Risk Management, PRMIA

December 11, 2011

EBA recapitalization results - EU set for a busy 2012 start

EBA (European Banking Authority) recapitalization results were released on 8th Dec, influencing some markets and surprising some banks.

It is important to note that this exercise was not a new stress test, but an update of the Oct Stress test results with current bank holdings data. In this excercise, no adverse macro-economic scenarios were applied to the figures provided by the banks.

It is certainly going be a busy start to 2012 with the Jan 20 deadline for the banks shortfall makeup plans to their respective national regulators.

The Oct. capital were indicative only based on banks estimates on capital positions and sovereign exposures. In this exercise, EBA used banks capital positions and sovereign exposures as at the end of September, rather than June estimates used in Oct.

On a related note, many banks are still in early stages of adoption and fine tuning of the new tougher Basel, CRD3 method of assigning & calculating the increased risk weights for Trading book. This exercise did reduce capital for some banks that sold off assets and retained higher percentage of their earnings.

Results:
- The overall capital shortfall was euro 115bn, nearly 8 percent above Oct estimate of euro 106bn.

- 71 percent of Europe’s banks are required to boost up their Tier 1 capital ratio to a new 9 percent by end of 2012 June.

-Some of individual countries are listed below by the decreasing order of capital required:

Greece: 30bn
Spain: 26.17bn
Italy: 15.4bn
Germany: 13.1 bn(6 of 13 banks tested)
France: 7.3bn (4 largest banks)
Portugal: 6.95bn (4 largest banks)
Belgium: 6.1bn
Austria: 3.9bn
Cyprus: 3.5bn

Way Forward for impacted banks:

- Jan 20, 2012 deadline to submit a "shortfall makeup" plan to respective national regulators
- End of June 2012 deadline to achive zero shortfall

Along with results, EBA also issued guidelines for bonds-Buffer convertible capital securities(BCCS)-a type of unsecured debt that converts into stock once capital trigger is breached. BCCS issue has very strict criteria.EBA is classifying bonds as a type of hybrid tier 1 capital.A banks overall capital can count these bonds.Some of the measures that the banks could adopt: Stop and or reduce dividend payouts; Convert capital on their balance sheet into equity.Contingent capital or coco, bonds could be an option too for banks.

Research sources: EBA, Financial Times

Posted by spachava at 09:20 PM | Comments (0)

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 | Comments (0)

February 23, 2011

2011 Risk and Compliance Initiatives - Top 10 List!

Picking up the thread again after some heavy lifting around our overall approach to Risk technology. I will share more on above in due course. Based on my discussions with companies around the world, following are my top picks for 2011 initiatives:

1.Basel III consultations for global/ EU based firms
2.New Liquidity Risk requirements for UK, Australia based firms
3.Dodd Frank Reform and Consumer Protection Law - interpretations and implications for US based firms
4.Basel II, IFRS for those countries that are on delayed timelines
5.Solvency II for Insurance companies
6.Electronic discovery (e-discovery) for US and global firms
7.Expanding and executing Operational Risk/Enterprise Risk Management initiatives
8.Technology Risk - Potential Cloud based business models
9.Reputation Risk - Social Media usage for business
10.Environmental Sustainability & Compliance – Green IT

What do you think ? Am I missing something major ?

Posted by spachava at 03:10 PM | Comments (2)

September 08, 2010

Future State of Risk & Compliance 2010 global benchmark survey

Today PRMIA & Microsoft jointly released a 2010 survey on global trends and industry view of future of risk management and compliance.

Big thanks to all of you who participated in this and to the PRMIA team (Marietta Ruppe,Cheryl Buck,Janet Tritch, Steve Lindo,Geoff Kates) for their support and help to put it together.

This survey provides a benchmark to risk and compliance practitioners across both financial and non-financial sectors.

I was privileged to be involved in structuring this PRMIA survey in my pro-bono capacity. It was about defining the future vision, blueprint and game changers for next-generation risk management practices. The main tenet being to uniquely capture the broader pulse of the risk profession beyond specific regulations, and which included future vision, game changers, productivity, and a generational shift in talent pool and technology.

The survey responses clearly confirm the global demand for easy-to-use automation and analytics, and validate the focus on solutions that automate and simplify governance, compliance and risk management.

As per responses, a sign of the enhanced work pressures and real-time turnaround is being reflected in a consistent focus on productivity and efficiency in Risk and Compliance functions across many areas to save valuable time and effort.

Responses also indicated a shared vision towards enhanced productivity and efficiency in future risk and compliance workflows. There is a clear sense of pain around being asked to do more with less. Most respondents expressed a future vision where they are able to spend more time on strategic and proactive risk mitigation activities, rather than on time consuming tactical tasks like data aggregation.

On technology front - Ease of use, flexibility, self-serve and integration with current environment were key expectations, along with the need for enhanced decision support, predictive analytics and high performance computing in the processes. Also implicit was the role of technology enablers to enhance productivity and efficiency in the workplace. Tools like risk computing via cloud start to become real.

On potential game changers, being an open ended question, there was a predictably a wide range of response. The top categories of game changers were new regulatory concepts, risk approach and next generation risk computing. Whilst I will cover the detailed results in next few blogs, some of the key areas covered in the benchmark survey are:

- Vision and pulse of the profession
- Empowerment and culture
- Generational shift in the risk talent pool & skills
- Future trends in Risk and Compliance
- Future vision of a Risk and Compliance workplace
- Budgets, Investment Expectations
- Technology Predictions
- Game Changers

PRMIA Seattle will be holding an event/webinar to discuss the results with the members. You are welcome to join in.

I certainly look forward to your comments & feedback.

Sai Sireesh
co-RD,PRMIA Seattle

Posted by spachava at 02:19 PM | Comments (0)

August 10, 2010

Top 6 Basel III Design Elements

Regulatory Blueprint - Top 6 Basel III Design Elements !
Let us start learning LR, LCR, NSFR, Capital Surcharge,Gone Concern! A mouthful isn't it?

Well, Basel III is coming our way sooner than expected ! The much awaited (do I hear a groan!) Basel III regulation is getting its final touches.

The Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, met on 26 July 2010 to review the Basel Committee's capital and liquidity reform package. The BIS with G20 consultation is driving the Basel III release by November 2010 with an implementation start by end 2012.
The deadline for final institution level Basel III conformance though is expected to be around 2018.

Their focus is on
- quality, quantity, and international consistency of capital
- to strengthen liquidity standards
- to discourage excessive leverage and risk taking
- and reduce procyclicality

In general banks will need to hold more capital and manage liquidity better to withstand economic and market events. The global regulators are reviewing a new bank's Tier 1 capital requirement from its current 4% level.

Another key decision awaited is the timeline for banks to exclude lower quality capital from their capital calculations.

Whilst the regulation is still evolving, some of the design elements of Basel III at high level are:

1. Definition of Capital - Tighter definition of top quality capital with a capital buffer range with capital distribution constraints around it
2. Treatment of Counterparty credit risk-Capital buffers
3. Leverage Ratio - Cap on debt via Leverage ratio; Definition and Transition; 2011start; Parallel run Jan 2013-Jan 2017; Disclosure starts Jan 2015; Migration Jan 2018
4. Regulatory Buffers, Provisions, and Cyclicality of the Minimum
5. Systemic banks, contingent capital and a capital surcharge
6. Global liquidity standard-Liquidity Coverage Ratio(LCR), Net Stable Funding ratio (NSFR)- Measure of long term liquidity but with diluted initial pilot of 1 year Horizon liquidity buffer

Some of the industry concerns are already addressed in Basel III. For e.g. less stringent treatment of deferred tax assets and affiliates for calculating capital, longer phase in for new liquidity rules and cap on debt. These specially help many banks gain time to raise vast amounts of funds and a more considered roadmap for their minority stakes.

Basel III originally proposed a ban on banks counting capital held in affiliates as part of their own holdings.This did trigger concerns of a freeze in acquisition of minority stakes or sell-offs to avoid the need for extra capital. Banks will now be able to include capital from minority-held companies up to a certain threshold. Basel III has included top rated corporate debt in short term liquidity buffer. The industry and regional concerns about including only government bonds being considered. For. e.g. many countries such as Australia with strong public finances do not have enough government debt for local banks to buy.

For those of you wanting to dig deeper, you can download the document from http://bis.org/press/p100726/annex.pdf
Look forward to your thoughts and comments.

Source; BIS, Reuters, Bloomberg

Posted by spachava at 05:59 PM | Comments (4)

July 28, 2010

Stress Testing - Measuring Systemic Risk across the globe

Last year EU was exploring a Systemic Risk Council to manage risks better across the EU. A small but significant step towards a consolidated EU Systemic Risk management is the recent round of Stress Tests in EU .

As we know, the US banks underwent a similar round of Stress testing exercise early in 2009. 10 out of 19 big US banks were required to raise a combined $75billion in capital after the stress testing results.

On Friday, CEBS released the stress tests results that subject each banks Tier 1 capital projections until end 2011 to worst case scenarios.

The tests were conducted on 91 banks across 20 countries. Only 7 out of 91 banks in EU failed the tests. EU banks need a total of 3.5 billion euros ($4.5 billion) to boost their capital reserves, much lower than expected. Given the diverse nature of EU states, there were different measures in different countries around some of the assumptions for the shock scenarios around recession, unemployment rates, property values, during economic and financial storm.

A total of 7 banks failed the tests - 5 small Spanish banks, Germany's state-rescued Hypo Real Estate and Greece's Atebank. There are 17 banks that met the borderline 6-6.9 % Tier 1 capital in the worst case scenario. There were 15 banks each on 7%-7.9% and 8%-8.9% range. There were 13 banks in 9% - 9.9% ratios, and 24 banks with 10% or higher Tier 1 capital ratios.

