Tying the knot between risk and performance management

Enhancing profitability and responding to regulation in Asia-Pacific banking

Contents

Executive Summary The Drive for Integration

Current Banking Challenges

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Seeking Coordination and Answers: The Drive for Risk and Finance Integration 3 Using the Right Measures to Monitor and Manage Shareholder Value 4

The Accenture IRPM Framework

IRPM as a Key Enabler IRPM Benefits IRPM Approach and Key Components Taking a Holistic View IRPM Improves Capabilities Across All Levels of the Organisation IRPM Supports the Implementation of New Risk-Adjusted Measures and Alignment Employee of Objectives IRPM Supports a Customer-centric View

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5 6 7 9 9 10

Enabling Technology Accenture Services

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Executive Summary

Two years after the collapse of Lehman Brothers and the global financial crisis (GFC), the areas of risk and corporate performance management have come under close scrutiny. Key questions are now being asked of these capabilities such as, Why didnt we see the warning signs earlier? Why were risks underestimated to such an extent? What must be done differently in the future to manage and protect shareholder value across economic cycles? Accentures Integrated Risk and Performance Management (IRPM) research was launched in 2010 to help companies develop new perspectives and capabilities to manage corporate performance. In particular, the research focused on helping financial institutions overcome post-GFC challenges, which include optimising capital, managing the cost of funding, compliance with new regulations, increasing customer centricity, and maximising long-term shareholder value.

The Accenture IRPM Framework provides a set of business processes, methodologies and supporting technologies that give financial institutions a new, risk-conscious way to monitor and manage corporate performance and improve decision making. Additionally, this framework supports institutions in overcoming todays siloed approach to risk and performance management, and helps ensure that decisions are no longer made on a mutually exclusive basis. Implementing the IRPM Framework provides organisations with the ability to manage risk-based performance across multiple views, while also providing a path for improving return on equity (ROE) by up to 1.5 percent, risk-adjusted return on capital (RAROC) by 2 percent or more and economic profit margin by up to 11 percent1.

In this paper we outline and discuss: The drivers behind risk and performance integration and the journey banks are taking to restore shareholder value Accentures IRPM Framework and how banks can use this framework to enhance risk and performance management capabilities across the organisation Enabling technologies available on the market to support an IRPM approach

1 Accenture IRPM Research 2010

The Drive for Integration

Current Banking Challenges
Financial services companies worldwide have experienced unprecedented value destruction since the GFC. Some institutions have not survived and total losses related to the crisis are expected to exceed US$1 trillion. Across the Asia-Pacific region, banks have emerged from the GFC in relatively strong shape. Many enjoy strong balance sheets and favourable macroeconomic conditions. However, there are still a number of downside risks including potential fluctuations in global demand, inflationary pressures and regulatory reform. Several key challenges have emerged following the GFC, which are dominating C-level executive agendas across the financial services industry. These challenges vary in importance and complexity across the Asia-Pacific region and include:

c. Adapting to regulatory reforms across geographies

Many governments have increased their role in regulating local markets since the GFC. In parallel, the G20 summit in November 2010 has seen agreement on revisions to the banking system under Basel III. On a phased basis between 2011 and 2019, banks across the globe will be subject to greater capital, liquidity and supervisory requirements.

Seeking Coordination and Answers: The Drive for Risk and Finance Integration
Getting to grips with the challenges facing the C-suite executive agenda will require a fundamental review of how financial firms manage their risk/ return profile. This starts with the economic measures executives use to monitor and manage corporate performance (such as ROE, RAROC, economic profit). Following that, executives need to consider the operating models in place across Risk and Finance to monitor and manage underlying key performance indicators and key risk indicators. In addition, the data management and analytical technologies in place to support this capability are fundamental to ensuring accurate and risk-adjusted calculation, aggregation and reporting of key indicators across all levels within the organisation. Integration of risk and finance reporting, together with greater analytical capabilities, is enabling financial institutions to manage the risk, funding, liquidity and capital requirements of their business in a more dynamic fashion. This includes the ability to monitor and manage risk appetite in real time. For example, the ability to quickly redirect marketing campaigns and business focus if established risk thresholds are crossed, such as the value of loans extended in a particular segment or geography. Integrating risk and finance capabilities also enables companies to introduce greater risk sensitivity into product pricing, through the standardisation and streamlining of risk and finance processes and IT systems. The tantalising possibility for leaders is to be able to easily answer questions such as: Have we adequately priced all of our risks?

