May 03, 2011
Risk expertise capacity building @ Regulators
Stress Testing, Liquidity risk, Basel III, Systemic Risk council, Dodd Frank,Financial Stability Oversight, Social media compliance...the risk oversight list continues on. With this increasing list, i often wonder how the regulators manage the increasing complexity of regulations as well as keep up with the complex world of financial innovation. The prestige associated with working at a regulatory body and the of course the breadth of exposure keeps attracting top talent. The ever increasing complexity, does require capacity building around Risk expertise for regulators. Also very critical to managing systemic risk, is the need to integrate the different risk supervision silos that exist within regulators.
Regulators are getting more creative about attracting the right set of Risk talent to enhance their risk expertise. This topic always comes up in my discussions with key regulators around the world. Over the years, I have been keenly following public news about regulators proactive capacity building of Risk expertise. In USA, SEC has a division dedicated to Risk, Strategy, and Financial Innovation - Risk Fin.
SEC Risk Fin:
Risk Fin, was created in September 2009 and is SEC's first new Division in 37 years. It is a think tank, risk centre of excellence, industry expertise all rolled into one. Risk Fin provides sophisticated, interdisciplinary analysis across the entire spectrum of SEC activities, including policy making, rule making, enforcement, and examinations.
Multi-disciplinary Think tank:
As the agency's "think tank," Risk Fin relies on a variety of academic disciplines, quantitative and non-quantitative approaches, and knowledge of market institutions and practices to help the Commission approach complex matters in a fresh light. Risk Fin has also helped in the Commission's efforts to identify, analyze, and respond to risks and trends, including those associated with new financial products and strategies. As an example, the division has assisted the agency in addressing issues related to derivatives and securitizations, proxy access, proxy infrastructure, and other corporate governance matters, and algorithmic trading strategies.
Risk Fin was also created to help break down the functional silos that typically inhibit the collective institutional knowledge and expertise.
Talent & learning hub: Since its creation, Risk Fin has recruited individuals who have corporate governance, financial, quantitative, risk management, scholarly research, and transactional expertise developed at major hedge funds, investment banks, law firms, and universities. Most have advanced graduate or professional degrees in fields such as economics, finance, law, mathematics, and statistics. The Division is also home to economists, risk analysis and data specialists, and others who worked in the former Office of Economic Analysis, Office of Risk Assessment, and Office of Interactive Disclosure. Risk Fin integrates all of the functions of those former Offices, in addition to its other responsibilities.
Risk Fin helps focus on 3 main areas:
1. Strategic beyond the tactical grind: Actively engage in considering the Risks that the Commission faces and the strategies for dealing with them.
2. Center of financial and economic expertise: A center that keeps up with the markets. Constantly learns the latest trends in market activity and new products, and disseminates across the dissemination.
products and strategies. It helps the Commission keep up with Financial Innovation.
3. Collective expertise: Help all divisions connect the dots, and to understand the economic and financial significance. RiskFin helps enhance the expertise of the other divisions, but also is an active participant in their rulemakings and, their enforcement actions.
Very commendable to see SEC being so proactive on its internal capacity building - a best practice that I am sure other regulators are emulating in different forms.
Posted by spachava at 03:53 AM
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October 08, 2009
Australian secret sauce for managing risk sprinkled with APRAs Meta Regulation !
I was fortunate enough to have short work stints in Australia (both Sydney and Melbourne), a beautiful country with its free spirited fun loving sporty population.
I continue to be amazed at the sophistication and depth of their financial markets. There is also a lot of cross pollination of global markets expertise, ideas and world class talent between London and Sydney.
Their regulators RBA, ASIC, APRA and ACCC are amongst the most proactive and knowledgeable in the world. Australia s top 4 financial groups - Commonwealth Bank of Australia(CBA), WestPac, Australia New Zealand(ANZ), National Australia Bank(NAB) rank amongst the top banks globally. Despite the crisis all round in banks globally, all of these Australian institutions remain profitable, well capitalized and well managed. The Australian banking sectors profit margin is
robust. At 1.3% of assets, Australian banks profit ratio sits in the middle-to-upper range on the international league table.
So what is Australias secret sauce?
Some of the key ingredients are:
Mortgage discipline: Securitization in lending is an Australian practice too. But banks in Australia did not adopt the US banking mortgage business model of originate to distribute.
They are more of an intermediaries with a balanced risk and reward equation. Also Australian financial institutions had relatively less or little exposure to complex structured
instruments collateralised by US sub-prime mortgages.