Spain, of course led the drive for transparency, and conducted much wider tests of its banking system and more disclosures. Other major economies are exploring stress testing too as a confidence boosting as well as systemic risk measures, for e.g. Chinese regulators are expected to conduct industry wide stress testing. Investors and analysts can also run their own risk simulations based on the detailed breakdown of the banks exposure to the sovereign debt of EU and other countries.

It will be interesting to see how soon other countries conduct their own industry wide stress testing to reassure the markets.

Posted by spachava at 11:02 PM | Comments (0)

June 08, 2010

Regulatory Vision 2020 - Top 10 list

I am a keen follower of the Australian regulator APRA that in my mind certainly ranks amongst the thought leaders in regulatory thinking. APRA has been at the forefront of many new regulatory concepts and pro-active adoption. Its current focus is on 3 major areas - Financial stability and systemic risk, Group Supervision, Remuneration. Their approach to reform being best captured by how they term it : just right - not too much, not too little.

Below is the my list of 10 areas that will serve as foundation for APRA 2010-2020 blueprint. This list is based on my reading of their consultative papers and speeches in 2010. In my humble opinion this could well serve as the top list for other regulators too.

1. Twin Peaks model - Continued enhancement and evolution of the twin peaks regulatory model- APRA (Australian Prudential Regulatory Authority) and ASIC (Australian Securities and Investments Commission)

2. Risk of Complacency - Proactive watch against risk of complacency by maintaining the intensity of supervisory rigor in their own activities as well as industry

3. Financial stability and systemic risk - APRA has an active role in the G20 Financial Stability Board as well as IAIS coordinated Financial Stability Task Force to review principles around - quality of liquid assets, longer survival horizon, longer-term funding

4. Inherent pro-cyclicality in prudential frameworks

5. Means to address the too 'big to fail' problem

6. Concept of macro-prudential supervision and surveillance

7. Effective cross-border cooperation

8. Group Supervision - legislative power, effective regulatory
frameworks, supervision capability for conglomerate groups

9. Risk Management oriented Sound Remuneration Policies and related Prudential Requirements

10. MOU on financial distress management with other regulatory bodies- both within country and cross border.

I have tried my best to capture the essence of their thinking, let me know if I have done full justice to their thought leadership or not!

Source: APRA consultative papers and speeches:
-Role of the Prudential Regulator 2010-2020, Helen Rowell, GM, Policy Development
-Reform of Global Banking Regulation -Wayne Byres, Exec. GM, Diversified Institutions Division
-Regulatory Update 2010- John Trowbridge, Executive Member, APRA

Posted by spachava at 08:53 PM | Comments (1)

May 22, 2010

Pro-active Systemic Risk mitigation by German regulator Bafin

There is increased speculation against euro, over concerns of euro zone sovereign debt levels triggered by the Greek debt refinancing crisis.

The euro has already hit a four year low of $1.2209. As expected and predicted in one of my earlier blogs, this crisis is forcing the shift much more aggressively towards water tight regulation mode from light touch supervision mode to ensure market stability, transparency & systemic risk management.

This week the German Federal Financial Supervisory Authority (BaFin) temporarily prohibited naked short sales of euro debt securities, naked short selling of shares in 10 leading German financial institutions, and naked transactions of credit default swaps (CDS) linked to euro govt. debt. The bans apply from May 18 2200 GMT to March 31 2011, 2200 GMT. This does not impact transactions in the specified shares that are backed by securities lending.

The 10 firms being:
-Aareal Bank AG
-Allianz SE
-Commerzbank AG
-Deutsche Bank AG
-Deutsche Boerse AG
-Deutsche Postbank AG
-Generali Deutschland Holding AG
-Hannover Rueckversicherung AG
-MLP AG
-Muenchener Rueckversicherungs-Gesellschaft AG

Earlier in March, BaFin also issued mandated that market participants notify it of any net short-selling positions in the same financial stocks of a threshold of 0.2% or more and publish the same of a threshold of 0.5% or more. This allowed BaFin to intervene sufficiently in advance and swiftly, against short-selling transactions that may trigger systemic risks. The provision provides for a two-tier transparency system: first, net short-selling positions of 0.2% or more of the shares in issue of the specified companies must be notified to BaFin. Further notifications are required when such positions reach, exceed or fall below a further 0.1% in each case. In addition, a publication of the position in anonymous form on the homepage of BaFin for 0.5% or more.

This decree, aligns to the proposals published on 2 March 2010 by the Committee of European Securities Regulators (CESR), that include Bafin for a pan-European transparency system for net short-selling positions. Paris-based CESR role is to coordinate national market regulators and make policy recommendations to the EU on securities regulation.

I was expecting other EU block nations to synchronize or follow suit for a wider impact, but has not happened yet. But there are similar discussions or measures in place in selected EU countries. Austria’s finance ministry is calling for talks on long- term regulation of credit-default swaps and naked short-selling of sovereign debt. Portugal restricts naked short-selling as far back as 2008 onwards. France and Austria restrict short selling of financial shares from 2008 onwards. Germany, along with the U.S. and other EU nations, has also banned short selling of banks and insurance company shares in 2008. BaFin had lifted its ban in January and reinstated it back now.

Certainly many more regulatory changes are coming (todays USA reforms proposal) but for this particular regulatory effort, my key takeaways are:

1. Underscores the challenge the ambitious new EU Systemic Risk council will have in executing its charter & blueprint to manage systemic risk across EU.
2. Perhaps there is a regulatory arbitrage opportunity given that the ban applies to deals executed on german market? Maybe not, but we shall see.
3. Surveillance Technology - I will be talking to my middle office/market risk contacts to see how the front office trading control rooms/compliance process works to handle the naked short sell ban for specific instruments. Beyond manual instructions to Money market, Equities, & Structured Products desks & traders, would firms look at front office trading systems technology to enforce automated alerts against trades? would they use pre-deal positions limits? Would an automated rule trigger a Bafin reporting flag alert if positions breach the prescribed bands ?
4. Increased pressure on governments to pass regulations against speculative practices
5. Traders with fat fingers being asked to tend gardens & stay away from trading floors (just kidding but an entirely plausible solution !)

Research source: Bafin, Reuters, Dow Jones, Bloomberg

Posted by spachava at 04:59 AM | Comments (0)

March 12, 2010

Future of Stress Testing - UK FSA and EU CEBS lead the way !

Earlier I had blogged about the pendulum shifting away from the light touch supervision mode to a much more prescriptive regulatory environment.

The new stress testing guidelines in Europe seem to be good indication of the trend. With most stress testing models failing to reflect the current crisis, many regulators are reviewing the stress testing guidelines and methodology. Typically in most markets, the stress testing is performed at 3 levels;

1.Institution level
2.Regulator stress testing of an institution
3.Industry wide Systemic level stress testing

Most of the changes focus on the first level of stress testing within institutions, but there is certainly thinking on other 2 aspects as well.

Purely going by the headlines, the Risk Managers in Europe must be quite stressed by the ongoing consultations around stress testing regulatory mandates. Let us look at CEBS & FSA in this blog;

CEBS Stress Testing guidance:

The new stress testing guidelines need to be carried out at portfolio, business and firm-wide levels, with specific focus on senior management and board-level engagement. They have to make sure the testing is sufficiently severe and in tune with overall strategy.

A key question to evaluate for the industry is whether it is realistic to expect the boards to have the expertise to oversee, challenge and approve stress tests, given the "quantitative “ aspects.

The guidance, to be used under Pillar 2 of the Capital Requirements Directive within the Internal Capital Adequacy Assessment Process (ICAAP) and the Supervisory Review and Evaluation Process, does potentially create duplication with the requirements proposed by national supervisors, and those within Pillar I. a good example being liquidity risk.

Another key concern is the recommended June 30th implementation deadline for complying to the more regulated stress testing methodology. Is too much prescriptive guidance good or bad? I do not know the answer. Does it start to negate the principle that every institution is best managed with their respective Risk models fine tuned to their business model ? We will have to watch and see, what the industry responses are to the consultations be end March.

FSA Reverse Stress Testing guidance:

For the first time, banks will need to implement reverse stress testing methodology that will help identify and assess the conditions and scenarios that will most likely impact its business viability and lead to its collapse.

So the banks will have to trace back from the worst case scenario possible to zero down on factors that led to the expected point of collapse. As a result banks are expected to be able to identify the highest risk factors and exposures of their current business models.

The FSA stress testing guidance is also revised to make it much more integral part of risk management accountability at sr. levels. And banks are expected to build/enhance a robust stress testing and scenario analysis infrastructure to assess capital needs in a crisis environment.

So Risk Managers, get busy refreshing your 101 training material for stress testing courses for your Board.

Posted by spachava at 06:26 AM | Comments (0)

January 08, 2010

Risk 2010 - Trends to keep in view

Happy 2010 to readers. Many in Risk Mgmt profession welcome 2010 with a sigh of relief, considering the financial markets turmoil and the resulting broader economic impact in 2009. So what can we in the Risk Mgmt profession look forward to in 2010?

As a passionate follower and student of global Risk mgmt practices, I see the following trends based on hands-on projects as well as close observation of how different firms are approaching risk mgmt posrt 2008-2009;

1. Risk Mgmt has become much more people centric. The dependence on quant models will obviously continue but no more blind faith in black box models, without knowing its internals.

2. Focus on organization wide employee buy-in for Risk mgmt practices at all levels i.e. Risk is really everybody's job.

3. Cross company collaboration as a key pillar of how companies manage enterprise wide Risk

4. Percentage of firms taking a more strategic and longer term view of Risk Mgmt practices will rise.

5. Emergence of more IT savy self serve Risk Mgmt power users who will be grow even more adept at sourcing and conducting their own analytics rather than rely on IT deptt. to spoon feed.

6. Liquidity risk and Asset Liability Mgmt back in focus

7. Risk computing via cloud becomes real

8. Closer link between pricing and clearing in Credit derivatives and move towards use of clearing houses for CDS & OTCs.

