Future of Risk IT after Crisis

Impact of technology in the Risk world

kb0905 — 2011-10-27T08:52:40+00:00

Market Trends
Risk management -Strategy & Appetite definition, Identification, Assessment (valuation & Aggregation), Monitoring, Controlling & Reporting is increasingly becoming technology dependent. Both traditional and innovative solutions are swamping the market place. One side of the spectrum is specific solution providers who provide components to address specific business modules like valuation to solution providers who provide integrated holistic end to end solution for risk management. Market is seeing large buyouts , many joint partnership models are designed to enhance market penetration – solution providers are realizing that gap in offering necessarily doesn’t mean that one needs to develop the solution to address the gap, collaborating with providers who already have an offering to address the gap would enable quicker and faster market penetration.
After the 2006 Sub prime crisis, risk technology solution market is crowded with lot of offerings but clearly one needs to wait and watch to see who would emerge as a market Leader, Follower, Nicher and Challenger. Market is waiting for solution which can be quickly implementable and can integrate with ease existing technology infrastructure of financial institutions which ranges from complex technology solution to spreadsheets based applications popular among traders and risk managers.
Technology Trends
Data services offering continues to generate demands followed Bi & Analytics. Then there is big ticket item in risk technology space – Real time risk. Real time risk assessment helps in measuring risk at trade, desk, portfolio and enterprise level on a real time basis (ranges from few mins to hours depending upon the data volume and processing capabilities ) - is driving specially Tier 1 banks to invest in real time risk solution and infrastructure. Even hardware and software pure plays are focusing on how to improve on latency front with offerings like appliance approach (hardware and software offered as one stack), even Grid , in memory database are not alien to financial institutions and they are eager to embrace such technology marvel to create state of art risk solution. BI solution providers have also geared up now to offer solution like column database, Change Data Capture etc. which lead to faster processing, low latency. Middleware technology like Complex event processing are now empowering financial institutions to design portfolio strategy (buy, sell, hold) and risk assessment (what if etc.) in response to market news like natural disaster, corporate actions, mergers and acquisitions etc.
Market is also seeing great momentum in improved mathematical modeling for e.g. to measure VAR specially when model assumptions are stressed (Stressed VAR), CVAR, liquidity modeling and long tail analysis are also in limelight. Distressed asset valuation, Mortgage based asset valuation and risk assessment are finding good market post crisis.
What are the Business challenges?
Financial institutions are struggling hard to manage and measure liquidity risk. For Financial Institutions which has retail and Investment Banking arm it is nightmarish challenge to have a holistic integrated picture of liquidity risk. Counterparty risk measurement , risk valuation model incorporating CVA (Credit Value Adjustment) are also in big demand post crisis specially when deluge of regulations are waiting to unfold soon. Financial institutions have overarching challenges to implement recommendations of Basel III ,Dodd Frank act - any technology solution provider who can offer seamless and painless solution to address this future regulatory roadmap would clearly may emerge as a leader. The daunting challenge would be though to fit in the solution seamlessly with existing heterogeneous technology solutions within the bank.
Stress testing is now mandated by many regulators and financial institutions are grappling in dark to look for easy technology solution to collate and analyze huge volume data to design stress scenarios for comprehensive stress testing.

Implementing Liquidity risk IT - Road ahead

kb0905 — 2011-01-09T07:12:44+00:00

Liquidity risk implementation is giving huge nightmares to software/IT arms of financial institutions across the world. Why so? Let us first try to understand what is Liquidity risk quickly.
Funding Liquidity risk – Current or prospective risk arising from an institution’s inability to meet its liabilities and obligations as they come due without incurring unacceptable losses.
Asset liquidity risk – Risk that a position cannot be unwind or offset easily at short notice without significantly influencing the market price, because of inadequate market depth or market disruption.
Historically banks have developed and maintained large and complex standalone systems with minimal opportunity for real time data sharing. Data normally in a bank is shared asynchronously through overnight batch processing which largely results into data incorrectness and data integrity issue.
Funding liquidity risk demands data across enterprise wide be consistent and correct. Balance sheet analysis, profitability analysis, cash flow analysis form the cornerstone of such kind of risk analysis though maturity time frame defining the payment/obligation closure time frame of liabilities and obligations also play an important role in defining this kind of liquidity risk. Apart from data correctness challenge, typically data availability should ensure fresh and right data when such risk reports are run and generated which translates to the fact that data “contemporariness” is also vital to paint right liquidity scenario, stale data obtained from overnight batch may loose the “contemporariness” aspect. The normal batch architecture followed in most banks to pass data from one system to another one may not be the right solution as it can provide “stale” data specially when one intends to run liquidity reports daily or after every few hours. Real time data architecture ensures data is transferred across systems real item would be the apt solution for such kind of requirements. This kind of architecture demands more funding apart from changes in technology ,people, process approach to embrace it.

