. Fixed income)
Mechanism of
charging
Chargelevel(bps)
Leverage
Chargelevel(bps)
Leverage
Average or
target
leverage
Chargelevel(bps)
Leverage
Average or
target
leverage
Chargelevel(bps)
Leverage
Stepped charge Progressive charge Contingent chargeFlat charge
1
2
3
4
38. 3737© Oliver Wyman | SIN-ZAK05401-017
Analytics – Capital
RWA optimisation remains firmly on the agenda for banks with the aim to
maximise the scarce resources
Typical RWA optimisation areas
Main areas Example initiatives
Methodology improvement
• Data quality refinement
• Improvement of guarantees eligibility
• Models and parameters refinement
• Best utilization of regulatory freedom
Business initiatives
• Tactical: headroom, uncommitted lines, collateral optimization,…
• Product features: Limits, early prepayment options,…
• Strategic: reprioritisation of new business, revisiting of capital management capabilities
• Incentivatisation (allocation of RWAs to engender desired behaviour)
Financial Optimization
• Traditional distribution
• Alternative distribution
• Hedging
Market and Counterparty
Risk Optimization
• Drafting and use of netting and collateral agreements
• Elimination of infragroup exposures
• Maximisation of VaR and IMM model adoption
Buffer Management
• Improvement of stress testing methodologies
• Optimal consideration of cyclicality in the calculation of risk parameters
Active RWA controlling • Setup of a unit dedicated to ongoing RWA monitoring and implementation of optimisation initiatives
Increasingcomplexity
B. Embed into how the business executes
39. 3838© Oliver Wyman | SIN-ZAK05401-017
Analytics - Liquidity
Thorough Balance Sheet reviews, institutions maximise return on long-term
funding and liquidity both from a tactical and strategic point of view
Source: Oliver Wyman analysis.
* Return defined as risk adjusted revenues for each segment.
Return on liquidity and funding balance by client segment
Universal bank example
Retail
Asset
Management
Private
Banking
Factoring
Consumer
finance
Portfolio in run off
Public Financing
Markets
Small business
Micro business
Leasing
Average
position
Average position
Examine options
of securitization
Investigate
opportunity to issue
bonds
• Stabilization of
liquidity utilisation
Reduction of liquidity
needs and monitoring of
off-balance sheet
positions
Increase
profitability profile
Capitalize on existing
client base to increase
deposits
Accelerated
disengagement of
activities in run off
0
ReturnonLong-termfunding
Net long-term funding consumption
Structured Finance
Corporate lending
B. Embed into how the business executes
Trigger
• Reduced
availability of long-
term wholesale
funding putting
limits on growth of
the balance sheet
• Economics of
different
businesses
changed
dramatically by
post-Lehman
funding reality
40. 3939© Oliver Wyman | SIN-ZAK05401-017
Process
Performance management processes are applied at different levels of the
organization in order to cascade, monitor and measure risk-adjusted metrics
KPI Management tools
Operational
level
BU
level
ExCo
level
Risk costs
Operating
costs
Revenues Costs
Lead
metric by
business
Extra-
ordinary
revenues
Revenues
from
operations
Capital
costs
Main-
tenance
costs
…
Credit
risk
costs
Other
risk
costs
Invest-
ment
rev.
…
Product
rev.
… …
• Risk-adjusted performance tool
• Capital planning tool
• Budget projection model
• Portfolio level risk models
• Stress testing models
• Target setting and incentives models
• Ex-ante models
• Target setting models
• Limit setting models
• Value at Risk models
• Simulation tools
Models differentiated by BU/Sub-BU
• Pricing models
• Wallet sizing models
• Valuation models
• Customer value and propensity
models
KPI cascading and management example
C. Ensure business is aligned to risk-return behavior
41. 4040© Oliver Wyman | SIN-ZAK05401-017
Analytics
The incentive framework should also have a clear linkage between risk-
adjusted performance and compensation to ensure aligned behavior
“Knock-out” factor values 0x 0,5x 1x
• Unauthorised breach of “Hard” VaR limit
• Breach of “Hard” compliance requirements
• Dealing in non-approved products
ExanteExpost
Attributable
Revenues
Direct/Indirect Costs
Cost of allocated capital
Risk adjusted cost of funds
Cost of leverage
Quality of earnings adjustments
Risk-
adjusted
profit
-=
Risk-adjusted profit
Bonus
R$ Flex
-Collaboration with other areas
-Operational quality
-Role-specific KPIs
-Efficiency/ Cost management
-Final score
-Risk & Compliance
ScoreWeightPerf. Indicators
-Collaboration with other areas
-Operational quality
-Role-specific KPIs
-Efficiency/ Cost management
-Final score
-Risk & Compliance
ScoreWeightPerf. Indicators
Employee XX
Calculated bonus Year 0 Year +1 Year +2 Year +3
“At risk” for senior management
and major risk takers
Financial performance of
individual/desk measured
on directly-influenceable
risk-adjusted results
I
Non-linear payout
function flexed for
non-financial performance
II
Knock-outs for serious
breaches of risk and
compliance requirements
IV
Bonus partly deferred
on pre-set bands and
“at risk” – clawback if
negative results
V
Financial
resources
incorporated either
in financial
performance or
in non-financial
scorecard
Example of emerging post-crisis remuneration framework
C. Ensure business is aligned to risk-return behavior
42. 4141© Oliver Wyman | SIN-ZAK05401-017
A robust capital planning and allocation process, coupled with successful
capital management will lead to the following benefits
1 2 3 4Reduced capital resources More efficient
allocation/structure of
available capital resources
Increased business
efficiencies
Improved external
perception
• Better understanding of
the drivers and dynamics
of the excess buffer
• Manage regulatory and
rating agency expectations
through demonstration of
sophistication and ability to
actively manage capital
• Help steer scarce capital
to sources of value
creation
• Optimise capital structure
(levels, instruments,
entities etc.)
