Enterprise risk management is not just a process credit unions utilize to mitigate and manage the negative consequences of normal business operations, it is a practice of balancing risk and profitability. By understanding and managing the critical uncertainties that affect day-to-day business, credit unions can execute the proper strategies to achieve their performance goals in a post-financial crisis era. In this 2011 NAFCU Annual Conference session you learn how to apply ERM to your corporate strategies, assure management that risks are properly identified and balance risk management and business objectives. Presented by Radu Miclaus, Senior Analytics Solution Architect, SAS Institute, Inc. More info at http://www.nafcu.org/sas

1. Enterprise Risk
Management: Balancing
Threats and Profitability
Presented by
Radu Miclaus
SAS Institute, Inc.
National Association of Federal Credit Unions l www.nafcu.org

2. “amat victoria curam”
Victory likes careful preparation. (Anonymous)
National Association of Federal Credit Unions l www.nafcu.org

3. Evolution of Industry Best Practices in ERM
Enterprise
Risk Management
Reputation
Operating
Strategic
Financial Compliance
Risk Management
Transactional
Market
Liquidity Liquidity
Market
Credit
Risk Management
Interest Rate Interest Rate
Credit Credit Credit
1970s 1980s 1990s
National Association of Federal Credit Unions l www.nafcu.org

4. Real Measures, Real Dollars
• Reduce Charge-Offs: 1%↑ earnings
• Risk-based Pricing: 1 to 2%↑ earnings
• Streamlined Underwriting Processes: 0.5 to
1%↑ in earnings
• Mitigating Operational Losses: 1 to 2%↑ in
earnings
National Association of Federal Credit Unions l www.nafcu.org

5. Regulatory Incentives
• Identifies and measures all material risks
• Relates capital to risk levels (cushion)
• States capital adequacy goals to risk
(Management)
• Assesses conformity to our stated risk
objectives (Board involvement)
National Association of Federal Credit Unions l www.nafcu.org

6. ERM Reflects the Paradigm Shift
Old Paradigm New Paradigm
• Fragmented • Integrated
• Ad hoc • Continuous
• Narrowly focused • Broadly focused
Key: Level of Sophistication
National Association of Federal Credit Unions l www.nafcu.org

7. Sophisticated Competitors Create
Competitive Inequality
• “Right” price all members
– Lower pricing on least risky/profitable
members
– Higher pricing on most risky members
• Better pricing/servicing to their best
members…
• …and to yours
National Association of Federal Credit Unions l www.nafcu.org

8. Regulatory versus Economic Capital
•Role of capital
– Institutions should have sufficient capital to protect themselves
and their depositors from the risks (credit/market/operational)
they are taking.
•Regulatory capital
– Amount of capital an institution should have according to a
regulation (for example, Basel I or Basel II)
•Economic capital
– Amount of capital a bank has based on internal modeling
strategy and policy
•Types of capital:
• Tier 1: common stock, preferred stock, retained earnings
• Tier 2: revaluation reserves, undisclosed reserves, general
provisions, subordinated debt (can vary from country to
country)
• Tier 3: specific to market risk
National Association of Federal Credit Unions l www.nafcu.org

9. Benefits of Sophistication
(We are judged by our Oversight and Controls)
• Regulators: Better, Improved CAMEL
ratings
• Ratings Agencies: Cost/Availability of
Funds
• Insurance Companies: Insurance
Premiums and Coverage
National Association of Federal Credit Unions l www.nafcu.org

10. How Do We Get that Level of
Sophistication?
• Borrow Industry Best Practices
– People
– Technology
– Processes
• Get Public Information
10
National Association of Federal Credit Unions l www.nafcu.org

11. Evolution of Industry Best Practices
Enterprise
Risk Management
Reputation
Operating
Strategic
Financial Compliance
Risk Management
Transactional
Market
Liquidity Liquidity
Market
Credit
Risk Management
Interest Rate Interest Rate
Credit Credit Credit
1970s 1980s 1990s
National Association of Federal Credit Unions l www.nafcu.org