More Regulations Pain or Panaceas?

kb0905 — 2010-09-14T13:55:46+00:00

Risk Management landscape has changed dramatically after the recent financial calamity, everyday you encounter white papers , Point of View and talks by experts on what and how Risk Management should look like post crisis etc. Capital Market Industry is waiting eagerly for the new set of regulations that are going to hit their shores soon. New Regulations may be required to prevent such calamity again but are they the only remedial actions? Shouldn't the regulators be more proactive rather than being remedial and passive in their actions?

Remembering CK Prahalad , The Father of Core Competency

kb0905 — 2010-04-20T13:48:25+00:00

Looking back at the recent Financial Crisis, Risk Pundits often ponder how Risk can become an integral part of financial institution’s strategy – strategy for growth and not mere survival strategy. Extending this thought to " Risk Management as the Core Competency of a firm? ” would be interesting to discuss.
Every Bank, Financial firm is today busy redesigning their risk practice, right from Risk Identification to Reporting every stage is being observed and dissected with minute analysis. We all are busy in building new and better Risk management practice which can enable business to grow stronger and provide sustainable competitive advantage. Competitive advantage naturally attracts and leads to what C K Prahalad and Gary Hemel coined as “ Core Competency”. Going by the copybook definition in Wikipedia : “A core competency is a specific factor that a business sees as being central to the way it, or its employees, works. It fulfills three key criteria:
1. It provides consumer benefits
2. It is not easy for competitors to imitate
3. It can be leveraged widely to many products and markets.”
Can any Financial Institution or Firm stand up today and say Risk Management Practice they have is core competency for them. Right from approaching towards Risk as strategy, Identification, Valuation, Governance, management to risk reporting - Does each such step encompasses unique value proposition which competitors find it difficult to emulate or adopt.

Plausible approach to build Risk as Core Competency?

• The leadership at the top has to make its intent clear about risk as a strategy. It has to be clearly communicated across organization regularly.
• The leadership also has to align this vision with people, processes, IT systems and even align with each bit of business execution it does so that whole DNA of the organization gets configured to the new vision, strategy and its execution.
• Organization is a huge wealth of knowledge – so it is better to reuse already established best practices around risk and look for the feasibility to extend such practices to other businesses.
• Work with ecosystem – Keeping Risk as central theme for Strategy involve Board, Investors, Clients, Business Partners, Broker dealers, Custodian etc. (all key stakeholders) to co create product and service offering to the market place harnessing its core competency – better Risk mgmt. practice compare to its competitors. Strategy has to be implemented by creating an ecosystem where all stakeholders buy-in and participation are there.
Finally core competency development is not a short term goal, it is a long term investment to build sustainable competitive advantage for a firm. To build risk mgmt. as core competency it requires paradigm shift in leadership thought process as well as the organizational culture has to be tuned to new strategic changes. It demands commitment ,discipline ,rigor and passion to excel as a leader.

