Risk management: Whose money is it anyway?

Capital is key to financial institutions, as its primary function is to cover unexpected credit and market risk losses. The global financial crisis highlighted the need for broadening risk outlook from managing market, credit and operational risks, to focusing on liquidity and reputational risks while formulating business strategy.

Basel II attempted to create an overarching framework that enabled banks to make provision for risk-taking activities through buffer capital, and strengthen the internal risk and control framework. It also helped financial institutions re-think their processes and solutions for risk and capital management. However, with the unfolding crisis in 2008, there arose a need for robust buffers against not just entity-wide risks but also systemic shocks. With the introduction of Basel III norms (through capital and liquidity reforms) there has been an attempt to provide a more comprehensive framework for integrated risk management.

In India, the banking system, on the whole, is well capitalised. However, migration to Basel II, involving establishment of sophisticated risk management systems and enterprise-wide risk and control framework, will be slower amid several challenges.

Human resources

Top priority should be given to induct a continuous learning process on risk management for line managers. As stated by RBI Deputy Governor K.C. Chakrabarty, this would be a “retirement decade” for public sector banks, with thousands among the senior workforce set to retire by 2020. Banks need to develop an effective knowledge management framework to help retain the tacit knowledge of the retiring employees. Initiatives such as a “No Transfer” policy up to five years for critical departments such as risk management will help stabilise the function. Furthermore, it is necessary to acquire the right people, and introduce various employment options such as part-time and contractual workers. This is both a challenge and an opportunity to transform HR processes and implement modern concepts.

Leveraging technology

Banks need to move beyond the core banking systems and assimilate innovative technology to improve and facilitate risk management processes. Data collection and analysis is vital, but the current infrastructure is inadequate for accurate monitoring and aggregation of risk exposure across the business. Integration of systems across silos and accurate assimilation of data within departments can help build a pool of quality data for effective risk management. Banks need to review existing technology, build controls, and integrate data flow to limit risk exposure.

Data Management

Risk management is supported by data-intensive analytics. Accurate, reliable and timely data is crucial to the development of predictive statistical models around credit, market and operational risks. However, the integrity and timeliness of data is a major challenge. The end-users should be functionally well-versed with the systems — for example, a risk rater should be conceptually clear about the data and process flow to avoid errors. A data warehouse can be leveraged using data mining techniques to help provide affordable and customised customer-centric banking solutions, and enhance risk management.

The biggest challenge is that of the mindset, which limits risk management to merely a compliance exercise. Indian banks are realising that risk management has to be looked at as a critical investment. An efficient and effective risk management framework helps in capital management, and reduces the likelihood and impact of losses (not just financial liability but reputation loss as well). With the Indian banking industry projected to grow exponentially and the risk contours constantly evolving, an enterprise-wide, sophisticated risk management framework is imperative.

Abhay Gupte is Senior Director, Deloitte Touche Tohmatsu India Pvt Ltd

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