9. More regulators/supervisors will shift to the heavy handed approach to Risk exposures vis-a-vis the light touch.

10. Goldman Sachs Risk professionals will be in even more high demand!

Posted by spachava at 04:52 PM | Comments (2)

December 24, 2009

The humbling rollar coaster ride for Risk in 2008-2009

It has been a humbling roller coaster ride for Risk Management globally in the past one year.

For some it has been plain scary to see the failures of much vaunted risk management capabilities, for some it has been life changing in terms of job losses and for some it has been just tremendous learning. I believe it has also been particularly humbling for all in the profession in many ways.

Some of my thoughts from Hyderabad, India as I wind down the year 2009. Merry Xmas, happy holidays and happy 2010 to all of you!

Without getting too deep or technical within Risk management practices, I make broad observations on the changes and impact for the Risk world. So what was reset in past one year?

1. Shaking up of the Wall Street/global centers - New York, London, Frankfurt have always been epicenter of global finance. But in many ways 2009 has been humbling for many global giants in these centers to revert to government bailouts - a concept that has always been scoffed at by Wall street traditionally. which is what promted me to look at other financial centers in my blog as leaders in managing risk better - Canada, Spain, Australia, Asia etc.

2. Banking book risk - Back to basics- For too long has the exotic world of trading book been the focus for risk mgmt and maybe rightly so. But it is now also back to basics for banks - Managing Banking book liquidity, credit risk, credit discipline, mortgage basics, loan to value ratios etc.

3. Investment Banking entities - Did 2009 sound the demise of true blue investment banks as separate entities? I do not know the answer. With Goldman Sachs record profits, maybe not.

4. Large scale layoffs impacted Risk Mgmt too - This one is a very strange one. Faced with harsh economic realities, the broad brush approach to cost cutting & layoffs impacted many top notch risk managers. Very surprising considering that this was the time I thought firms would really want to retain their top risk managers. But apparently was not the reality, judging by the considerable time I spent connecting friends in risk community and providing referrals. I will never understand this one.

5. Doing more with less - Related to above point, I also saw Risk Managers (and actually everyone who were left behind post layoffs) under tremendous pressure to do much more with much less. I call out Risk managers especially as post crisis, everyone wanted to demonstrate they were on top of managing risk.

As I blog on this topic, so many thoughts jump at me, I could very easily write a doctoral thesis. But one of my 2010 resolutions is to be short and crisp so this last of my 2009 blogs will bear the brunt of being cut short abruptly. Let us see if i stick to my resolution in 2010.

Wishing you a productive and prosperous happy 2010 year!

Posted by spachava at 08:49 PM | Comments (0)

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 | Comments (0)

August 08, 2009

Risk Management & Regulatory frameworks - The Canadian Loonie Way

I often refer to FSA, Fed Reserve, APRA, ECB, MAS in my blogs. During my ongoing research on next generation regulatory and supervision frameworks, I start to identify some of the leading economies where financial institutions managed their risks comparatively better. Canada, worlds second largest country by area is on the top of my list. In this blog I cover off some of the Risk management practices & the supervisory framework in Canada. A free spirited multi cultural country, C$1 and C$2 coins are referred fondly by its citizens as the loonie and twoonie respectively. The one dollar coin has a image of a Canadian Loon; the two dollar coin has an image of a polar bear.(thanks to Greg Keeling from BMO, Canada for his insights on the terms loonie & twoonie).

OSFI (Office of the Superintendent of Financial Institution) or BSIF(Bureau du surintendent des institutions financieres Canada) supervises all the Canadian financial institutions. Some of the differentiating factors and broader learnings and best practices from Canada being:
1. OSFIs razor sharp mandate & focus on Solvency vis-a-vis competitiveness of the financial sector
2. Gross Leverage ratio
3. Quality of Tier 1 capital
4. Treatment of High Loan to Value ratio
5. On-site supervision
6. Through the Cycle estimates under Pillar 2

1. OSFIs razor sharp mandate & focus on Solvency vis-à-vis competitiveness of the financial sector-OSFIs single point focus is on Solvency of its financial institutions. It is relatively less saddled with the financial sector competitiveness that other supervisors routinely are required to balance for their respective financial centres.

2. Gross Leverage ratio to limit Leverage- Many countries have woken up to the need for constraining bank leverages and the promise of a gross leverage ratio for banks to do this. Canada for a long time already has this in place through its maximum assets-to-capital multiple. OSFI has been using a leverage ratio, on top of risk based capital to ensure solvency even when risks are not measured with 100% accuracy.

3. Quality of Tier 1 capital-75% of Tier 1 capital has to be in common shares and targets of 7% Tier 1 and 10% total capital.

4. Treatment of High Loan to Value ratio-All high Loan to Value ratio loans need to be insured either by a government agency or agency with a government guarantee.

5. On-site supervision-High reliance on the robustness and rigor of the On-site supervision. Still regulatory mode and not light touch supervision as in other firms.

6. Inspirit adoption of Basel II by 2007 and special attention to Through the cycle PD estimates-Canadian banks were Basel II ready by 2007 and encouraged to adopt Basel II in spirit and not as a tick mark exercise. The local banks were able to avoid capital requirement spikes by developing through-the-cycle estimates of probability of default and other measures. This is particularly a key learning for those banks that experience capital requirements spike due to limitations of their approach that was focused on Point in-time PD estimates. This can make system less pro-cyclical and or more counter- cyclical.

7. Some of the other areas where OSFI is taking a lead are-Loan Loss Provisioning, Compensation, Constitution of Risk experienced/aware Boards members, Macroprudential Monitoring, Macroprudential Calibration of Policy Tools, Liquidity, management, Capital rules specific to securitization and counterparty risk.

OSFIs top priorities in 2008-2011 are:

A. Enhanced Identification of Emerging Risks
B. Institutional and Market Resilience
C. Changes to International Financial Reporting Standards(IFRS)
D. Minimum Continuing Capital Surplus Requirement (MCCSR)
E. Financial Sector Assessment Program (FSAP)/Financial Action Task Force (FATF)Reviews
F. Basel II Capital Accord – Post- Implementation phase
G. People Identify changing human resources requirements
H. Pensions Systems and Processes

Sources: www.osfi-bsif.gc.ca; OSFI 2008-2011 Plan & Priorities; Julie Dickson, Superintendent, OSFI speech at Asian Banker 2009, Risk Magazine

Posted by spachava at 06:17 AM | Comments (2)

July 14, 2009

Risk Career Series - 7 Traits & Habits for a Risk Management Career - Part 1

I am starting this blog series in response to many requests for career advice and guidance that we all keep getting from time to time from young bright aspirants! Also when i started my blog i listed the below 10 Risk mgmt frontiers ideas, so next few blogs are going to be adressing the ideas not addressed so far.

1. Risk Visualization
2. Next Generation Risk & Compliance Architectures
3. Risk Pricing Clusters
4. Risk & Compliance Taxonomy
5. Pan Regional Risk Data Grids
6. Digital Assets Mgmt
7. Cross Industry Risk mgmt practices
8. Incubating Centers of Risk Mgmt Excellence & practices
9. Risk Management Career Options
10. Embedding Risk Mgmt & Compliance in an organisational DNA

My thanks and sincere apologies to all of you who took time to write to me. To some I have responded already and I really wish I could respond to all of you individually on your interest to work in the Risk Mgmt area, but a more efficient way to respond would be via this PRMIA blog.

Let me start by saying to all the young & old, inquisitive, brilliant minds out there, we need more of you in this dynamic and exciting profession. So please do keep flocking to the Risk profession.

This is not a one off blog. I will keep posting regularly on this topic regularly. I also hope that this blog topic will evolve into a Risk Mgmt Career thread with lot of questions, and inputs from the more seasoned Risk mgmt gurus and experts from the industry, so we all get a much wider perspective on entry in the Risk mgmt profession. Perhaps we can evolve into an annual PRMIA Global Risk Mgmt Career webcast.

Being involved in the selection process of the PRM candidate of the year for the last 2 years and looking at the caliber of candidates, it seems a logical extension of developing the Risk mgmt profession.

Note: Certainly do not consider my thoughts as absolute truth as they are colored by my limited personal experiences. Do take them with a pinch of salt and beware of the extra mix of continental and asian spices thrown in.

Having been fortunate enough to have lived and worked in 6 countries so far and delivered Risk projects in more than 10 countries, I see that young aspirants to Risk Mgmt industry have the same issues and questions world over. Let me try to answer some of them from a financial services industry perspective first. And will color them with examples from other industry sectors that I know of;

Q1: What does it take to be in Risk Management field ?

Response: There are 7 traits and habits that I see that consistently define a Risk Mgmt professional. This may be embodied in many other similar profession but I find these specially enhanced in top notch Risk professionals. These is just a listing of a few characteristics. It’s brilliant to have all these qualities, but one does need to have a combination of at least 4-5 skills.

1. Intellectual curiousity & Rigor of thought - Risk Management is about being intellectually curious (or being a busy body as they say in South East Asia) about what, where, when, how and who.
2. Constant and Dynamic Changes - Be able to deal with a dynamically changing environment that one works in
3. Good grounding in at least two or more disciplines - Math, Finance, Stats, Financial Engineering, Quant Finance, IT
4. Constantly Learning- If one does not believe in continuous learning, this area is not for him/her as one will find it hard to keep up with the pace of change
5. Detail oriented - At more junior level, have interest to drill down into details when required. Risk management is about details; As one goes sr. the details evolve into bigger picture but still need to detailed oriented many times.
6. Tech savy - Be it Microsoft Excel, Visual C++, Visual Basic, Microsoft ACCESS, and be able to learn different Risk applications and technology.
7. Being able to break down complex concepts into simple terms, communicate and explain clearly

Having listed the above, I must also highlight the fact that Risk Mgmt being a very vast discipline, the above skills are by no means exhaustive.