Transformation of Risk IT Function

kb0905 — 2010-03-21T11:46:28+00:00

IT traditionally has been supporting Risk function by providing framework for Calculation, reporting, enablement of workflow, analytic framework and Risk adjusted performance parameters. However due to enterprise data challenge and regulatory deadline pressures IT function has always been in “Catch up” mode with the changing landscape of Risk. After recent financial meltdown when the industry is taking a step back to relook and revalidate the whole risk arena, how IT solutions and products supporting Risk function would change to face the paradigm shift and challenges ahead? The IT function is expected to evolve from support function to provide more predictive model and patterns to enable more forward looking and proactive support to Risk function – a transition that would be eminent for the eventual survival of the Business.
How Predictive is Risk now ?
Perhaps the biggest hurdle a risk officer has to thwart and strategize is to overcome the randomness associated with the financial business. Risk IT department is also facing the insurmountable pressure to consolidate, rationalize and integrate all their systems and platforms but behind all these transitional changes the fundamental question that would crop up - can we have a Risk solution that can help Predict disaster before it strikes?
Can IT solution provide a predictive framework so that one can get an indication of Tsunami ahead of time?
Can we create an analytical platform which would enable detection and recognition of patterns that can give early warnings of risk events that might occur in future so that early precautions can be taken? It is like a Seismic detection system which aims to give early warnings. There are Business scenarios and indicators that can help design a predictive system.
The BCBS recommends scenarios which can definitely act as early-warning indicators, some of them are as follows:
• Rapid asset growth, especially when funded with potentially volatile liabilities.
• Growing concentrations in assets or liabilities.
• Increases in currency mismatches.
• Stock price declines or rising debt costs.
• Widening debt or credit-default-swap spreads.
• Increasing redemptions of CDs before maturity.
• Difficulty accessing longer-term funding.
• Difficulty placing short-term liabilities (e.g., commercial paper).
If we relook at the past and focus on failures of financial institutions (e.g. LTCM), the then macro and micro scenarios can potential get added to the list above. Monitoring of Intraday Liquidity and Collateral Management can also give some potential patterns as well. Analysis of market behavior can lead to detection of unusual behavior like “Herding” , “Domino effect” etc.
Eventually collection and assimilation of all these data can lead to design and build of expert system which would continuously enhance the Risk knowledge base . With the aid of this Knowledge base assessment of the current situations would be possible and can lead to issue of warnings and alerts using sophisticated workflow system to senior leadership and Board members for appropriate and timely actions. Though past is just an indication of future but such knowledge base can still provide good indications of what might come in the future. The predictive model hence would be more diagnostic by nature though eventually it can suggest remedial and self healing steps as well.
What are the impediments?
Data Challenge
Enterprise wide right data definition and accuracy continues to haunt large financial institutions. Success of such expert system and knowledge base driven approach can only be successful if right data is available at right time.
Analytic & Reporting
Complex Analytic routines would demand high system design skills. Right choice of technology stack would also be key. From my past experience of BASEL 2 Implementation for a large European Bank, I have seen 500+ reports were written by a vendor but simple report like in a single day what is the exposure the bank has globally across all asset classes for each market was missing , one needs to manually combine 4 -6 reports to get a single view like that. Later the vendor was awarded the contract of writing such “Simple” reports.
Computing power and right Infrastructure
Such expert system would require high end computing power and right Infrastructure support to make it successful.
Right understanding of the Business
Right understanding of the Business is key to develop a solution that caters the need of the Business. Poor understanding of Business and its needs results into poor functional specification and that is the single biggest source of trouble for all software solutions.
Understanding of each of the scenario, its business significance and relevance would be key to generate the right knowledge base and its applicability to the current situation.

Road Ahead
Regulators globally have already come up with scenario based guidelines so such expert system and solution is no more wishful thinking but going to be real happening in future. However one word of caution it has been seen in the past that all sweeping changes in regulations have only enhanced the revenue of technology and consulting firms in manifold but the predicament of the financial industry and eventually its cascading impact to the miseries of the world economy continues.

About Kausik

kb0905 — 2010-03-19T10:57:30+00:00

Kausik has 19+ years of IT exp.He has managed complex systems for various Capital Market clients globally in risk and regulatory space.
He is a PRM along with SII (Securities Investment Institute, UK) certified in Securities and Investment advice. Apart from this, he is a certified Stress Test Expert.
He had held senior leadership positions with Oracle,Goldman Sachs,Accenture.
Currently he is the risk and analytics product and solution engineering head for a leading Capital Market software solution provider.
You can connect with him :
http://www.linkedin.com/profile/edit?trk=hb_tab_pro_top
or at
banerjee.kausik@gmail.com