d. Improving the quality of assets on and off balance sheet

The quality of on-and off-balancesheet assets has come under close scrutiny. The GFC saw a flight to quality as market confidence sank across many asset classes. Financial institutions now need to look at how asset quality is monitored and maintained across their banking and trading books. In addition, changes to the definition of Tier 1 capital under Basel III will bring off-balance-sheet instruments under further scrutiny.

a. Restoring shareholder value and stakeholder confidence

Responding to post-GFC challenges effectively, efficiently, and responsibly while also restoring shareholder value is now a key focus. More broadly, the perception of the banking industry has taken a considerable hit and many executives face a battle to improve confidence across stakeholder groups including investors, regulators, governments, customers, media and the general public.

e. Supporting the changing business

Banking business models are undergoing a period of reform across the region. Banks are under various pressures including governmentenforced business model changes, growth strategies in new and emerging markets, an evolving mix of business and asset classes, and greater complexity as interconnectedness and risk are better understood. Getting to grips with each of these challenges will require fundamental reforms to internal banking operating models, processes and systems, and most importantly, a new outlook on risk and corporate performance management.

b. Managing higher costs of capital

One of the key impacts of the GFC has been the higher costs of capital and the impact to balance sheets and profitability. In the Asia-Pacific region, the focus has been on both: 1) managing the funding models (deposits vs. wholesale capital markets), and 2) finding ways to tap the investor base in the developing world.

Figure 1: Key challenges and priorities facing the Asia-Pacific banking industry

Australia
1. Managing higher costs of capital 2. Adapting to regulatory reforms 3. Supporting changing business models and growth strategies

Singapore
1. Supporting changing business models across the region 2. Managing higher costs of capital 3. Improving asset quality

China

Market Overview Japan

1. Restoring shareholder value and stakeholder confidence 2. Supporting changing business models and drive for profitability 3. Adapting to regulatory reforms 4. Improving asset quality

1. Supporting changing business models and foreign participation Managing the move to a marketorientated banking system 2. Adapting to a state-controlled and regulatory-driven banking system 3. Managing higher costs of capital and broader management of NPLs

I know my risk, but how can I improve the return for that level of risk? Can I dynamically price and reprice risk by customer, portfolio, and product type, taking into consideration factors such as wrong-way risk? What is the risk-adjusted profitability of my business unit, portfolio or activity when allocated capital and risk are taken into account? How can I rationalise my decisionmaking process regarding risks and investments? Can I compare the performance of my business lines according to their risk profile? Where in my company is value being created and where is it being destroyed? How can I incentivise my team to take a risk-adjusted view of business decisions?

Using the Right Measures to Monitor and Manage Shareholder Value

Leading banks no longer use risk and finance measures purely for control purposes. Instead, they recognise their potential usefulness in driving valueenhancing strategies: from corporate strategy to better understanding customer behaviour. Traditionally, financial institutions have been measured (internally and externally) on historically focused indicators such as ROE. In some cases, firms have also looked to monitor RAROC as a risk-based profitability measure of financial performance. Accentures IRPM research has shown that executives should seek to monitor financial performance through multiple lenses, from traditional financial measures (e.g. ROE), to risk-adjusted performance measures (RAROC), which take into account not just historical performance, but also the risks taken and opportunities forgone to realise those returns (economic profit).

The ability to viewat all levels of the organisationtraditional and riskadjusted measures, via these different corporate lenses, will improve the ability of decision makers to judge short-term and long-term impacts to the balance sheet. However, to do this properly, banks need greater real-time and analytical capability across existing reports and controls, including: real-time limit and exposure management, dynamic appetite setting in response to changing market conditions, improved risk-based pricing, real-time portfolio reports to improve capital, funding, and liquidity management. An integrated risk and finance capability will also support changes to employee incentives to drive more appropriate decision making, aligned to risk and reward objectives, in critical areas such as product pricing.

The Accenture IRPM Framework

IRPM as a Key Enabler
Accenture has developed the IRPM Framework as a direct response to the challenges now facing financial institutions post-GFC. The IRPM Framework provides a set of business processes, methodologies and supporting technologies that give financial institutions a new, riskconscious way to monitor and manage corporate performance and improve decision making. The framework directly targets the integration of people, processes, data and technology between risk and finance departments to directly enable superior risk-based performance management. From a business and operational perspective, IRPM helps organisations overcome operational silos, which reduce the ability of corporations to monitor and react to external shocks. It also introduces new measures and methodologies for managing corporate performance across multiple levels, ultimately improving the information and insights generated across the organisation. From a technology perspective, the IRPM Framework provides a solution blueprint and methodology for integrating IT systems across the organisation to enable superior analytical and reporting capabilities. In addition, the framework provides an overview of the leading technologies available on the market to support system implementations (including the key Oracle, SAP and SAS platforms).