12. Credit
People Technology Processes
• Business • Predictive • Account level
Analysts Modeling risk profiling
• Underwriting • Simulation (credit rating
Background (VaR) system)
• Statistical • Reporting • Loan portfolio
Background (multidimensio level outcome
(novice-expert) nal) simulation
• Stress Testing
• Healthy Capital
Structure
National Association of Federal Credit Unions l www.nafcu.org

13. Credit Risk Analytics (Example)
Credit Unit A is aiming to reduce bad credit charge-offs,
and improve the process of reserving and capital
structure.
Account
• PD, LGD, EAD (Data Mining)
• Credit Scorecards
• Credit Rating (IRB)
• Stress Testing (application and
Portfolio
macroeconomic factors)
• Exposure Simulation (50-th
percentile vs. 99-th percentile)
• Define Policy and Thresholds
National Association of Federal Credit Unions l www.nafcu.org

14. Market
People Technology Processes
• Business • Forecasting • Performance
Analysts • Simulation Monitoring
• Investment (VaR) • Asset allocation
Background • Performance based on risk
• Statistical Reporting profile
Background (multidimensio • Stress Testing
(novice-expert) nal) • Healthy Capital
Structure
National Association of Federal Credit Unions l www.nafcu.org

15. Market Risk Analytics (Example)
Credit Unit A is aiming to improve portfolio
performance through investment policy in order to
better meet profit goals and buffer capital structure
• Instrument/Position Level
Instrument
Exposure Calculation (MTM)
• Pricing functions
• P/L curve/ Surfaces
• Performance Monitoring
• Stress Testing (based on risk
Portfolio
factors- pricing and macro)
• Exposure Simulation (50-th
percentile vs. 99-th percentile)
• Define Investment Policy and
Thresholds
National Association of Federal Credit Unions l www.nafcu.org

16. Operational
People Technology Processes
• Business • Integrated data • Centralized
Analysts/ Risk collection and Approach
Managers process • Awareness and
• Business Unit management Mitigation
experience • Performance Action
Reporting • Outcome
(multidimensio Simulation
nal) • Healthy Capital
• Simulation Structure
(VaR)
National Association of Federal Credit Unions l www.nafcu.org

17. Operational Risk/ EGRC (Example)
Credit Unit A is aiming to improve the operational environment
through increased awareness of risk pockets and better actions
plans for mitigation and planning
• Centralized data
Business Unit
collection/reporting
• Centralized/Streamline
process management
• Ownership and
Awareness
• Event Modeling at BU level
Capital
• Exposure aggregation by BU
and Risk Type
• Capital Allocation
National Association of Federal Credit Unions l www.nafcu.org

18. Not an Initiative or a Culture Change
• It’s a New Way of Life
• It’s a Shift in Thought (not in culture):
Everyone is a risk manager, not just the
CRO
• Nurture the entrepreneurial spirit and take
calculated risks Business
Acumen
• It’s both Art and Science Goal
Achievement
Analytics
National Association of Federal Credit Unions l www.nafcu.org

19. Art and Science
“This, ultimately, is what risk management
and decision-making are all about and where
the balance between measurement and gut
becomes the focal point of the whole story.”
--Peter L. Bernstein
Against the Gods:
The Remarkable Story of Risk
National Association of Federal Credit Unions l www.nafcu.org

20. NCUA’s Risk Categories and Risk Indicators
CREDIT RISK Low Medium High
FACTORS:
Board and Operational Fully understands all Reasonably understands Does not understand
Management aspects… key aspects… risks…
Understanding
Etc.
INTEREST RATE RISK Low Medium High
FACTORS:
Board and Operational Fully understands all Reasonably understands Does not understand
Management aspects… key aspects… risks…
Understanding
Etc.
Art or Science?
From NCUA Letter No.: 02-FCU-09
National Association of Federal Credit Unions l www.nafcu.org

21. Final Thought….
• Awareness Analytics
• Expectations
Goal
Achievement
• Decisions Business
Acumen
• Executions
National Association of Federal Credit Unions l www.nafcu.org

22. Any Questions?
Radu.Miclaus@sas.com
(919) 780-8193
National Association of Federal Credit Unions l www.nafcu.org