Too strong to fail & 4 Pillar Policy : The small number of Australian banks are extremely large relative to the size of its economy. There is a 4 pillars legislative policy that maintains the separation of the four largest banks in Australia by disallowing their merger or acquisition by any of the other four banks. This is both a handicap and an asset. But as a result the banks have also been able to withstand the takeover pressures that other banks around the world face. And all these banks have adopted a fairly robust risk management cultures, prompted by tight regulations. Australia was one of the first countries to adopt and achieve Basel II compliance for its banks. With higher capital adequacy norms, healthy capital buffers have also been an critical confidence factor for the banks.
Credit assessment standards for 3rd Party Loan Origination:
For e.g. banks can use third party loan originators. But banks must ensure that the originator applies the same credit assessment standards as the banks own. Also banks must monitor and audit loans being originated via third party for on-going compliance with its lending criteria. Additionally banks can also include a best practice of a risk-based component in the fees it pays for broker-originated loans.
Higher capital charges for Sub-prime lending:
There are significantly higher capital charges for 'low-documentation' loans since 2004. APRA has adopted a higher capital adequacy norms than most countries.
APRAs Meta Regulation approach
APRA adopts a 'risk-based' approach to regulation. Its focus is to empower and ensure that banks embed sound Risk management practices deeply across their organizational DNA. Some academics refer to this method as 'meta-regulation'.
This is backed up by risk assessments of the bank to check internal risk management processes; and direct intervention for improvements. Australia has four government agencies overseeing the financial system, namely the ACCC(Australian Competition and Consumer Commission), ASIC (Australian Securities & Investments Commission), APRA(Australian Prudential Regulatory Auth.) and the RBA. There are 'twin peaks' model with APRA as the prudential regulator and ASIC as the market conduct regulator.
Ozzie..Ozzie..Ozzie..oye..oye..oye.
(a popular cheering cry in activities, sports etc.)
Sources: My own personal experiences, APRA speeches 2009, David Lewis, GM, March 2009, John Laker, Chairman, Aug 2009;
Posted by spachava at 05:49 AM
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September 10, 2009
The Spanish approach to Risk management !
As a major European economy Spains banking sector has relatively fared well in the international financial crisis. Both Banco Bilbao Vizcaya Argentaria (BBVA) and Banco Santander (BS), amongst the largest banks in the world have done relatively well compared to their peers. Very few banks have needed capital infusion and government hand holding. Spanish banks have done quite well in past years fueled by a real estate boom. Of course as the real estate declines over the past two years and the economy is in recession, many banks do have heavy exposures to the real estate sector and are saddled with a rising rate of bad loans. The government is stepping up with a fund of up to euro90 billion (US$125.46 billion) to help banks restructure and cope with the effects of recession.
However the relatively better performance of Spanish banks is still commendable and can be attributed to below key factors.
1.Strict financial regulation environment enforced by the Bank of Spain (Banco de Espana)
2. More prudent Trading and risk management practices
3. Dynamic Capital Provisioning-Banks forced to set aside provisions during an economic boom fueled by construction and consumer spending.
4. Loan Loss Provisioning-Spanish banks have higher loan-loss provisions than many of their foreign counterparts because of the way Banco de Espana set reserve requirements.
5. Traditional banking focus-Most banks focus on traditional retail banking business and are less enamored by exotic business lines and products.
6. Spanish approach to Securitization-More for funding purpose than the most common risk transfer mechanism.
7. Strict treatment of Off Balance Sheet items-All instruments need to be reflected in balance sheets and i.e. no structured products that treated as off balance sheet items.
8. Strong on-site supervision
9. Different capital requirement for mortgage loans depending on their loan-to-value ratios.
In many countries across the world, banks are required to increase reserves as losses increase and allowed to decrease reserves as profits rise. This setup increases bank lending during economic boom periods and decreases lending activity during downturns, a cyclical tendency.
Banco de Espana sets reserves based on an weighted average of a banks assets, with the weights determined by past default frequencies for different asset classes. The hypothesis is that historical default frequencies will accurately reflect reserves going forward. This presumes that the historical record provides a good indication for distinguishing between cyclical and more permanent components of loan performance.
We already see many countries starting to look at dynamic provisioning as a best practice. Of course the issue with dynamic provisioning is that its compatibility with IFRS needs to be handled.
Here again Bank of Spain has led the way to find common ground with accounting standards.
So hats off to Spain for showing the way for prudent banking via solid commonsense risk management.
Sources & Acknowledgements: BBVA Economic Research Working Paper,Feb 2009-Dynamic Provisioning and other tools, Banco De Espana, Financial Times, Financial Week.
Posted by spachava at 10:25 PM
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