Snapshot: How IRPM supports superior performance management and risk integration
IRPM gives senior leaders and others the right information to assess whether the organisation is realising its strategy and vision. Well-designed performance measures are typically generated by the finance function. They enable managers to monitor and adjust their operational activities or to change strategies. The IRPM methodology for performance management brings together measures from across the organisation to provide a comprehensive picture. Risk management activities have traditionally focused on protecting banks from financial, customer and external threats. The steps involve identifying and assessing risks, developing responses, implementing controls, capturing information and continually monitoring the situation. The IRPM approach to risk supports simulation, calculation and aggregation of risk measures across all business lines. Risk reporting measures include credit risk, liquidity risk, market risk, operational risk, fraud, anti-moneylaundering measures and local regulatory requirements. Most banks struggle to generate enterprise-wide performance and risk information, let alone to connect the two. The reason is that large financial institutions are typically broken down into distinct operating silos and data sharing is hampered by traditional business processes or legacy technology systems. The IRPM Framework enables organisations to truly manage riskadjusted performance at all levels of the organisation.

IRPM Benefits
The IRPM Framework provides a structured approach to integrating risk and finance processes to gain a range of business benefits, including improved economic profit, greater capital management capabilities and better decision making, based on an integrated view of risk and performance. For the Asia-Pacific region, we estimate that banks can lift economic profit by as much as 11 percent by implementing an IRPM business and technology solution. This translates into a ROE gain of up to 1.5 percent and a gain on the RAROC of up to 2 percent across the Asia-Pacific region2.

The improvement in performance can be attributed to a number of benefits tied to introducing the IRPM Framework: Improved risk-based pricing incorporating cost of capital Risk-based customer analytics, enabling banks to focus on the right customers Improved asset quality Improved risk monitoring and capital management Integration of the finance and risk functions Improved investor confidence in risk management processes

Figure 2: Implementing an IRPM solution can directly benefit the bottom line

Potential Benefits of IRPM Solution*

ROE Australia
0.4% - 0.6%

RAROC
1% - 2%

Economic Profit Margin

5% - 8%

North America

0.3% - 1%

0.5% - 2%

3% - 7%

Europe

0.3% - 1.5%

0.5% - 2.5%

3.5% - 11%

Asia

0.5% - 1.5%

0.5% - 2%

4.5% - 11%

*Analysis is based on the latest available year-end financial statements for the five biggest banks (excluding investment banks) by market capitalisation in each geography. Each had revenues greater than US$10billion.
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Accenture IRPM Research 2010 6

IRPM Approach and Key Components Taking a Holistic View

The objective of the IRPM approach is to develop a clear view of the ideal end-point, which is tailored to individual institutional needs, and then to work towards realising it in feasible and affordable steps. At Accenture, we have mapped out this end-point in the IRPM Framework and developed a range of supporting methodologies. The steps and enablers involved in realising the IRPM approach are:

4. Monitoring
Develop action plans, re-allocate resources and update forecasts, accounting for risk Review performance with executive management and analyse variances Monitor and report KPIs and KRIs, and review risk controls

5. Enablement
Integrated IT architecture and reporting Infrastructure for risk and performance management Standardised procedures for risk performance management and reporting Data structures and controls, governance, quality and accountability Risk-metric-driven incentives and rewards Leadership and culture

1. Strategic planning
Refine corporate vision and strategic objectives, considering enterprise risk strategy and appetite Determine key value drivers, taking into account the impact of risks across categories Determine KPIs and key risk indicators (KRIs) and define accountabilities Create the strategic plan, in the context of the broad risk management plan

2. Target setting
Conduct portfolio value assessment, allowing for risks Set targets or limits for key measures of performance Cascade measures (KPIs, KRIs) and targets or risk limits to lower-level metrics or categories

3. Operation
Review, challenge and finalise riskadjusted plans and forecasts Develop plans to achieve targets, based on risk modelling and scenario analysis Allocate resources to achieve plans, accounting for risk and compliance Review, challenge and finalise riskadjusted plans and forecasts

Snapshot: Targeting higher, risk-adjusted returns

The end goal is to redeploy capital to earn higher, risk-adjusted returns by integrating risk, return and capital considerations into core strategic decision-making processes. This enables banks to focus on more profitable and less capital-intensive areas of business. To do this, leaders need to see their organisations differently. Widely used measures of banking performance such as return on equity, net interest income and loan-to-value ratios are vital, but they do not take risk into account. The measures that do take risk into account and that help drive sustainable performance and the most efficient allocation of capital are those such as risk-adjusted return on capital (RAROC) and economic profit. As Figure 3 illustrates, executives need to manage corporate performance from a range of points of view that span straightforward returns, risk and capital. From an organisational perspective, this involves integrating the views of the organisation as held by the CEO, CFO and CRO.

