Economics/1. Banks and bank system
Cand. Sci. in Physics and
Math. George G. Zhyrnyy
European University
(Sevastopol branch),
Department of Information
systems and Technology
1. Introduction. Recent events on financial markets once again have stressed the
significance of risk management. It turned out that even huge financial institutions
can experience critical problems due to inadequate risk management. This work
is devoted to Key Performance Indicators (KPIs) used to assess risk management.
While being within the framework of [1] we made an attempt to fill the gap in
the list of possible Production Indicators (PI) by augmenting this list with
PIs used to assess risk management.
2. Problem setting. As it is pointed in [2] four major differences in the firms’ approaches
to deal with market turmoil were:
-
the balance between desire to do business,
appetite to risk and risk control;
-
the role of senior management in identifying and
mitigating the risks;
-
presence and adequacy of channels to escalate
managers’ view about emerging risks to senior management;
-
breadth and depth of cross-disciplinary
discussions and communications of insight into relevant risks across the firm.
Even these four items can
suggest that there is need to assess separately
a) activity used to reveal, identify, evaluate and mitigate risks;
b) ability of organization to conduct to senior management and use results
of a);
c) readiness and willingness of senior management to accept and use results
of a);
We
will concentrate on a) rather than on b) or c).
3. Main consideration. We consider adequate Risk Management as Critical Success Factor (CSF)
for banking business and we will prove it. Note, that Risk Management has not
been explicitly listed among CSF in [1]. We will fill this gap.
According to [1] CSFs are inherently linked with vital activities of
company, critically impacting on state and viability of organization.
Commercial banks loan to individuals and businesses, invest into different
securities, etc. These activities are risky but banks can’t abandon them.
Incorrect risk evaluation can lower the income of bank and even can drive bank
to bankruptcy. So, correct risk evaluation is vital for financial results of
banks.
Further, 10 carats diamond is a perfect pawn for one year loan of $100
at interest rate 10%. But such ‘risk management’ greatly decreases the quantity
of prospective clients. So, correct risk evaluation should be used along with
correct risk management.
Evaluating risks, diversifying risks, watching for risk concentrations,
developing proactive risk monitoring methodology is not full list of tasks of
Risk Management Department of commercial bank. Adequate Risk Management is true
Critical Success Factor as it greatly influences several areas of activities
which are acknowledged as key areas of activities for any commercial bank.
First, it is obvious that adequate risk management improves use of
financial assets by providing guidance and warnings. Adequate risk management
can prevent losses. Better risk evaluation also helps to define capital charges
better and can show opportunities for better price policy.
Second, adequate risk management can allow more bank products, can
increase quantity of clients and even can help to improve their quality! Actually,
better prices and large assortment and timely loan/contract approval can
attract more clients while correct risk evaluation helps to select clients
better. All this can improve reputation of bank to some extent.
Third, being forgotten once too often, employees-related risks cannot be
handled well unless enough efforts are spent for education and training and
making employees satisfied with their work.
Finally, it is obvious that adequate and constantly improving risk
management is core part of adequate and constantly improving internal business
processes in any commercial bank. Industry leading products, up-to-date and
correct information, timely assets replenishing are scarcely possible without
adequate risk management.
So, according to [1], we conclude that adequate Risk Management as
Critical Success Factor for banking business.
While [3] contains a lot of guidance how to organize
processes of risk evaluation and supervision process it has a few paragraphs
(##732 – 748) devoted to assessment of quality of risk management department
itself.
Risk Management Department is making forecasts and
these may be forecasts for very long periods. So, evaluation of true quality of
work of Risk Management Department can be deferred to distant future. This
calls for some indicators capable to evaluate work of Risk Management
Department.
4.
Results. For above purpose we propose three
KPIs.
KPI-1 and -2. Ratios of actual and expected defaults/problems
computed for:
-
lost value of
problematic contracts: (actual possibly lost value of problematic
contracts)/(expected possibly lost value of problematic contracts);
-
quantity of
problematic contracts: (actual quantity of problematic contracts)/(expected
quantity of problematic contracts), before
the work to process problematic contract is started.
KPI-3. Time necessary to perform
risk evaluation and assessment (by types of contracts), including time to
collect necessary data.
These quantities should be
computed based on daily data but first two KPIs should be adjusted as to reflect
the fact that quality of risk evaluation should be assessed for portfolios of
contracts of the “same” type.
References:
1.
Parmenter D. Key Performance Indicators. – John
Wiley & Sons, 2007.
2.
Observations on Risk Management Practices
during the Recent Market Turbulence. – Report by Senior Supervisors Group,
March 2008.
3.
International Convergence of Capital
Measurement and Capital Standards. A Revised Framework. Comprehensive Version.
– Basel Committee on Banking Supervision, June 2006.