1. Risk Management: Critical Success Factors M. Jayadev Indian Institute of Management, Lucknow 28 th November 2005 jayadev@iiml.ac.in 7 th Bank Educationists’ Conference 2005, November 28 th and 29th

2. Risk Management: Conventional thinking Risk management is perceived as a cost center whose primary purpose is the reduction of financial risks that are seen to be undesirable virtually ‘a priori’. It is viewed as a necessary evil

3. Risk Management: Modern approach Banks leverage their internal risk management processes into potentially significant efficiency gains and new product development opportunities. Risk is a vital component of business and critical source of innovation and growth

4. Risk Controllers Efficiency Enhancers Risk Transformers Effectiveness of Internal Risk Management Processes: Three Business Models

5. Classical Risk Controllers Risk management as a cost center More focused on minimising the gaps between actual risk exposures and target risk exposures (examples: gap reports, exposure norms)

6. These firms significantly emphasis on VaR policy measures, hedge ratios, collateral management etc.. Third party services on risk management and risk transformation products, and services often meet the risk management needs. Suppliers of risk transformation solutions are swap dealers, clearing houses, exchanges, derivative instruments etc.. Significant amount is spend on consulting services and on consulting firms.

7. Efficiency Enhancers Focus on strategy of risk management rather than on tactical implementation issues. Use of risk control tools not just for classical risk control but rather to operate their businesses more effectively. Paramount importance on strategic consulting services rather than pre-canned software solutions and over used policy and procedure templates.

8. Risk Transformers Risk management is viewed primarily as a business opportunity.

9. Risk management: Critical Success Factors Corporate Governance Line Management Product Management Customer Management Knowledge Management

10. Corporate Governance Risk appetite and policy Organisational Structure Risk culture and corporate values

11. Corporate Governance Sound internal risk management process requires independence of risk management decisions from risk taking activities to preserve the integrity of the risk management processes. Governance characterizes the relation between that internal risk management process and new business opportunities.

12. Incorporate economic value, risk adjusted returns and expected losses in the performance metrics. Better information about economic profit and incentives built around economic profit are expected to lead to value adding behaviour.

13. Key success factors for a sound governance process include: a) independence between risk-taking and risk controlling areas of the firm; b) clear determinations of risk tolerances by senior managers, and directors; c) regular outside reviews of the process

14. Role of Senior Management To coordinate the risk management process in a way that limits risk while eliminating duplication of hedging, controls and costs To design incentive system that encourages line managers to carry out the corporations’ risk management goals

15. Line Management In commercial banking risk management is a multilayered process, with each manger down the chain partly responsible for his/her portfolio of assets or risks, and senior management overseeing the process from the top.

16. Line Management: Key sources of conflict Offense Vs Defense Policy and Policing Partnership

17. Line Management: Key challenges Conflict resolution between line and staff Incentive alignment Introduction of non-financial risk measurement

18. Product Management Risk transformation products (including trading and clearing products) Advisory services: Includes consulting services provided concerning any aspect of a risk management process, as well as transaction structuring advisory services Decision support systems; which have wider applications to the risk management process.

19. Product design: Assessing the risk profile of the customer and his willingness to pay for that risk profile. This is essentially risk- based pricing.

20. Customer Management Exploring the opportunities for economies of scope and riding on the informational advantage through multi product dealings with customers. Balanced alignment of corporate strategy, operations and culture

21. To whom do we sell risk management products and services? What specific risk management products and services do we sell? With whom do we compete? How do we win?

22. Leverage the internal risk management processes to an external set of products and services. For this shift, banks have to organize itself for success, drive attitudes and behaviors within the firm to organize itself for success, drive attitudes and behaviors with in the firm toward a new strategic customer-centric vision, and fill any critical skill gaps.

23. Operational excellence of the risk management process is probably the key ingredient to sound customer management

24. Knowledge Management Organisational learning involves joint contributions of individuals towards organisational problems. The ability to learn depends on experience, ability, and, actions of individuals

25. It is not alone metrics and data are important, but the quality of dialogue between the top management and managers around risk variables. Value from risk management system is generated out of this dialogue. People at all levels should understand interactions among the business units

26. Dialogue among various parts of organization is essential and it is part of organizational reengineering.

27. Knowledge Management: Dimensions Content Process Culture Infrastructure

28. Content Which knowledge is relevant for strategy and ongoing operations. The goal of knowledge management is to determine critical knowledge requirements for achieving strategic goals and improving operational efficiency. How the models are being applied and the lessons learned by line offices while using the models.

29. Process Defining and redefining objectives Creating and updating knowledge Storing and disseminating knowledge Assign tasks and responsibilities of knowledge management Define new roles like, knowledge sponsor, knowledge integrator or steward, knowledge base architect, and knowledge base administrator

30. Culture Corporate culture should support the creation and exchange of knowledge Knowledge management must ingrain into the culture of the firm that risk is vital for business, innovation, and growth and risk management is a source of opportunity as well as a means of maintaining the required internal controls.

31. Infrastructure Define the requirements for IT infrastructure Integration of knowledge management tools in to IT infrastructure

32. Board-Approved Policies and Procedures, and Business Goals Governance Communication Between Risk Management and Business Lines Knowledge Management Enhance Customers Relationship Management & Communication Customer Management Product Management New Product Financings to Exploit Internal Comparative Advantages Control Risk Oversee, Audit Tune, and Realign Identify Risks and Determine Tolerances Measure Risks Monitor and Report Risks Efficiency Enhancers Risk Controllers Risk Transformers The Risk Culture of a Firm Business Processes Examples of Outcomes Source: The Risk Management Process, Christopher L Culp page 224

33. References Christopher L Culp, The Risk Management Process: Business Strategy and Tactics, John Wiley and Sons, 2001. James Lam, Enterprise Risk Management: From Incentives to Controls, John Wiley and Sons Inc, 2003 George Dallas (ed), Governance and Risk, McGraw Hill,2004.

34. Thank You