Figure 3: An integrated view of risk, return and capital for all C-level executives Return Management
Managing the value contribution of the business as a whole and of its inherent value drivers

Return
Employing risk most effectively Integration of risk, return and capital into a single framework allows the organisation to manage its performance in a more risk-centric manner Achieving highest return on capital

Risk

Managing solvency and capital adequacy Capital Management

Capital

Risk Management
Qualifying and managing the economic risk embedded in business

Managing the economic net worth of invested shareholder capital and funding future growth

IRPM Improves Capabilities Across All Levels of the Organisation

The IRPM Framework uses standard financial and risk-adjusted KPIs to provide alternative lenses on corporate performance in order to drive increased risk-adjusted returns. As this capability is fully realised and understood, the board and executive team can better view and manage the performance of the organisation. In turn, C-suite executives, business unit managers and compliance officers are empowered to take timely action to protect and enhance the banks capital, and ultimately increase shareholder value.

Leadership role Outcomes of the IRPM Framework

Chief Executive Officer Enhanced ability to manage corporate performance, based upon superior risk-adjusted management reporting to support decision making across geographies, organisational units, products, customers and channels. Enhanced ability to manage risk across the organisation. Availability of a single, consistent, data set and analytical capability across the enterprise. Superior ability to manage risk and return in real time. Enhanced ability to plan, measure, analyse and report financial performance, taking into account risks confronted by the organisation and the rewards expected by shareholders. Availability of a single, consistent data set and analytical capability across the enterprise. Enhanced ability to analyse and manage business performance from a risk/return perspective that distinguishes impact to short-and long-term corporate performance. Realtime reporting and analytical capabilities. Implement adequate controls for risk and performance strategy to ensure compliance with best governance practices as well as regulatory requirements.

Chief Risk Officer

Chief Financial Officer

Business Unit Managers

IRPM Supports the Implementation of New Risk-Adjusted Measures and Alignment of Employee Objectives
The RPM Framework provides a mechanism for aligning the goals and KPIs of individual managers to those of the bank as a whole. The strategy and objectives identified by the banks leadership flow through to the setting of objectives, and reporting on performance, at all levels of the organisation. This is achieved by breaking down corporate, risk-related measures into lower-level metrics for use within the organisation. In turn, managers and employees can determine where to focus their efforts. Specific performance scorecards can be used to help employees draw connections between their behaviour and their contribution to overall business outcomes such as economic profit and capital optimisation. In each case, the bank will move from a focus on traditional financial KPIs to the use of risk-based performance measures such as the examples shown in the following table.

Compliance

Traditional financial KPIs Cost-to-Income Ratio Loans / Deposits AUM / Deposits Dividend pay-out ratio Interest margin Non-interest income

Risk-based performance measures Risk-adjusted return on capital Economic profit % defaults to total credit exposure Earnings at risk Risk-weighted assets Loantoloss ratio Increase in Loantovalue ratio due to drop in the value of the asset financed Number of loan defaults due to incorrect creditworthiness assessment Enterprise stress lead indicators Portfolio indicators (e.g. Var, cVar)

IRPM Supports a Customer-centric View

Integrating risk and performance management enables banks to optimise customer value. The same infrastructure required to make riskconscious decisions at the individual customer level can help drive other forms of service personalisation and understanding. With a next-generation risk and performance infrastructure underpinned by powerful data management and analytical capabilities, from the transactional level to the enterprise level, banks can dynamically set product pricing based on individual customers profiles, behaviours and risk appetites. This infrastructure supports single views of the customer and portfolio, product customisation, more intelligently targeting of campaigns, and detailed profit and loss reporting at the customer level.