Let me stop here and continue on in my next blog. Pls. do write in your comments, questions directly on this blog, instead of individual emails. Happy Risk mgmt job hunting.

Posted by spachava at 08:33 PM | Comments (2)

June 18, 2009

7 pillars of US Financial Regulatory reform & the European Systemic Risk Council - The new blueprint

Risk & Compliance Managers, Private Equity(PE) firms, Hedge Funds, Credits firms and Consumers, in the USA and global financial markets are going to remember this week for a long time to come due to the epic changes in the financial regulation and supervision. I had blogged earlier about move to regulation from the light touch supervision. The latest US proposal on financial regulatory reform does skew towards tighter regulation.

In the EU summit starting today, a tighter financial market regulation is being discussed with 2 extra mandates for EBC - a European Systemic Risk Council and a body to set standards for closer supervision of banks, insurers and other firms. The European Systemic Risk Council, is proposed to be chaired by the European Central Bank president but will include central banks and the EU Commission representation to look at broader interlinked systemic risk issues.

The proposal is still evolving and subject to congress approval, but a quick summary of the 7 key areas and the possible impact on Regulatory Risk Management and compliance functions:

1. Consumer Protection Regulator - The UK FSA took a lead with having TCF (Treating Customer Fairly) approach but US has gone one step ahead with this new proposed agency with oversight over mortgages, credit cards, savings accounts and annuities.
Impact: World of retail financial services would have new tighter regulatory requirements.

2.Executive Pay:Investors to have a greater say in executive pay
Impact: Link of executive pay to risk management

3. Private Equity and Hedge Funds Regulation: Under Federal regulation.
Impact: Demand for Risk Management & Regulatory compliance professionals in Hedge Funds and PE firms.

4. Mortgages & Asset backed securities: Firms need to hold a portion of the loans they package and sell. E.g. 5% for ABS firms. This contrasts with the 20% proposal in EU.

Impact: Huge change in business models of many firms that are essentially in mortgage origination business to move to portfolio risk management business. ALso big impact for the underwriters of asset backed securities as they need to retain a 5% stake to improve asset quality.

5. OTC Derivatives business model: All standardized contracts derivatives contracts to be traded on regulated and transparent venues such as exchanges or electronic marketplaces and cleared centrally to reduce risk.

Impact: Deeper integration of Derivatives business with exchanges;
Greater emphasis on Risk management at exchanges; Emergence of Clearing houses as a critical Risk management institution.

6. Insurance Supervision - Possible Single Federal Regulator instead of a distributed regional state regulators networks.
Impact: Streamlined and efficient regulatory reporting

7. Financial Services Oversight Council - A consolidated group comprising all regulators to oversee systemic risk.
Impact: Less confusion on who does what

There is much more to share about the European proposal but that is a blog by itself. so watch out for next blog.

Exciting times ahead for all of us, as i do believe a lot of risk management, and regulatory compliance roles should open up in all these bodies. Happy hunting !

Posted by spachava at 03:14 PM | Comments (3)

June 03, 2009

SEC tweets on twitter too - Digital Assets Risk Managment- Has its time come?

Digital Assets Risk Mgmt as a key management priority? US President's 10-point Cybersecurity Action plan

Blogs, Wikis, Twitter, Facebook, Linkedin, Secondlife - all start to become key component of the millenial generations activities at workplace and lifestyle. Its but natural that even regulatory bodies such as SEC and stock exchanges start to embrace twitter to boost their transparency and and outreach to the net savy investors.

In a development that will have a wide reaching impact across the world, US president Obama last week released his 10-point plan to secure and protect digital infrastructure. I see this as a part of a broader recognition of the need for Risk mitigation practices in the increasingly digital world with almost 1.5 billion people being online or logging in. This plan calls for an enhanced coordination between public and private sector.

To me this explicit recognition of the information and underlying digital infrastructure as strategic assets, could be a quantum leap forward in accelerating the slow paradigm shift of how digital information risk is perceived and managed today at senior executive levels. I believe many other countries and industry sectors will follow suit.

Many questions come to the mind. Just as this plan calls for an updated national strategy to secure the information and communication infrastructure, will many corporates follow suit in terms of Designating digital assets risk management as a key management priority; awareness around digital assets; global digital assets management policy framework etc ?

Does this mean that companies will start to have a specific Digital Assets Risk Management plan, that includes Reputation Risk management, Online Assets compliance and a digital identity plan that combines the customer secuirity and privacy aspects of customers in the new online business model ?

What do you think ?

Posted by spachava at 10:24 PM | Comments (0)

April 08, 2009

Liquidity Management - The future blueprint

With Liquidity management emerging as a key area of focus in the financial sector crisis, this article summarizes some of the key trends as to where the liquidity management practices are headed.
It summarizes regulatory and industry thinking i.e. BIS, CEBS and UK's FSA around liquidity management both pre and post systemic risk context.UK is probably going to be the first country off the block to implement significant changes to the new liquidty requirements with their aggressive timelines of Oct 2009.

I believe these will be epic changes in the one of the key pillars of risk management.

Let us look at the summary of the broad thinking on liquidity management based on different papers available.

I. Latest is the Dec 2008 UK FSA consultative paper on liquidity. The industry feedback closed early this month 9th March 2009 and we should see the response soon.

This was FSA quick response to drive a fundamental refresh of the liquidity management approach and requirements. The FSA’s consultative paper focus is to suggest measures that would take liquidity risk management to the next level, influencing future business models and improvements to its own ability to monitor and supervise industry wide liquidity management oversight.

Future blueprint of liquidity Management: Broadly the key tenets of the changes being proposed by FSA are:
• A new, quantitative framework for liquidity risk management which places greater emphasis on firms’ ability to assess liquidity risks and develop policies to tackle them
• a strengthened qualitative framework for liquidity risk management, with an increased focus on firms’ stress testing and contingency funding plans;
• new liquidity reporting requirements;
• a new approach to firms operating in the UK which are part of a wider UK or international group
• Cost benefit analysis (CBA) that clearly articulates the long-term impact of a strong liquidity framework
• Combination of an individual liquidity adequacy assessment (ILAA) and a supervisory liquidity review process (SLRP) conducted by FSA
• Most importantly also calls out that this would have impact on the business models going forward, so its not business as usual

Going into more specifics, some of the key pillars around this new requirements are:

A. Adequate liquidity and self sufficiency – 2 high-level principles. 1. All FSA-regulated entities must have adequate liquidity 2. No dependence on other divisions of their group to survive liquidity stresses, unless permitted to do so by the FSA.

B. Systems and controls framework- A new systems and controls framework based on the recent work of the Basel Committee on Banking Supervision (BCBS) and the Committee of European Banking Supervisors (CEBS).

C. Individual Liquidity Adequacy Standards (ILAS) – A new domestic quantitative framework for liquidity management for many of the firms that we supervise. This framework is based on firms being able to survive liquidity stresses of varying magnitude and duration.

D. Group-wide and crossborder management of liquidity - New framework for allowing firms, through waivers and modifications, to deviate from self sufficiency where this is appropriate and would not result in undue risk to consumers and other stakeholders whom the rules in question are intended to protect.

E. Reporting - A new reporting framework for liquidity, which will enable us to collect granular, standardised liquidity data at an appropriate frequency so that we can form firm-specific, sector- and market-wide views on liquidity risk exposures.

Some of the reporting frequency being suggsted:
- Enhanced Mismatch Report, incl. daily flows out to three months - Weekly, with the ability to report daily
(switches to daily in crisis times or if firm deviates from ILG)

- Pricing Data Daily pricing, Submitted weekly
- Marketable Assets Report Monthly
- Funding Concentration Report Monthly
- Retail Funding Report Quarterly
- Off-Balance Sheet Report Monthly

- Clearing & Settlement Banks Only - Intra-day Liquidity Report Daily

- Systems and Controls Questionnaire Quarterly

Expected Impact:
- Enhanced liquidity risk management capabilities, including greater use of stress testing and improvements to contingency funding plans (CFPs);
- less reliance on short-term wholesale funding, including on wholesale funding from foreign counterparties
- greater incentives for firms to attract a higher proportion of retail time deposits
- a higher amount and quality of stocks of liquid assets, including a greater proportion of those assets held in the form of government debt; and
- a check on unsustainable expansion of bank lending during favourable economic times

Interestingly the paper also calls out some of FSA own internal improvements initiatives listed below. So there is inherent recognition of need to step up its own expertise, skills and in terms of committing to set the bar higher for itself as well as the industry. I know of some regulators and supervisors that are ahead of the game and actively seek and acquire top class talent, but it would be good to see more countries take the pro-active approach.

1.Upgrade systems, embed new procedures into existing supervisory processes and help their staff deliver the high expectations that we require of firms

2. Upgrade of internal systems so FSA is capable of delivering and managing its proposed new reporting framework. Includes advanced business intelligence BI) capabilities, automated analysis and early warning indicators. FSA’s ARROW6 technology infrastructure is also being upgraded to allow for liquidity risk assessments and returns data to feed directly into FSA’s risk architecture, allowing for
aggregated liquidity risk monitoring.

3. Investing in further specialist liquidity resource, including retaining and developing liquidity risk experts.

4.Investing to help ensure that all its supervisors are competent in
liquidity issues. Every supervisor will receive training on liquidity, its liquidity policy and its internal policies and procedures for ensuring the implementation and maintenance of high liquidity standards at firms.

