Alarm sounded on banks' risk-management frameworks
An influential survey due in late June will reveal banks are still failing to craft a risk-governance framework applicable across business units, its author said at the Institute of International Finance spring conference.
On June 21, the Institute of International Finance (IIF) will produce its third annual survey on the improvements banks have made to their risk-governance frameworks in the aftermath of the financial crisis.
Patricia Jackson, partner and head of financial regulatory advice for Europe, Middle East, India and Africa at Ernst & Young, which compiled the survey, offered a foretaste of its findings at the IIF spring conference in Copenhagen.
The banks will try to put a brave face on the report but it won’t make pleasant reading for bank regulators or investors in bank debt and equity.
First, the good news. According to Jackson: “More than half the 75 institutions we surveyed say they have changed their risk appetite at board level.”
This is the least that investors and regulators are entitled to expect, given the evident failure of the senior managements and boards of directors at so many banks to understand the risks they had been taking in the rush to drive up returns before the crisis.
Even now, says Jackson, while banks have learned to tick some boxes and many have appointed chief risk officers who report to CEOs or even jointly to boards of directors and to CEOs – rather than, as in the past, to CFOs or to the businesses – banks still have much work to do.
The bad news is that of that 50% of banks that have at least tried to define a risk appetite to board level, only 26% of those say this is impacting day-to-day business decisions being taken down through the organization.
Jackson says: “That may be because the metrics being chosen to define a risk appetite, in terms of willingness to take loss of certain amount of earnings or capital to achieve business strategy, may not allow for comparability across business units and subsidiaries. What is needed is a framework that can be allocated down through the business units.”
She adds that while many organizations are now adjusting their funds transfer pricing policy, so that the cost of liquidity is properly reflected in the risk-adjusted profitability of different businesses, most banks still have a lot of work to do in this area.
Jackson adds: “The crisis showed that banks have to supplement risk models with regular stress testing but our survey shows that implementing stress tests is still too slow and that they are still tied to capital rather than to a holistic view on profit and loss.”
Euromoney reported a year ago on worrying findings of previous IIF reports into risk IT and the proper framing of risk appetites. Beset with immediate worries over sovereign solvency, and pressing questions over which businesses to retain and which to exit in light of imminent regulatory change, the industry has not progressed far.
Koos Timmermans, vice-chairman of ING Bank, confirms that progress is painfully slow in what seems like the most basic of requirements for financial institutions: first establishing what resources a bank has to absorb risk in the pursuit of profit, and then defining an appropriate risk appetite.
“Just developing the discussion on risk appetite can take time – it can take a year,” he says, adding it is unfair to make this the responsibility just of risk committees of boards of directors. It should be the responsibility of the entire board.
Jackson says: “My view is that boards are really struggling.” She recounts a meeting with one board director who complained of being dumped with 1,500 pages of uncollated risk reports from various business units in the run up to one bank’s accounts committee meeting.
It’s impossible to work out from such a mass of data what the most important questions are to throw at senior management. An investor must surely wonder whether a bank that presents its directors with such a mass of raw data is being run by a management team that does not itself have a true picture of the aggregate risks it is running.
Regulators are also getting impatient. Daniel Zuberbühler, now a senior financial consultant at KPMG and previously head of the Swiss Federal banking Commission, says: “I wonder if we’ve gone down the right road in regulation by using banks’ own internal risk models, which may be designed to minimize or optimize regulatory capital. Their use always leads to less capital. And banks say ‘yes, that’s because there’s less risk’. Well, I doubt that.”
At another panel at the IIF spring conference, a representative of one of the ratings agencies rebuts the charge of being a pro-cyclical force amid market turmoil and guilty of tipping struggling borrowers over the edge.
He points to bank ratings, which, in many cases, are still far more generous to the banks than the market implied ratings from their CDS spreads or from their shares trading at wide discounts to book value.
Hearing the latest updates on banks’ inability to sort out their risk-management frameworks, why would banks be surprised if investors treat them as close to insolvent?