New and complex regulations such as the Basel II capital accord are forcing banks to turn to outside service providers to manage their risk structures. Responsibility for the major risk categories — market, credit, and operational — that were once exclusively the domain of internal risk managers, is now being shared with outside entities, as banks mount a full-court press to comply with the new regulations.
U.S. banks have until January 2008 to comply with Basel II, but given the amount of work involved, it will be a race to the finish line. In 2004, the Bank for International Settlements, the governing body of the world's central banks approved the Basel II. It's intended to motivate banks to upgrade and improve their risk-management systems by requiring that regulatory capital — the funds banks must set aside to cover losses from bad loans or other problems — should be computed based on the risk factor of a bank's assets. Central to this approach is letting banks create internal rating systems for grading loans and other financial instruments, and develop advanced measurement approaches for operational risk such as the likelihood of losses caused by unpredictable events.
Banks are hooking up with service providers, who contribute domain expertise and application development technology to the effort. Zions Bancorporation, in an effort to enhance the delivery of its credit risk management systems and strengthen compliance with Basel II regulations, is implementing Infosys Technologies' credit risk management solutions delivered by its global delivery model. The agreement provides Zions’ loan officers an end-to-end web execution of the bank's existing risk rating models that supports a more strategic approach to financial risk management.
Infosys’ application development model has brought greater consistency to the financial risk management model for credit risk management solutions. "With the challenges of industry regulations and a desire to remain competitive, Zions is focused on executing the best risk assessment strategies," says Gerald Dent, Chief Credit Officer, Zions Bancorporation.
Infosys and Zions have partnered on implementing an advanced risk system that will allow Zions to gain a competitive edge. "We are looking beyond its credit risk management services to enhance our services and our cost savings," says Michael DeVico, EVP and Head of Operations/Technology at Zions Bancorporation. "Our priority is to stay a step ahead of the continuously changing market."
Operational risk management has historically been a much-neglected area. However, recent high profile losses have made the case for operational risk management even stronger. Some of the issues that organizations face are huge operational losses, inefficient processes, allocation of capital charge, and regulatory requirements.
Infosys' operational risk management solution is a platform that enables financial services firms to effectively manage operational risk based on post-event data and automating the capital allocation process to derive the required capital charge. At another level, the solution focuses on risk management through process monitoring and process redesign.
The solution comprises three major components. The risk engine supports the entire risk measurement process — managing both internal and external data, monitoring and analyzing loss events, quantifying risk, allocating capital charge, and reporting. The process monitor captures process data on a real-time basis and creates a more robust risk management framework. The third component attempts to streamline inefficient processes. More often than not, a process redesign initiative would involve multiple business activities and would usually result in the integration of numerous activities.
Analyze this
Gruppa Banca Lombardo in Italy has implemented a risk-management system developed by IBM and SPSS which combines predictive analytics and database technologies in order to achieve an internal-ratings approach for determining credit risk that satisfies Basel II, and allows the bank to ensure better capital adequacy.
Basel II introduced an internal ratings-based approach for evaluating credit risk — the risk due to uncertainty that loans will be repaid. Under the approach, a bank is allowed to make its own assessment of a borrower's creditworthiness in determining its capital requirements. However, to obtain authority to use the internal-ratings approach, internal rating models must be an integral part of the bank's procedures for credit risk control and must be broadly used within the organization.
To implement the changeover to an internal-ratings based methodology, Gruppa Banca Lombarda turned to IBM and SPSS. Clementine, an enterprise data mining system from SPASS, was used to analyze the bank's store of customer information. The software allows companies to quickly develop predictive models using their business expertise and to deploy those models into their operations. In this case, Clementine was used to build the credit risk analysis algorithms and tools that could be run against a multibank credit data warehouse from various operational sources.
“SPSS is the main solution for integration with the bank's DB2 data infrastructure and for the analytical needs of the ratings system,” says Giacomo Petrini, VP, Credit Risk. "With SPSS, we can manage both statistical techniques and data mining processes,” he adds.
A key factor in the decision to use Clementine was its tight integration with DB2, which is deployed throughout the bank. Clementine capitalizes on the performance of DB2 to increase data mining productivity and returns.
Clementine also performs critical data preparation, modeling, and model scoring tasks —all within the database. Its visual workflow interface allows users to conduct analyses so they can stay focused on business objectives.
As of end of 2006, Gruppo Banca Lombardo has deployed its own internal credit risk profile to capital requirements, established methods, procedures, and technological tools to better manage risk, achieved more effective balance sheet management, and increased efficiency and competitiveness. With the experience and knowledge gained from the credit risk project, the bank is using SPSS and DB2 to help its marketing campaigns.
Beyond Basel II
IT service providers are offering custom-developed applications that enables swift access to the often disparate, enterprise-wide information needed to meet Basel II requirements. These systems go beyond Basel II to incorporate best practices for risk management, which can aid capital allocation and improve return on capital.
HP's enterprise risk management solution provides a pre-designed data warehouse that can meet Basel II requirements, providing readily available data that's consistent of high quality, and predictive of behavior.
The physical data model is modular, enabling banks to parse large and complex projects into manageable work streams, which can then be implemented based on business priorities. The solution uses industry-standard hardware components to reduce cost of ownership. It supports leading extract, transformation, and load systems (Attunity, Informatica, Neon Systems), business performance management and business intelligence vendors (Cognos, Business Objects, Hyperion), and analytics vendors (SAS and SPSS).
HP's phased data warehouse implementation allows banks to gain business benefits and value during the implementation. This value takes the form of improved risk management, more efficient economic capital allocation, and risk-adjusted pricing. It complements and enhances compliance and reporting efforts, eliminates data redundancy, and enables faster, more accurate reporting. It also becomes a reference database, which — because its mixed workload capability enables simultaneous loading, updating, and querying — can be leveraged across the enterprise in support of more effective business decision-making and performance management.
Accenture and SAP have collaborated on a database-analytical system that offers banks compliance and high-performance risk management including tighter financial controls, reduced compliance costs, better capital management, reduced capital costs from better risk management, and improved operational efficiency.
Several Accenture-designed tools complement the SAP software for regulatory compliance. These include a Web-based Basel II diagnostic tool, compliant data model, process model, operating model, and solution map. The system's open architecture, enabled by SAP's NetWeaver platform, makes use of existing platforms.
The Basel II module helps banks meet requirements for risk exposure and capital adequacy, as well as impalement of new supervisory review and disclosure statements. It integrates internal and external credit risk management on a single platform, and supports all Basel II-specified methods for credit risk calculations, including the internal-ratings based approach.
The market risk management module supports an analysis of value-at-risk, a measure of a bank's exposure to interest-rate fluctuations. It helps banks measure and control market risk based on different simulation scenarios. The financial database provides a framework for a bank's analytical data and all related engines. Asset liability management weighs a broad range of business opportunities against the cost and risk involved, helping banks analyze the effects of interest rate and foreign exchange risks, and control revenue per period.
Next Steps
- Quantify and prioritize market, credit, and operational risks
- Seek out technology partners with proficiencies in data warehouse, risk analytics, and regulatory compliance
- Develop proactive, holistic business and technology strategies to measure and control operational risk.