5. Regular self assesment of competence in liquidity area regularly

II. Early 2007 & Sept 2008 - Committee of European Banking Supervisors CEBS): Key principles:
• an agreed framework for host supervisors delegating liquidity supervision of branches of EEA credit institutions to the European consolidated supervisor;
• exploratory work on internal models and methodologies for liquidity risk management;
• supervisory guidance on the use of transfer pricing mechanisms
• development of common reporting for liquidity throughout the EEA (European Economic area)

III. Sept 2008 - Basel Committee of Banking Supervision issued its guideline on Principles for sound liquidity management:• consistent global implementation of the recently agreed Principles for Sound Liquidity Risk Management and Supervision
• agreed global standards for supervisors on the appropriateness of cross-border management of liquidity
• developing cross-border resilience benchmarking exercises on internationally active groups
• further moves torward consistency on the definition of liquid asset buffers
• exploratory work on internal models and methodologies for liquidity risk management
• further work to understand and mitigate intra-day liquidity risks run by firms.

Sources:
http://www.fsa.gov.uk/pubs/cp/cp08_22.pdf
www.bis.org/publ/bcbs138.pdf
www.c-ebs.org/formupload/f8/f8c4ac3d-ca0a-4e86-8aae-d5c6f97f6192.pdf

Posted by spachava at 11:11 PM | Comments (3)

February 14, 2009

Regulatory Oversight & Risk Mgmt impact - The way ahead !

The ongoing global credit crisis and the systemic risk tsunami is definitely leading to an overhaul of the regulatory frameworks around the world.

It remains to be seen if the pendulum will swing from the much touted Supervisory mode back to Regulation mode. It’s a devil and deep sea choice between light touch and heavy handedness. This article highlights some of the trends that I observe around the world around Regulatory oversight and possible impact for Risk management principles.

Regulation vs. Supervision - In the US, the US Treasury mandated executive pay ceiling of 500, 000 for institutions receiving exceptional TARP funds in an indicator, Regulation is back in full force for some time at least. At the US senate hearings this week, some of the captains of the financial sector were themselves advocating stronger regulation.

UK FSA has long been considered to be at the forefront of new thinking on regulatory frameworks, prudential policies but with a market friendly intent. It has been fairly known for its advocacy of “light touch” based supervision approach vis-à-vis regulation approach. But since a few months, FSA has tightened its regulatory touch and requires some of UKs largest financial institutions to provide it with weekly disclosures on risk and performance, vis-à-vis monthly or quarterly requirement earlier. Each supervisor and regulator is scrambling to enhance its supervisory staff strength and capabilities, which has always been a challenge. Bigger fines and active role in executive hiring are some other facets that one sees.

Super Regulator - Many of them talking the need to have a ”Super Regulator”. Something that UK FSA, Singapore MAS and Australia APRA (Australian Prudential and Regulatory Authority) has been experimenting for a while now. It will be interesting to see if USA will follow the route of a federal “Super Regulator” that combines and perhaps even supercedes silo functions of OCC, FDIC, SEC, US Treasury, and host of state level regulators. Australia - APRA adopts a twin peaks model - Regulation being split into Prudential or traditional oversight and Market behavior with focus on business conduct and investor protection.

Stress Testing - Hearing a lot of focus on deeper and industry wide Stress Testing. I remember my time in Singapore & Malaysia during the 1997 Asia currency crisis, and some of the supervision departments in Asia - Bank Negara(Malaysia), MAS, Bank of Thailand, Reserve Bank of India (India) started exploring projects to model industry wide Risk to be able to simulate scenarios and impact around a system wide impact. I believe that this might be something that needs to be revisited back today in broader global system risk context & strong links between global financial services.

Liquidity Management - Focus on organizational level Liquidity management function and across the value chain. Specially with many global cases of the failure of the traditional principle of “ Central Bank Discount borrowing” window as a possible short term liquidity shortfall lender of last resort. This will be a key pillar of the rating frameworks of the supervisors in their onsite and offsite assessment. Some of the broad thinking is to embed the preparedness of an organization’s ability to tap short term liquidity into extra capital. Does this mean more focus on CFAR vs VAR ?

Traditional Measures of Bank Capital Requirements - Harsh scrutiny of the traditional measures of measuring a banks financial viability - e.g. Right before my eyes in Seattle, Washington Mutual with a Tier 1 Capital ratio of 8.4%, crumbled like a pack of cards, with liquidity issues, deposit over runs and free fall stock price before dramatically taken over by FDIC overnight and being sold to JP Morgan Chase. Similarly Wachovia, that was sold to Wells Fargo has a 3rd quarter Tier 1 ratio of 7.49%. National City Corp. had a Tier 1 capital ratio of 11%. All these being above the US 6% threshold for being well capitalized. Spain has a model wherein its banks need to increased their capital chests during good cycles, as a buffer against bad cycles. Something that FSA and a few other regulators are exploring.

Remuneration tied to Risk taken - One of the interesting comments made by Morgan Stanley Chairman during this week Senate hearings was around Call back or was it Claw back ? Those of us who have been in Sales functions understand Claw back quite well i.e. the need to pay back bonus/commissions etc. on a deal that backfires. Morgan Stanley has a policy (not sure if existing or new) that requires return of bonus/remuneration even after leaving the firm if in violation of some core guiding principles. Also see a lot of chatter around remuneration tied around amount of risk taken in the transaction. It will be interesting to see how far this really goes.

Many many more thoughts around this but will address them in another article as trends evolve globally.

References: FSA, The Financial crisis and future of financial regulation, The Economists Inaugural City Lecture. Wall Street Journal, Alistair Macdonald, Jan 2009; APRA Website & Consultation papers; MAS website & Consultation papers.

Posted by spachava at 12:35 AM | Comments (0)

January 17, 2009

GRM- Global Risk Mgmt and Governments Risk Mgmt with a $5 trillion plus kitty

Wishing everyone a happy and safe new year!

2008 was a humbling and disruptive year for the Financial sector, specially the bulge bracket Investment Banks as well as Risk Management profession on the whole. Many epitaphs will be written for legendary institutions that disappeared overnight and will be spoken about for decades to come in terms of the crunching global impact and the associated learnings. About $650bn of sub-prime bonds outstanding in March 2008, about 75% of them being rated triple A at issuance, and banks raised around $600 billion in 2008 worldwide to survive. This blog sets the context to a global development with wider and long term implications for the Risk Management role and function of the Governments and Sovereign Wealth funds.

GRM - Global Risk Management or Governments Risk Management
With FDIC chair floating the Aggregator bank idea this morning, there is a fascinating convergence of free markets and role of Governments as Risk Managers of last resort. There is an ongoing global risk management effort that although coordinated in some parts (e.g. G7, EU) and disparate in other parts of the world, does show signs of an orchestrated and coordinated effort. The different measures listed below really being the tactical components of a broader and longer term Governments Risk Management effort to rescue firms and economies -
1.Unprecedented direct intervention by Govt. bodies and regulators like FDIC in overnight in takeover/shotgun sales of financial institutions
2.Unprecedented but time bound Governments pledge to guarantee all loans and deposits
3.Bailouts plans such as US TARP
4.Stimulus packages
5.Benchmark rates cut
6.Assumption of toxic securities
7.Equity stake and nationalization in extreme cases
8.Interbank and debt guarantees
9.Recapitalization
10.Asset Restructuring body/Aggregator bank

Today, it is very rare to hear debates on the role of direct government intervention even in the strongest bastions of free market economies. In the past it had been very subtle support and interventions by Sovereign Wealth funds (SWF), but never of the current scale.

Below is a summary of the global risk management efforts of governments of some of the major developed and emerging economies around the world.

USA - $ 850bn (6% of GDP) - $ 700bn TARP; $300bn guarantees, FedReserve rate cut to 1%, $1.3 trillion bank lending, $150bn stimulus package, ($ 500bn planned by new govt)

China - $586bn (16% of GDP) – 2 yr stimulus comprising rural infrastructure, social services, railroads, airports, health, education, housing & more

UK - $ 450bn (21% of GDP) - $311bn to exchange illiquid securities for govt. debt, $116bn to recapitalize, $389bn guaranteed new bank debt, $23bn tax breaks

Russia -$ 209bn (12% of GDP) - $ $50bn credit line for Corp debt refinance, $88bn bank loans,$19bn stock market support

Germany -$ 151b( 7% of GDP) - $101bn in new capital, $25bn bad loans cover, $504bn interbank guarantees,$25bn tax breaks

South Korea - $ 80bn (9% of GDP) - $25bn stimulus, $55bn forex loans for exporters, $100bn guarantees for banks forex liquidity

Japan - $ 68bn (1%of GDP) -2 stimulus packages incl. tax cuts, tax breaks, credit guarantees,$322bn loan guarantees for small & midsize businesses

France - $ 50bn (2% of GDP) - $13bn to recapitalize($37bn more pledged), $403bn interbank guarantees

India -$ 41b(5% of GDP) - $ $4bn loans to mutual funds, $37bn in bank loans due to reserves rate cuts

Summary: The GRM program around the world is committing to around $5 trillion plus with amounts committed being anywhere from 1% of GDP to a high of 21% of GDP in UK. Many countries GRM initiative includes nationalizing failed financial institutions as well. So the GRM is a facet of Risk Management that will remain in forefront for years to come and CRO’s

Takeaways –

1.An additional dimension for CRO to deal with, if their institution is subject to GRM activities

2.Lessons learnt from GRM will feed into a heavier touch for Regulators in industry Risk mgmt

3.The lessons learnt by governments around the world in rescuing” Too big to fail” firms will have an impact on the future viability and ambitions of the “financial supermarts” around the world.

4.This GRM effort will have far reaching impact on the Risk Management role of governments and implicitly the role of Risk Management in society.

Sources: Dow Jones Financial News, Issue 635,A year in numbers; Business Week Dec 1 2008(Peter Coy, Enough Shock treatment)

Posted by spachava at 05:26 PM | Comments (2)

September 08, 2008

Managing the $6 trillion systemic risk at the global iconic legends - Fannie Mae & Freddie Mac

Fannie Mae (The Federal National Mortgage Association) and Freddie Mac(The Federal Home Loan Mortgage Corporation) - the twin iconic GSE (Govt. sponsored enterprises) institutions that own or guarantee more than $5-6 trillion of the total 12 trillion mortgages have always been the legendary pillars of the US mortgage industry but their span of influence and prestige spread much wider across the entire financial markets around the world.

