Published on March 14, 2014
The Risk/Capital Management Matrix Where do you fit? How to go for the gold
Capital management and risk management are both fundamental to banking success. By looking at these two dimensions of performance together, you gain a view of your bank’s current position in relation to world-class performance levels. You see the directions your organization needs to move to create more competitive advantage. Learn how a global bank generated 60+ basis points of organic capital year after year despite economic and regulatory pressure Two management dimensions drive world-class performance low RISK MANAGEMENT MATURITY high weakstrongCAPITALMANAGEMENT/POSITION Integration ©2014 Fair Isaac Corporation. All rights reserved. 2
©2014 Fair Isaac Corporation. All rights reserved. 3 Complementary disciplines with intersecting effects… Virtuous circle of complementary disciplines Capital management levers Risk management levers These disciplines have traditionally been thought of and conducted separately. But when they’re both performed well, they become two halves of a virtuous circle. Capital management levers: Affect how much capital and funding are available for risk-managed retail lending. Risk management levers: Affect how efficiently lending consumes capital. Impact how much capital is required to cover the resulting risk-weighted assets. Largely determine degree to which lending produces profit, return on assets and funding for further investment.
©2014 Fair Isaac Corporation. All rights reserved. 4 …can be integrated to generate more competitive power Emerging best practices link capital management and risk management. Push both sets of levers together to improve: Capital efficiency, RoRWA (return on risk-weighted assets) and ROE (return on equity) Risk exposure estimates for loss reserves Portfolio responsiveness to Executive Committee direction Capital control Accuracy and reliability of portfolio profitability forecasting and stress testing Allocation of available capital across competing requirements Linking capital management with risk management creates more competitive power
©2014 Fair Isaac Corporation. All rights reserved. 5 low RISK MANAGEMENT MATURITY high weakstrongCAPITALMANAGEMENT/POSITION Sharper risk assessments through Big Data analytics: u More insights from unstructured data u Risk/reward balance u Customer-level decisions u More comprehensive and adaptive fraud detection Oﬀset or enhance regional/ market conditions through: u Capital planning (3–5 years) u Basel II/III controls u Modeled/monitored portfolio-level RoRWA u Economic impacts built into analysis and planning Integration Chart your course to world-class performance No matter where you are now in the matrix, you can: Improve your performance along one or both dimensions. Start moving toward the most competitive position of integrated risk and capital management.
©2014 Fair Isaac Corporation. All rights reserved. 6 low RISK MANAGEMENT MATURITY high weakstrongCAPITALMANAGEMENT/POSITION Au Strong capital management/position u Low risk management maturity Characteristics: Banks in this quadrant have the capital to pursue market opportunities, but ROE from growth initiatives may be low due to inadequate risk management. Typically they have higher-than-necessary origination costs, delinquency rates and collection costs along with lower-than-necessary credit usage, revenue and customer profitability. Next steps Æ Implement risk-based decision systems across credit lifecycle: Rules-driven. Business users create/change decision policy rules. Open to analytics. Analytic models and segmentation strategies easily added to decision processes. Structured for learning. Systematic champion/challenger testing drives continuous improvement. Quad A: Improve ability to manage risk in operational decisions
Example ©2013 Fair Isaac Corporation. All rights reserved. 7 A A Brazilian bank consolidated its risk management after a merger The company implemented a single customer management system that performs customer-level decisioning across its multiple portfolios. With the ability to set pre-approved limits across products, the bank has been able to achieve results like these: Pre-approved limits across all portfolios Customer-level collections +9% Proﬁtability –18% Attrition –60% Probability of default final notice $ 10% È from 15–19% 30-day delinquency rates $ past due other exampleother example
©2014 Fair Isaac Corporation. All rights reserved. 8 Characteristics: Banks in this quadrant currently have limited capital to invest in growing their business. In addition, results from whatever they do invest are likely to be disappointing. As long as risk management is underdeveloped, costs will be higher than necessary and ROE lower than necessary. Next steps Æ Implement risk-based decision systems across credit lifecycle: For lots of risk-based decisioning power at low cost, build apps/services on a BRMS (business rules management system). Interact with customers in low-cost ways through intelligent omnichannel communications (e.g., mobile SMS, voice). Use analytics to increase risk/reward differentiation among existing customers. Use economic impact analytics to improve capital allocation and reserve estimates. low RISK MANAGEMENT MATURITY high weakstrongCAPITALMANAGEMENT/POSITION Bu Weak capital management/position u Low risk management maturity Quad B: Reduce spending to free capital for better risk management
