Prevention and stress testing key to risk management

The crisis has highlighted the limitations of so called “all-weather proof” risk models, says Anuj Jain of Innovations Software Technology.
Anuj Jain of Innovations Software Technology
Anuj Jain of Innovations Software Technology

In today’s competitive business environment, banks and financial institutions are striving to improve their risk management methods and tools. At the same time, they must ensure that their systems comply with Basel II and Basel III requirements, which have expanded risk assessment models in elaborate ways.

Anuj Jain, managing director of Innovations Software Technology Asia, discusses the role of risk management and what his company can offer to tackle the challenges facing banks, financial institutions and corporations.

The financial crisis highlighted the need for more effective cash and risk management. How has the importance of risk management evolved post-crisis?

The most recent financial crisis has been unprecedented in many ways. This crisis has shown that even the biggest and most sophisticated players can be hurt, thus putting the fundamentals of risk management within most banking and financial institutions under the microscope.

There is now a clear and strong drive across the world to evaluate the risk function on various fundamental points. One of these is the reporting line of the risk department. Increasingly, this is being moved from the business or executive functions to independent governing bodies like the board of directors. Companies are also looking at ways to do a closer review of assets and assess vulnerability impact by ways of stress testing. Organisations are also adopting a more preventive approach and doing a closer review when it comes to risk management. Regulatory bodies have been playing the role of the tough guy, making changes to the risk function so that banks can be more responsive to changing market conditions in real time, sustaining through difficult times and protecting investors’ money.

There is an emergence of different kinds of risks on the horizon, such as liquidity risk, model risk and even sovereign risk, all of which have never been a priority of the risk function. Counterparty risk has also gained attention and attempts are being made to get a consolidated view of multiple risks – these were being handled in isolation before.

The crisis also highlighted the limitations of so called “all-weather proof” risk models and highlighted the importance of validating models and making them suitable for a given business. This has resulted in company managers looking for enriched risk data generated within the organisation and a review of IT systems managing the risk and risk data. These changing times have put the risk manager in the hot seat and the performance is closely monitored. The risk manager would need tools that allow him or her to model risk dynamically without the tedium of legacy systems and development cycles and technologies.

Can you highlight the risks involved with cash and foreign exchange transactions and trade finance for banks, financial institutions and corporations?

It is now post-economic crisis. However, things have not gone back to where they were pre-crisis. The erratic pace of the economic recovery is having an impact on the currency market which is changing rapidly. Banks are faced with challenges such as constantly balancing their portfolio particularly in the trade finance area. Recent actions from the US Federal Bank have impacted long-term currency views, leaving bankers on toes to review their treasury positions not only in cash but also in fixed income securities. Government initiatives on spending cuts indicate that the growth of budgetary deficit is in an undesired zone that is to be avoided, making the cash base in market even thinner.

The economic downturn has impacted corporations in two ways. Firstly, their top lines have declined and with the emergence of liquidity risk, banks are extra cautious about credit quality, making it difficult for corporations to get access to credit that was easily available during the pre-crisis period.

Moreover, due to geo-political influences on economic decisions such as to adjust or not to adjust the currency rate or influences on central bank actions such as printing notes, interest rate changes and interventions for currency protection are likely to impact cross-country trades. This means challenges for banks as well as corporations for their foreign exchange or trade policies.

How can they improve their risk management methods and tools in these areas?

The risk rating models that encompass key risk parameters are often complex and must be continually adapted to regulatory requirements and market dynamics. The traditional approach of using Microsoft Excel/VBA or hard-coding solutions to implement, deploy, and manage automated assessment models have proven too inflexible to meet these requirements. Today’s credit managers and analysts need an internal rating process that is transparent, flexible and agile.

The evaluation of customers’ creditworthiness within a process-oriented IT application brings a succession of benefits, which ensures more confidence and promptness in managing requirements:

  • Integration of internal and external data for risk analysis and customer evaluation.
  • Central storage and immediate availability of all information e.g. customer scoring and credit limits.
  • Business rules for the flexible implementation of enterprise-specific credit policies and processes.
  • An early warning system to recognise trends and promptly initiate counter-measures.
  • Simulation tools to analyse the effects of modifications to the risk models.

What are some solutions Innovations offers to tackle challenges related to risk?

Innovations' credit management platform is an end-to-end software solution that supports the entire credit application process including loan origination, risk assessment, credit decisions, and reporting. The software is being used by banks and financial service providers as well as by corporations. The dynamic application model is designed for flexible implementation and adaptation of bank-specific rules, procedures and processes. This framework facilitates the implementation, modification, and extension of all functional components, such as rating and scorecards, user interfaces, business processes, and more.

With its credit risk rating platform, Innovations offers a comprehensive solution for the transparent and flexible development and implementation of credit risk rating models. Innovations’ credit risk rating platform comprises of core components like model authoring platform, rating manager, stress testing and rating database. This ensures compliance with the bank’s credit and rating policies – and exceeds all Basel II regulatory requirements.

Innovations also provides a comprehensive compliance suite to enable financial institutions to model their entire compliance and risk requirements into a single console. The compliance suite has a modular architecture and consists of the following modules:

  • MLDS : money laundering detection system.
  • Name matching: name matching and embargo monitoring.
  • MAID: market abuse and insider dealing detection, and
  • FDS: fraud detections system.

Will risk management remain a focal point as the global economy recovers?

The answer would be a definite “yes”. The financial crisis of the last two years has led banks and financial institutions to do some soul-search and review their standards, assumptions, and internal processes. The so-called “best” practices of the pre-crisis era have become obsolete. Financial institutions have also felt a strong need to adopt more robust scenario analysis and stress testing in financial risk management. Even the regulators are emphasising risk models to incorporate a wider range of possible outcomes and responses. The crisis had also proved that risk cover is utmost essential during the good times as the biggest of mistakes are committed when nothing is seemingly going wrong. These changes indicate that risk management will be the prime focus point into the future.

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