• Better dialogue and
steering in business unit
planning round
• More forward looking
approach to capital
planning helping to put in
place contingencies before
things become expensive
• More focused external
communications
• Appearance of “leading
edge” sophistication
43. 4242© Oliver Wyman | SIN-ZAK05401-017
This is so easy to
use, you don’t
need instructions
Integrated reporting to senior management should be made iPad compatible
Graphical user
interfaces are designed
by professional graphic
layout designers
D. Reporting and monitoring
45. 4444© Oliver Wyman | SIN-ZAK05401-017
Solutions range from narrow measurement improvement to a fundamental
shift in the performance model
• Adjust for risk to encourage good credit/pricing decisions
• Include cross-channel success to promote co-operation
• Avoid volume metrics that encourage mis-selling
Align interests
(Better measures)
Create transparency
(Better targeting)
Create motivation
(Better model)
Quick fixes
(Easy, low impact)
Structural change
(Hard, big impact)
• Adjust for local market potential
• Strip out uncontrolled events (e.g. margin impact)
• Adjust for service quality and other strategic goals
• Strip out legacy income and allocated costs
• Build local plan/process to promote new revenue growth
• Create steep team incentive for success
46. 4545© Oliver Wyman | SIN-ZAK05401-017
Strategy
process
Performance
monitoring and
compensation
Budgeting and
resource
allocation
Aggregation,
challenge
and debate
BU-level
planning
Top-down
group and
BU planning
• Strong focus on the
identification and
prioritisation of
changes in the
environment, and
strategic thrusts
• Provides qualitative
and quantitative
input into the target
setting process
• Targets and high-
level plans
developed based
on a variety of
inputs
• Group allocates
capital to each BU
based on:
• Performance
projections, (e.g.
net income, EP and
RAROC)
• Consumption of all
risk resources
• Overall group
strategy – i.e.
where do we want
to be?
• BU-level plans
developed using
fast, easy to use
tools and based on
top-down targets
and strategy –
not a detailed
budgeting process
• Performance
and risk
consumption under
multiple strategies/
scenarios is
analysed and
shared with Group
Finance and
other BUs
• BU plans
aggregated and
compared to Group
plan – “planning
gap” quantified
• BU plans
challenged by other
BUs and Group
Finance
• Group ExCo
evaluates the BU-
level plans and
plays out needed
resource allocations
which are needed
to maximize return
• Plans are iterated
until the planning
gap is closed and
ExCo signs off
• Detailed budgeting
process occurs
after BU-level
planning and
challenge and
debate
• Only a single
iteration required by
Group, although the
BUs may choose to
drill down to the
detail at any time
• Tolerances for
KPI’s set based on
the final plan
• Performance
against these KPI’s
is tracked on a
monthly basis
• Performance vs.