For sometime now, both the mortgage icons have been under tremendous pressure due to the sub prime, mortgage and housing crisis in the US market. Although they guarantee or own only half of the mortgage market, because the subprime mortgage crisis has caused almost all other lending sources to pull out of the market, they are responsible for more than 80% of new mortgages being made in 2008.

There was fervent hope from many informed quarters that these prestigious GSE's would somehow weather the perfect storm and lend the much needed stability to the mortgage market. More so as many U.S. banks as well as foreign governments own stock or debt in the two giants, implying gigantic proportion of the systemic risk beyond the US housing market.

But this week a new chapter in managing the gigantic systemic risk will be written via the US Treasury, Fed Reserve and the Federal Housing Finance Agency(FHFA) coordinated intervention at these 2 iconic firms. As of yesterday Sept 7th 2008, both firms are now under conservatorship of the FHFA.

GSE background - For a little bit of history, the US congress created Fannie Mae as a government agency in 1938, during the Great Depression, to buy government-insured mortgages from lenders, providing them fresh money to make more loans. In 1968 it turned into shareholding entity.

The government sponsored enterprises (GSEs) are a group of financial services corporations created by the United States Congress. Their function is to enhance the flow of credit to targeted sectors of the economy and to make those segments of the capital market more efficient and transparent. The desired effect of the GSEs is to enhance the availability and reduce the cost of credit to the targeted borrowing sectors: agriculture, home finance and education

Freddie Mac is a government sponsored enterprise (GSE) of the United States federal government. It is a stockholder-owned corporation, authorized to make loans and loan guarantees. It was created in 1970 to expand the secondary market for mortgages in the US. Along with other GSEs, Freddie Mac buys mortgages on the secondary market, pools them, and sells them as mortgage-backed securities to investors on the open market. This secondary mortgage market increases the supply of money available for mortgages lending and increases the money available for new home purchases.

It's a rather dissapointing twist for the 2 legends that are bearers of more than $5 trillion of mortgages, having suffered combined losses of about $14 billion over the past four quarters as they make provisions for a wave of defaults.

The unique psrt is that both are profit making firms but with charter by US Congress to support the housing market. Being seen as backed by the government, their cost of funds was close to those of U.S. Treasurys.

Earlier the 2 firms explored raising capital through the sale of their common or preferred shares. But investors were not to keen given the uncertainity of federal action.

In days to come we will see the Treasury, Fed Reserve along with Federal Housing Finance Agency that oversees both Fannie Mae and Freddie Mac implement this conservatorship plan that amounts to almost takeover of these 2 institutions. These measures should help remediate and manage the 5 trillion systemic risk these two pose to the broader global markets.

The plan is injecting significant government funds into both over a period of time rather than one off along with management shakeup.

The US Treasury, Fed Reserve as part of their broader systemic risk mitigation efforts are reported to have been reaching out to reassure foreign central banks and other overseas institutional buyers about the creditworthiness of the debt and instruments issued by these 2 firms.

Other details:
Some of the plan of action items for the Federal Housing Finance Agency conservatorship are:

1. Business will be transacted normally, with stronger backing for the holders of Mortgage Backed Securities (MBS), senior debt and subordinated debt.
2. The Enterprises will be allowed to grow their guarantee MBS books without limits and continue to purchase replacement securities for their portfolios, about $20 billion per month, without capital constraints.
3. As the conservator, the FHFA will assume the power of the Board and management.
4. Appointed as CEOs are Herb Allison for Fannie Mae and David M. Moffett for Freddie Mac. Allison is former Vice Chairman of Merrill Lynch and for the last eight years chairman of TIAA-CREF. Moffett is the former Vice Chairman and CFO of US Bancorp.
5. To conserve over $2 billion annually in capital, the common stock and preferred stock dividends will be eliminated, but the common and all preferred stocks will continue to remain outstanding. 6. Subordinated debt interest and principal payments will continue to be made.
6. There will be financing and investing relationship with the U.S. Treasury via three different financing facilities, to provide critically needed support to Freddie Mac and Fannie Mae and the liquidity of the mortgage market. One the three facilities is a secured liquidity facility which will be not only for Fannie Mae and Freddie Mac, and also for the 12 Federal Home Loan Banks that are regulated by FHFA.

The Treasury support programs and credit facilities being:
Four aspects of the U.S Treasury's support:

1. "To promote stability in the secondary mortgage market and lower the cost of funding, the GSEs will modestly increase their MBS portfolios through the end of 2009. Then, to address systemic risk, in 2010 their portfolios will begin to be gradually reduced at the rate of 10 percent per year, largely through natural run off, eventually stabilizing at a lower, less risky size."

2. The Treasury and the FHFA has established Preferred Stock Purchase Agreements, contractual arrangements between the Treasury and the conserved entities. "Under these agreements, Treasury will ensure that each company maintains a positive net worth. These agreements support market stability by providing additional security and clarity to GSE debt holders – senior and subordinated – and support mortgage availability by providing additional confidence to investors in GSE mortgage backed securities. This commitment will eliminate any mandatory triggering of receivership and will ensure that the conserved entities have the ability to fulfill their financial obligations.

3. "The Treasury established a new secured lending credit facility, available to Fannie Mae, Freddie Mac, and also Federal Home Loan Banks. "This facility is intended to serve as an ultimate liquidity backstop, in essence, implementing the temporary liquidity backstop authority granted by Congress in July 2008, and will be available until those authorities expire in December 2009."

4. "To further support the availability of mortgage financing for millions of Americans, Treasury is initiating a temporary program to purchase GSE MBS. Treasury will begin this a program later this month, investing in new GSE mortgage backed sequrities (MBS). Additional purchases will be made as deemed appropriate. Given that Treasury can hold these securities to maturity, the spreads between Treasury issuances and GSE MBS indicate that there is no reason to expect taxpayer losses from this program, and, in fact, it could produce gains. This program will also expire with the Treasury's temporary authorities in December 2009.[7]

Sources: WSJ
http://en.wikipedia.org/wiki/Federal_takeover_of_Fannie_Mae_and_Freddie_Mac

Posted by spachava at 04:31 AM | Comments (0)

August 24, 2008

Basel II Cross border realties - EU's CEBS releases range of practices

As the Basel II journey continues world over, the European Banking Supervisors (CEBS) recently released a range of practices on Basel II implementation issues.

I found this paper very informative and interesting and highly recommend to anyone interested in the practical realities of Basel II implementations across borders.

This compilation is based on CEBS significant involvement over last year in collecting and analyzing the Basel II implementation issues that cross-border groups and their supervisors believe to be the most challenging from a cross-border perspective.

This report classifies Basel II implementation into 3 groups and addresses some practical issues observed.

A) Supervisory process for model validation.
B) Pillar 1 technical issues
C) Pillar 2 issues

I cover off only some of the high level aspects to pique your interest to read the entire 18 page paper. The paper handles key issues in each of the above 3 areas and provides examples from specific scenarios around them.

A) Supervisory process for model validation
A key question handled is - Has delegation/division of tasks between supervisors been applied in practice? Which are the most relevant tasks to be delegated/allocated to home and host supervisors?

Summary of the observation - This is effective where the supervisors collaborate to perform the task they are best placed to conduct. The key point being that delegation needs to work both ways i.e. Host delegating to Home and Home delegating to Host. Generally speaking, home supervisors should inform hosts of centrally performed model reviews, and hosts are responsible for the supervision of local model implementation issues.

More specifically the home supervisor being responsible for the review of the internal governance of model validation (rating process, control environment, stress testing, worldwide model implementation, internal audit etc.), including the review of a sample of centrally developed models, and the examination of the adequacy of the related IT environment.

In the case of centrally developed models that are applied across the banking group (group-wide models), the home supervisor leads the approval work. Where models applied across the banking group are developed/managed/enhanced at a subsidiary banking entity, the home and host supervisors jointly carry out the approval work. Host supervisors are responsible for the assessment of specific local requirements. Host supervisors are generally responsible for the examination/assessment of the implementation of the rating systems developed by the local subsidiary.

Where a model is applied in several countries, the host supervisors of the subsidiaries where the main developmental work has been performed are responsible in consultation with the home supervisor.

- Local and central models A key question addressed was -
- How are local and central models defined? Are differences driven by specificities and/or organizational arrangements of banking groups?

Summary - Here broadly two main approaches were seen to be prevalent on the basis of the experience gained so far.

- The first one uses geographical specificities as the driver for separation and examines whether a particular rating system requires any local aspects to be taken into account. If this is the case,
the model is defined as local; if local aspects do not have a role, the model is considered to be central.

- The second approach focuses on the division of tasks within the banking group. Models developed, tested and validated by a central unit and used on a group-wide basis are defined as central models while models developed, tested and validated locally, and used in one or more entities, are considered to be local models.

The other issues handled in this section being:

- Portfolio classification - Is it possible for banks to adopt the IRB classification for exposures subject to the Standardised approach on a temporary (roll-out) and/or permanent (permanent partial use) basis?

- Use test for new models - How can the use test requirement be applied practically for new models?

- Supervisory assessment of group-wide models - What is the role of home and host supervisors in the validation of central models?

- Language of IRB/AMA application - In which language do banks have to submit the application to use internal models to the home supervisor? Is the approach consistent across banking groups?

B) Pillar 1 technical issues. In pillar 2 key topics addressed are around default defintion and downturn LGD.

- Definition of default - Which definition of default (DoD) is applied in practice across a cross-border banking group? How is the default of individual entities related to the default of groups?

Summary - Some groups use a different DoD for the consolidated calculation, whereas others use a single DoD across all the group’s entities. However, the first approach is not perceived to be a major problem.