©2014 Fair Isaac Corporation. All rights reserved. 9 Example B A South African bank implemented rules-driven decision making in originations and customer management The result is lower application development and maintenance costs, plus flexibility to outmaneuver competitors. Changes to policy rules and score cutoffs can now be made by risk management staff, including simulating impact on portfolio profit/loss and deploying the changes, within a matter of days. Sample of customer management results: +13% Proﬁt/active account +5% Average credit limit +3% Total sales +7% Debit balances +5% Finance charges +2% Interchange fees other exampleother example
©2014 Fair Isaac Corporation. All rights reserved. 10 Characteristics: Banks in this quadrant may have seen strong capital positions reduced by economic stress. Still, with their advanced risk management capabilities, they can make the most of currently scarce capital and deliver high ROE and RoRWA for every investment they make. By making additional analytic enhancements, they can drive ROE even higher. Next steps Æ Make more decisions at the customer level. Add new data sources (text, speech, etc.) and advanced analytics for deeper customer insights. Use decision modeling and optimization to identify superior risk management strategies with fewer test-and-learn cycles and to pinpoint the best next action for each customer. Begin integrating capital management into risk decisions by incorporating Basel II models/metrics into decision strategies.low RISK MANAGEMENT MATURITY high weakstrongCAPITALMANAGEMENT/POSITION Cu Weak capital management/position u High risk management maturity Quad C: Organically boost capital by improving customer profitability
Example ©2014 Fair Isaac Corporation. All rights reserved. 11 C A European bank standardized and automated risk management as it expanded into additional markets in Europe and Africa Initial focus: Put right systems in place to improve efficiency in originations and customer management (current accounts, credit cards, loans, mortgages). Next: Sharpen segmentation with data mining and custom predictive models. Currently: Use decision modeling and strategy optimization to improve decision performance. Results include: Ability to set customer-level exposure limits, updated each time any credit product is used. 90% Origination decisions automated 99%+ Overdraft self-cure È Loss provisions other exampleother example
©2014 Fair Isaac Corporation. All rights reserved. 12 Characteristics: Banks in this quadrant have ample capital. They also have sophisticated risk management infrastructure and best practices, increasing likelihood of success wherever they choose to invest. Everyone in the company thinks about how capital impacts the business. Capital- based decision making is the modus operandi, not only in planning cycles, but also in everyday operations. Next steps Æ Move to fully customer-centric operations. Implement analytic learning loops to progress faster than competitors. Scale up/speed up model generation, deployment, updates, compliance review with automation. Fully integrate risk management and capital management. Optimize at both level of strategic portfolio management and operational (customer and account) decisions. Quad D: Build on success with most advanced analytics available low RISK MANAGEMENT MATURITY high weakstrongCAPITALMANAGEMENT/POSITION Du Strong capital management/position u High risk management maturity Integration
©2014 Fair Isaac Corporation. All rights reserved. 13 Example D +25% Authorization approval rates –50% Delinquency rate A global banking group generated organic capital of €17 billion (more than 60 basis points annually) in 4 years One reason the bank is so profitable: Enterprise-wide use of the same predictive analytics, decision systems and customer service business model. Across originations, customer management and collections, this approach creates cost and revenue synergies, a high degree of control over risk and capital, and opportunities to invest efficiently. Another profit driver: Systematic test-and-learn cycles, which constantly drive improvements like these: other exampleother example
For more information North America toll-free Latin America & Caribbean Europe, Middle East & Africa Asia Pacific www.fico.com +1 888 342 6336 +55 11 5189 8222 +44 (0) 207 940 8718 +65 6422 7700 firstname.lastname@example.org LAC_info@fico.com email@example.com firstname.lastname@example.org FICO is a trademark or registered trademark of Fair Isaac Corporation in the United States and in other countries. Other product and company names herein may be trademarks of their respective owners. © 2014 Fair Isaac Corporation. All rights reserved. 3049BK 1/14 PDF Go for the Gold! Tightly integrate both performance dimensions for unprecedented levels of capital control, RoRWA and ROE Learn more: Download the white paper on this topic: Insights #61: Where Do You Fit on the Risk/Capital Management Matrix? Check out our blog: Banking Analytics Blog Results from optimizing portfolio strategies become constraints for optimizing operational customer decisions ÇÈResults from optimizing customer decisions become constraints for optimizing portfolio strategies
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