KPI’s is tied directly
to remuneration at
an appropriate level
in the organisation
To have an impact, risk-adjusted performance measures need to be well
embedded into strategic processes
47. 4646© Oliver Wyman | SIN-ZAK05401-017
Questioning, debating and
resource allocation
Business planningBusiness guidelines
Strategy Guidelines
Business
segment
strategy
Planning
detailing
Resource
allocation
Aggregation,
questioning,
debating
Budgeting,
action
planning
Requirements
• Clear up-front guidance, informed from the
strategic balance sheet
– Financial resource strategy considered
from the outset
– Supply of funding as constraint to
asset-side activity
• Financial resources treated with
the same rigour as the P&L
– Granularity
– Challenge
• Strong central team
– Analytical capability to rapidly aggregate and
stress developing plans
– Regular feedback and support to businesses
to structure plans
Leading banks have an integrated resource planning process, with Risk
playing a crucial role
Vision of the group
• Clearly formulated vision of
the future of the business
segments, defined
through consensus
• Clarity about the expected
contribution of the business
segments to the
accomplishment of the
vision of the future
• Strategic balance sheet
Risk strategy
• Risk tolerance
• Target-risk profile
Approving risk
• Final check of plans with respect to risk
tolerance and limits
Risk effects
• Review the risk on the group
level and the risk
of diversification effects
• Stress scenarios
Business segment
contract
• Profit objectives, limits,
resource allocation
• Responsibility of
management
(e.g. product/market)
• Management initiatives
• Value drivers/KPIs
• Personal goals and
compensation
• Agenda for
performance evaluation
Approval of capital and financing
• Approval of capital and financing
• Derivation of capital and financing plans
Capital and financing
effects
• Coupling of asset and
liability plans
• Assessing requirements with
available resources
Capital and financing
strategy
• Efficiency of capital
and financing
• Consideration of capital
market circumstances
48. 4747© Oliver Wyman | SIN-ZAK05401-017
Strong central capabilities are needed to effectively engage with the
businesses across the planning cycle
Group Risk
Treasury
Investor
Relations
Group Finance
Translate targets into
internal measures and
issue planning
guidelines
Executive/Board
Identify performance
targets (EPS, RoE
etc.)
Divisions
Aggregate
plans
Feedback to
divisions
Develop initial
business plans
Refine plans
Stress test and
assess aggregate
capital implications
Risk
parameters/
assumptions
Provideassistance
Provideassistance
Recommendationsforcapital
allocation
Capital
allocation and
budgets
Input on risk appetite
and measurement
issues
Input on capital
structure issues/
specify info required for
capital mgmt
Capital plan
sign-off ALCO reporting
Develop Group capital
plan
- Forecasting and
stress testing
- Confirm risk appetite
- Contingency planning
- Structure optimisation
Market input on
dividend policy etc
Update
capital
plan
Structuring and
execution of one-off
transactions
Interaction for one-
off transactions
Execution of
capital plan
Monitoring,
Reporting and
analysis
Reporting
Execution of
plans
Detailed information to
support planning
Aggregate
reporting
Divisional
target
setting
Input on market
perception/appetite
etc
Measurement
support
Market input on
dividend policy etc
Input from Strategy, Finance,
Risk, Treasury, Divisions
Preparation of
ICAAP
Clear up-front guidance
• Informed by analysis
– Group-level targets
– Resource availability
– Risk appetite
– Key watchpoints
– Etc.
• Includes key planning
dimensions , KPIs and
constraints
Aggregation & support
• ‘Helpdesk’ & BU feedback
• Aggregation of plans to
ensure Group issues
reflected
• Scenario testing of
business portfolio
• Refinement of guidance
as appropriate
Challenge & allocation
• Central confidence in
numbers
• Decision informed by
– Cross BU comparison
– Portfolio rebalancing
exercise
• Clear performance
targets agreed
Monitoring & re-allocation
• Monitoring of BU
consumption and
efficiency
• Re-balancing options
regularly updated
• ‘Shaking the tree’ for
resources in between
planning period
49. 4848© Oliver Wyman | SIN-ZAK05401-017
Today’s context of high P&L uncertainty and market & regulatory pressure has
led many firms to improve scenario-based planning capabilities
Regulatory & market pressure
• Increased regulatory requirements
impacting performance
– Higher capital requirements defined by
BIS3/EBA incorp. into local regulation
• Recurrent stress-testing exercises
and increased regulatory scrutiny
– Periodic Stress Testing exercises for
EBA/BoS/FSA w potential market
impact generate additional pressure to
generate/control forecasts
• Changes in local regulation
(e.g. Provisions in Spain; Liikanen; ICB)
• High market sensitivity to entity
results
High P&L and market uncertainty
• Macroeconomic environment
(global and local)
• Financial Services
– Bankruptcy risk from sovereigns
and financial institutions
– Competitive pressure in key markets
(E.g. Spain deposits war)
• Bank specific – E.g.