- Downturn LGD - What are the banks’ methodologies to estimate the “downturn LGD”, as requested by the CRD? What is the supervisory approach?

Summary - Different approaches are explianed via different real life examples. Example 1 is around UK FSA. The UK Financial Services Authority has published a paper in which the results of an empirical exercise on downturn LGD estimates are presented1; data were gathered from 12 firms. The main outcome at this early stage is that the degree of variation of the two key downturn parameters (i.e. reduction in property value and probability of possession given default) is quite large. Therefore, some “reference values” for these variables are provided (-40% and 35% respectively), which could be used by each bank for discussion with supervisors. As soon as firms improve their estimation techniques, and the available data increase, FSA expects the thinking on this topic to evolve.

Example 2 is around Spain. The Bank of Spain has published a paper2 in which the requirements for downturn LGD for residential mortgages are presented. The document defines the following concepts: realised, long-run average and downturn LGD; it also requires a minimum segmentation in the estimation process based on risk drivers; and finally, it identifies the estimation procedures accepted.

Other issues covered in this section being-

- Estimation and validation of risk parameters in “low-default-portfolios” - What are the approaches followed by banks to estimate and validate risk parameters for “low default portfolios”? What is the supervisory approach?

- Project finance - What are the banks’ methodologies for estimating risk parameters for Project Finance? What is the supervisory approach?

C) Pillar 2 issues
- Scope of application of ICAAP - What is the scope of application of ICAAP?
- Requirements imposed for ICAAP - What are the requirements that banks have to follow for ICAAP?

Acknowledgment and Source: CEBS Paper on Range of Practices on some Basel II implementation issues.

Posted by spachava at 07:34 AM | Comments (1)

March 12, 2008

Basel II 1st Jan 2008 accreditation milestone

It's time to appreciate and salute the tireless efforts of the folks driving the Basel II initiatives for the last couple of years around the world.

For many countries, 1st Jan 2008 accreditation being a big milestone for Basel II project sponsors and executives who i am sure have spent many sleepless nights during last 2-3 years on the Basel II accreditation and model validation initiatives.

Reviewing the current state of Basel II initiatives in 2008, provides some interesting insights on the journey of Basel II early adopters. The Basel II was expected to first be implemented as per the 2008 timelines in the 13 financially important countries represented on the Basel Committee on Banking Supervision (BCBS). They include Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Spain, Sweden, Switzerland, the UK and US. And majority of the Tier 1 financial institutions in the above economies achieved their host country Basel II accreditation on 1st Jan 2008.

There were another category of early adopters such as Australia, Singapore, South Korea & Hong Kong, driven to enhance their reputation as major financial centers even further. The above is by no means an exhaustive list and we can safely expect every developed country’s top financial institutions operating globally to have achieved Basel II accreditation in some form or the other.

Summarizing some of the key points based on recently published reports/updates in some of the countries.

Australia - Australia went live with Basel II accreditation from 1 Jan 2008 – a significant accomplishment for this medium sized economy with financial markets sophistication matching that of leading financial centres. The Australian Basel II effort was characterized by regular guidance and interaction with the industry via discussions and consultative papers. The Australian Prudential Regulation Authority (APRA) granted Basel II accreditation to a number of banks, including Commonwealth Bank of Australia Ltd (CBA), Australia & New Zealand Banking Group Ltd (ANZ) and Westpac Banking Corp Ltd effective 1st January 2008. CBA, ANZ and Westpac were granted advanced accreditation, allowing them to adopt the internal-ratings-based approach to credit risk and the advanced measurement approach to operational risk. Australia's largest investment bank, Macquarie Bank, has also gained Basel II accreditation at the foundation level. Some of the outstanding issues to be addressed in Australian market over the next year or so being:

o Prudential Capital Ratio (PCR) to be determined based on 2 key inputs – one from the supervisors assessment and the other from the bank’s own internal capital adequacy assessment.

o Deferring of banks own counterpary credit risk estimates to be included in the IRB.

o Future review of 20 per cent risk weight currently assigned to margin lending exposures Also review of internal models for interest rate risk in the banking book

United Kingdom - Following the Basel II in EU as introduced via the Capital Requirements Directive (CRD). Some of the financial institution in UK accredited for Basel II are Alliance & Leicester(IRB), Nationwide, HSBC (IRB approach), Standard Chartered Bank (IRB approach). Most UK banks chose to adopt the standardized approach as on 1st Jan 2008. Out of the 350 banking subsidiaries (not including building societies and securities firms), about 25-30 adopted IRB approach.

As per, the Financial Services Authority (FSA), the capital requirements at IRB approach institutions will change from their current levels over a two-year period, to avoid an overnight step-change in the industry’s total capital. Some of the insights being: Review the potential failings in existing regulatory capital regime. Appropriate use of Ratings being one such area. The use of ratings is a central feature of Basel II and the problems in ratings revealed by recent events is an issue that is coming to fore.

Review of the liquidity mechanisms towards a uniform and internationally agreed policy on liquidity. Given the urgency of dealing better with liquidity issues. local supervisors may initiate measures quicker than wait for an international consensus.

USA - Basel II journey in US - Notice of Proposed Rulemaking (NPR) - There are vastly different local flavors of Basel II approach variations across the globe. As many developed economies approach the final Basel II implementation milestones in their respective jurisdictions, the US banks Basel II & Basel IA initiatives have entered final stages of comment, review and adoption. A key consultation being around the Basel II NPR guidance with the formula for LGD computation. This papr understand the complexities involved as it serves as a quick summary for others wanting to know where US Basel II is headed.

The US Basel II 2009 roadmap proposes the advanced approaches for computing risk-based regulatory capital for the largest US banks numbering around 10-20, and permits the smaller and mid size domestic banks numbering around 9000 to continue to conform to flavour of Basel I. The top 10" group of core banks are mandated to operate the advanced approaches for credit and operational risk in 2009. Of course most global institutions operating in US with home Basel II accreditation also plan to conform to the Basel II. The Basel II NPR proposal includes a formula to relate LGD and the expected LGD (ELGD), in the Basel II Supervisory review of Capital Adequacy in Pillar II. Some believe that this is overly conservative limiting the capital reduction benefit for the US banks.

Learnings post Basel II accreditation : Taking some key data points from some of these Basel II initiatives so far.
Summarizing the key global observations from countries and financial institutions that have achieved Basel II accreditation in 2008:

• Most Tier 1 financial institutions have either adopted or on a roadmap to adopt Advanced approaches.

• Capital Adequacy around Basel II is not panacea solution for managing bank’s risk and capital. Banks do still need to continuously monitor and enhance their agility to react o market conditions, specially on the liquidity management aspects.

• Basel II impact on industry - Improved Risk management practices across industry with increased overall rigor and oversight on the process, workflows, models and methodology driven by the advanced Basel II approaches. Also forced banks to integrate their systems and processes better.

• Financial Institutions underestimated the amount and extent of work for accreditation from the supervisor.

• Even for those countries where Basel II accreditation is complete, the Basel II journey continues on. Banks still need to spend significant effort to make supervisors comfortable on the robustness of the quantitative estimates of risk that form the foundation for their regulatory capital calculation. In the interim, supervisors such as APRA are providing guidance in terms of sufficient regulatory capital.

• Banks also do not expect any material change in its capital management approach until the full implications of the new arrangements are finalized with the regulatory authorities. Most supervisors have introduced /looking to introduce “thresholds” or “floors” to ensure that capital requirements do fall too quickly from Basel I levels in the early years post implementation. Therefore, generally financial institutions will see a gradual rather than a dramatic reduction in minimum capital requirements post Basel II. E.g. APRA has placed a cap of 10 percent in 2008 on any reduction in capital from the Basel II changes & the cap will be retained into 2009 pending a review of the Basel II experience. (Source: APRA Basel II update, Feb 2008),

Banks already with accreditation do agree that it enhances risk measurement and management techniques and will significantly increase flexibility in decision-making and capital management.

References & Sources: Basel II NPR & Proposed Supervisory Guidance documents from US Agencies:Board (Fed Reserve System), OCC, FDIC, OTS, Treasury, APRA publication, Feb 2008, Basel II update- Katrina Squares, Thomson News Report.

Posted by spachava at 08:20 AM | Comments (2)

December 25, 2007

New frontiers in the Insurance supervision world

Wishing everyone merry Christmas, happy holidays and a very happy new year too !

Whilst reading up on the convergence of supervision practices for financial conglomerates operating across Banking, Capital Markets and Insurance, I came across some interesting developments in the Insurance supervision world led by International Association of Insurance Supervisors (IAIS). There is a BIS Joint Forum comprising IAIS, Basel II, IOSCO to deal with issues common to the banking, securities and insurance sectors, including the regulation of financial conglomerates.

Supervisors undoubtedly being key influencers of Risk mgmt practices globally. This article focuses on the developments in the supervision world and its impact on Risk mgmt in the Insurance industry.

Background: Established in 1994, the IAIS represents insurance supervisors from 190 jurisdictions in nearly 140 countries constituting 97% of the world's insurance premiums. The IAIS issues global insurance principles, standards and guidance papers, provides training and support on issues related to insurance supervision, and organizes meetings and seminars for insurance supervisors.
Website: http://www.iaisweb.org/

A global climate for change: The Future of Insurance Regulation - IAIS forum, 2007
In Oct 2007, the 14th annual IAIS forum was held in in Florida with the above theme. It was attended by over 600 senior level Insurance regulators (e.g. FFSA, FSA, NAIC, OSFI, CIRC, IRDA) and Insurance executives globally. I am sure some of our own PRMIA C-suite members would have attended too.

Insurance being one of the fastest growing sectors specially in the BRIC economies. Insurance supervisors face the challenge of improving supervisory expertise to cope with pace of emerging regulatory initiatives and the increasing complexity of risk assessment.