– Revenue generation
– Funding costs
– Trading book volatility
– RWA sensitivity to risk
– International expansion / contraction
Scenario-
based
planning
Objectives
• Better understand key strategic “bets and threats” and overall P&L, B-S and Solvency impacts
• Embed risk and scenario-based considerations into strategic planning (vs. one base case)
• Evaluate/challenge the real feasibility of business plan projections and performance levers
• Real-time impact evaluation (incl. mitigation strategies) supporting informed management discussions
• Enhanced consistency, transparency and transversality across individual risk drivers and
stakeholders involved in the strategic planning value chain
1
2
3
4
5
50. 4949© Oliver Wyman | SIN-ZAK05401-017
A model of the bank can help provide Group and businesses with an
understanding of scenario impacts on financial performance
Transversal view
Scenarios & Inputs Sensitivity modelling Financial impact
Macro-scenarios
Research Department
Bank strategy
Planning / BUs
Scenarios
Inputs
Budget/Plan
Finance / Risk / Capital
Parameters
Scenario results
Profit and
Loss
Balance
Sheet
Solvency
Other KPIs
(ROE, CIR…)
Modular projections
Net Interest Income
Commisions
Expenses
Expected Loss
Capital requirements
Business Volumes
Available capital
Provisions
• Top-down modelling of key performance drivers
• Reconciliation mechanisms ensure bottom-up coherence
• Synthetic reporting of key P&L/
B-S/Capital items aligned w AR
• Sourced from Bank MIS
& bottom-up models
Client model overview
51. • 10 year interest rate peaks
at 8.8%
• Home price inflation slows down
to ~6% for one year
• 10 year interest rate peaks
at 9.2%
• Home price inflation slows down
to ~0% for one year
• 10 year interest rate peaks
at 9.6%
• Home prices drop by 10%
(30% real)
• 10 year interest rate peaks
at 11.3%
• Home prices drop to -20%
(40% real)
-5
-4
-3
-2
-1
0
1
2
3
4
5
6
7
Banc-
assurance
&
Wealth
Retail
Deposit
Small
businesses
Capital -
Banking
Credit
Cards
Trading² Business
Banking
Personal
Loans
Home
Loans
Corporate
Banking
PF
Lending
VAF
EPBN
Positive Current Base Mild High stress
Structurally
attractive
Selective segments will be
attractive
Value preservation using
downside protection
Market EP under four scenarios
Positive case Base case Mild stress (1:4) High stress (1:10)
The capability to run central scenarios can assist the management of
earnings volatility
2) Trading here means Market Corporate Sales
53. 5252© Oliver Wyman | SIN-ZAK05401-017
Example structure of a successful program
1
Annual
Planning
process
2 Allocation
3 Performance
management
4 Reporting
Bank-wide RAS
Scenario planning/
top-down stress
testing capabilities
Annual
planning
upgrade
(linkage to
RAS, scenario
planning)
Capital management
(Capital allocation
framework)
Liquidity
management
RAPM framework RAPM cascading
Linkage to Pricing
strategy
Risk-adjusted
compensation
models
Reporting framework
(including risk
elements)
RAS Cascading
2-4 months 3-5 months 2-4 months 3-5 months2 monthsDuration
Exact sequence and duration would vary based on the existing capabilities of a bank
54. 5353© Oliver Wyman | SIN-ZAK05401-017
Closing remarks
• Regulation is making the efficient utilisation of financial resources increasingly important
• Risk-adjusted performance management can be a key tool to assist this, enabling
management to compare diverse portfolios on a like for like basis
• As with any single approach, RAPM has its limitations – management should not over-rely on
the power of a single number
• In an increasingly volatile financial world, stress and scenario testing capabilities are vital
• Risk, Finance and the Business have a crucial role to play in steering the organisation to
maximise shareholder value
55. QUALIFICATIONS,
ASSUMPTIONS AND LIMITING
CONDITIONS
This report is for the exclusive use of the client named herein. This report is not intended for general circulation or publication,
nor is it to be reproduced, quoted or distributed for any purpose without the prior written permission of . There are no third party
beneficiaries with respect to this report, and does not accept any liability to any third party.
Information furnished by others, upon which all or portions of this report are based, is believed to be reliable but has not been
independently verified, unless otherwise expressly indicated. Public information and industry and statistical data are from sources
we deem to be reliable; however, we make no representation as to the accuracy or completeness of such information. The
findings contained in this report may contain predictions based on current data and historical trends. Any such predictions are
subject to inherent risks and uncertainties. accepts no responsibility for actual results or future events.
The opinions expressed in this report are valid only for the purpose stated herein and as of the date of this report. No obligation
is assumed to revise this report to reflect changes, events or conditions, which occur subsequent to the date hereof.
All decisions in connection with the implementation or use of advice or recommendations contained in this report are the sole
responsibility of the client. This report does not represent investment advice nor does it provide an opinion regarding the fairness
of any transaction to any and all parties.