One of the key challenges identified being the need for a paradigm shift both within regulatory authorities and insurance entities to cope with the rapidly evolving financial landscape, including the move towards principles-based requirements and in the area of cross-border mutual recognition of supervisory regimes.

Some interesting top line discussion points at IAIS forum being:
(Source: Summarized from IAIS newsletter)

Regulatory challenges - striking the right balance and the need to change mindsets
The need for insurance regulators to strike the right balance from a number of perspectives, including: differing interests of key stakeholders; potentially conflicting regulatory objectives; and rules-based versus principles-based supervision.

Convergence in supervisory regimes to cope with globalization -
Insurance regulators need to enhance cross-border supervisory efforts as insurance markets and operations become more inter-dependent and transcend geographical boundaries.

Supporting the development of emerging markets -
Establish international supervisory standards for the rapidly emerging Microinsurance sector. Microinsurance provides low income populations in emerging markets with access to insurance. The development of supervisory standards is expected to contribute to greater financial inclusion in developing economies.

The above becomes critical with the BRIC nations emerging as the growth engines for the Insurers. Many global players are already engaged or in advanced stages of entry plans into these markets. The local players are also readying themselves for the ensuing competition as well as strategic tie-ups. The scale of these markets may seem intimidating to those players that are accustomed to more sedate growth rates and market aggressiveness.

For e.g., the Indian insurance sector had a CAGR of 175% over the last few years. Both life and no-life sector in India alone are forecasted to grow by over 200% and private insurers by 140% in the coming 3-4 years. In most BRIC countries, largely state owned insurance firms are now losing market share to private insurers. With the private insurers aggressively offering higher rate of return to its policy holders against state owned firms, the nature of insurance business is dramatically changing and this poses a big challenge to the supervisors.

Whilst admittedly achieving global regulatory convergence and creating a common structure on insurer solvency still have a long way to go, my top 8 KIV (Keep in view) list for its Risk mgmt impact would be as follows:

1. Stress Testing: Focus on enhanced use of stress-testing to demonstrate value of cross border operations. Jurisdiction boundaries are an issue for the companies & regulators. So in addition to internal models, would use of stress testing be one way to for firms to reassure local regulators, that in face of a major catastrophe, which potentially could wipe out many balance sheets of insurers around the world, the required capital sitting in each country will not be enough and cross border operations would become critical for capital to be tapped.

2. Sophistication of Actuarial Models and Risk Analytics – Increased demand for more sophisticated computational actuarial and risk analytics-related computing capacity.

3. A global Minimum Capital Requirement (MCR)- Is this possible & more importantly result in equitable treatment for all players in the market?

4. Solvency based Supervision to Principle based supervision -
The debate around solvency-based supervision being not nimble enough to keep pace vis-à-vis the contrarian view that the principle-based supervision may involve more financial investment to comply with, which could impact smaller firms. But largely, most supervisors are slowly but surely moving towards a principle-based supervision.

5. Mutual Recognition Agreements (MRA) for global firms to avoid duplication - To avoid duplication of regulations, effective use of mutual recognition agreements (MRA) as a possible way to streamline regulation.

6. Business Records Retention compliance: Insurance being a documentation-intensive industry, increased regulatory focus on retention and retrieval of business records, for legal discovery process as a key internal control and operational risk requirement.

7. Reinsurance being an important risk mitigation tool for insurers, improvements in supervisory
approaches to facilitate global diversification of reinsurance risk.

8. Focus on Improved supervisory expertise to cope with emerging regulatory initiatives and
the increasing complexity of risk assessment. Specially to cope with the expertise required to
effectively monitor principles-based practices and assess internal models.

Source: Research based on IAIS website, IAIS newsletter, Business Standard & PTI articles.

Posted by spachava at 12:31 PM | Comments (1)

October 14, 2007

Convergence of Risk Capital, Disclosures in the PE, Hedge Funds, M&A era !

Hola from Barcelona, Spain.

In preparation for a Risk mgmt and Excel bootcamp here in Barcelona, I was studying the European Risk mgmt practices related to transparency and risk controls specially in context of Private equity, Hedge funds and much publicized M&A deals. At a broad level, these are about more transparency for investors based on EU instituted guidelines for streamlining M&A regulations last year as well as related to Hedge Funds operations. These are expected to have wide ranging implications for the markets guidelines in the US and the rest of the world too.

I am discussing two developments - one in Germany, the other in UK.

Germany Modernization of the Conditions for Risk Capital - Germany’s Cabinet has issued a draft law to regulate the country's private equity industry. This proposed law has 2 goals in mind - 1. Protect domestic companies from corporate raiders 2 . Make M&A more transparent for investors. The govt. will vote on this new risk management law. This will require investors to publicize minority holdings owned through options, identify the actual owners of individual holdings and, when acquiring more than a 10% stake, announce their intentions.

The German securities regulator BaFin will have greater power and flexibility to decide if minority investors such as hedge funds "acted in concert" to influence the corporate strategy. If its proved that shareholders did join forces, the new law would compel them to bid for the company. The new law would require companies to announce their positions regardless of how they acquired or would acquire the stakes, while current legislation allows investors to hold off reporting an investment when it's held through options. Germany's new law would enable the country's securities regulator to prohibit a company from exercising voting rights tied to a stake if it decides the investor violated any new regulations.

Switzerland - Companies are now required to announce any stake of more than 3%, regardless of how it's held.

UK - Last week, a group of 14 of London’s biggest hedge funds under a Hedge Fund Working Group drew up a voluntary industry code of conduct. Under the plan the London group, which manages approx. $180 bn of assets or about 10 per cent of the global industry total, Hedge funds would have to “comply or explain”, agreeing to meet the standards or tell people why they were not meeting them.
The plan focuses on 3 main standards to protect investors.
1. Disclosure of holdings of complex hard-to-value securities, and the methods used to value them
2. Clear risk management plans, including plans to address liquidity risk
3. Clear policies on dealing with the conflicts between investors and managers

US - It will be interesting to see the resulting developments in our own market in the US. This growing push by foreign markets to improve global oversight and transparency of financial markets, including hedge funds and complex financial products is bound to influence U.S. oversight practices as well especially given the subprime-lending exposures.

The markets supervisors too are certainly nudging hedge-fund managers and investors to develop voluntary guidelines to help improve disclosure and mitigate the systemic risks.

In a related development the President's Working Group on Financial Markets is creating two advisory groups to develop "best practices" for investors of hedge funds and the managers who run the investment vehicles.

The first group comprising hedge-fund managers will develop guidelines such as valuation and enhanced disclosures to investors.

A second group, comprised of investors, will develop guidelines on the type of "due diligence" necessary for hedge funds investors, as well as the information investors should receive. The timeline for expected recommendations is by the end of the year.

In summary, in my humble opinion, self regulation and tighter Risk controls for Hedge funds, PE firms and M&A deals are pretty much on cards in the near horizon.

Posted by spachava at 04:21 AM | Comments (0)

September 01, 2007

Financial Services for the Poor - Risks & Defaults !

Desiring a break from following the subprime lending woes & the associated default risks in the US market, I jumped on a chance to work on a Research paper on Micro ventures financing.

This blog is about some interesting facts about risks and defaults in the world of microfinance, micropayments, peer to peer lending and financial inclusion initiatives.

In early days of Microcredit and when the concept of Financial services to the poor was in its infancy, the segment of poor people was considered to be potentially high risk in terms of defaults.
The perception was strong enough to influence even the most local of the financial institutions to be not too enthusiastic on lending to this market segment. It was so bad that finally a form of credit was made mandatory under “ priority sector lending” schemes by many Central banks in most poor and developing countries to provide some basic level of liquidity for this segment.

Despite pockets of success for Microcredit initiatives in early 70’s& 80’s, the failure of too many aggressive Microcredit ventures in mid 80’s to early 90’s was again a proof to many naysayers about the repayment viability of this segment.

However ever since late 1990’s, the consistent success of microcredit business model around the world have slowly started to change this old paradigm.

Today there are numerous data points to support the contrarian hypothesis that the segment of poor actually can have an overall better credit rating & higher repayment rates as compared to people in the more richer countries.

It is estimated that an estimated 2.5 to 3 billion people live on less than 2-4 US dollars per day. Around 2.0 billion people have never used a bank. This has led to many governments actively pushing a financial inclusion agenda to have more equitable society in future.

With the Risks & defaults picture across the microcredit sector looking positive, the business viability of financial services to the poor is looking extremely attractive. Many global and local financial institutions are now reviewing their business models to be able to serve this underbanked segment across the world & recalibrating their traditional risks and defaults paradigms associated with the poor !

Once the new disruptive business model of Peer to Peer Lending networks becomes mainstream and start to look at this segment, there may be a potential trigger for another big paradigm shift on looking at risks,defaults,collateral from a portfolio to an individual peer to individual peer level. But then that’s a topic for another blog !

Posted by spachava at 03:51 AM | Comments (1)

April 12, 2007

10 Risk Frontiers ideas seeking thought leadership !

Risk Mgmt & Compliance developments and practices continue to evolve so dramatically each day!

Sleepless in Seattle, I start this blog to share, discuss and most importantly learn about the new Frontiers in Risk & Compliance - both current & futuristic trends with signficant impact on the Risk Mgmt & Compliance practices & profession.

My future observations would focus on the following 10 Risk frontiers:

1. Risk Visualization
2. Next Generation Risk & Compliance Architectures
3. Risk Pricing Clusters
4. Risk & Compliance Taxonomy
5. Pan Regional Risk Data Grids
6. Digital Assets Mgmt
7. Cross Industry Risk mgmt practices
8. Incubating Centers of Risk Mgmt Excellence & practices
9. Risk Management Career Options
10. Embedding Risk Mgmt & Compliance in an organisational DNA

Posted by spachava at 07:49 PM | Comments (3)