Figure 4: Customer optimisation framework

Single view of customer Customised products Customer profitability

Customer value optimisation

Targeted marketing campaigns Riskbased pricing Customer analytics

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Case Studies Leading financial institutions on the IRPM journey

Leading banks and financial institutions around the world have commenced the journey of building an integrated risk and performance management capability as per the integration steps outlined in the IRPM Framework. The following case studies outline the steps organisations are taking to realise an IRPM vision. Bank A Integrating risk and performance management
This investment bank was organised into silos, resulting in a fragmented and inconsistent approach to finance, risk, compliance and performance management. Duplication of roles and services across departments was widespread, and the bank needed a true analytical capability to better drive C-suite decision making. To resolve these issues, the bank worked with Accenture to define integrated governance, capabilities, process models and architecture for finance and risk management. The project involved multiple initiatives to standardise, integrate and automate finance, credit and risk capabilities across the bank, including reporting and data analytics. Accenture also supported the design and implementation of a technology solution to support the integration of risk and performance management. The first release focused on finance and a consolidated sub-ledger, general ledger and statutory reporting approach for the bank. The bank now has clearly defined roles, responsibilities and accountabilities, effective reporting and information management, and holistic risk management processes that facilitate superior performance management of the enterprise.

Bank B Ensuring confidence after the crisis

Following the GFC, this leading North American bank needed to improve its risk management capabilities to retain the confidence of regulators, shareholders, lenders, analysts and depositors. In addition to driving discipline by voluntarily adopting Basel II regulations, the bank worked with Accenture to implement a new financial data warehouse to gain a comprehensive, integrated view across numerous financial dimensions. Accenture also helped design and deliver a solution to calculate risk-adjusted performance metrics. This included the ability to analyse profitability at the individual product, portfolio and officer level, and to compare risk-adjusted returns against the banks cost of capital.

Bank C Responding to regulation

Faced with impending regulation including Basel II and International Accounting Standards, this bank drove closer integration of the data produced by its risk and finance divisions. After building consensus among stakeholders within both groups, the bank engaged Accenture to help put in place a new operating model that would support compliance with regulatory obligations in an effective and efficient control environment. The wide-ranging project also enabled the organisation to maximise the value it received from its US$200 million investment in regulatory driven initiatives.

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Enabling Technology
Current database, analytics and communications technology systems are critical to the effective integration of risk and performance information management. Accenture provides its own technology support and partners with a range of leading vendors to implement the myriad tools required to make the full IRPM Framework a reality. Of paramount importance is improving the quality of data sources, data management systems and storage infrastructure. This ensures that data is of sufficient quality before being supplemented and manipulated by the various core systems downstream, including core banking systems, payment and ledger systems, risk engines, finance systems and reporting tools. Among the most important considerations are the business intelligence and performance management systems in place to monitor and manage corporate performance, which must be able to cater for a variety of tasks including: Data cleansing and reconciliation Calculation, simulation and aggregation of key measures Analytics and modelling Reporting

Figure 5: Leading IRPM technology providers Products

Oracle

Features and capabilities

Oracle Financial Services Analytical Applications (OFSAA) Immediate benefit realisation via out-of-the box reporting and dashboard suites covering customers, account, transactions, OFSAA Enterprise Risk Management products, and, organisation units OFSAA Enterprise Performance Management Modular components allowing for tailored capability build-out Oracle Hyperion Planning Reduced implementation time and ability to leverage packaged Oracle Hyperion Strategic Finance functional planning modules Oracle Scorecard & Strategy Management Supports business-driven deployment SAP Bank Analyser Solution Suite SAP Price Optimisation SAP FICO SAP Business Object Predictive Modelling Workbench SAP GRC SAP EPM High level of configurability minimising customisation requirements Ability to integrate with third-party tools Full audit functionality for complete traceability Slice-and-dice reporting capability Provides a fully integrated system from core bank to GL to financial accounting, management accounting, sub-ledger and IFRS Automated monitoring and alerts for key indicators

SAP

SAS

SAS Strategy Management SAS Enterprise GRC SAS Financial Management SAS Risk Management for Banking SAS OpRisk VaR SAS Optimisation SAS Business Intelligence Suite SAS Fraud Framework for Banking SAS Anti Money Laundering SAS Intelligent Forecasting SAS Profitability Management

Best-of-breed business intelligence and performance management tool suite Robust data integration with data cleansing capabilities allowing true drill-down from summary reports Advanced engines and data models to assist in summarising and calculating data for strategic monitoring purposes

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Accenture Services
Accenture provides a broad range of risk, performance, technology strategy, and implementation services. For IRPM solutions, Accenture clients receive a unique combination of services and resources spanning the end-to-end program lifecycle, from strategy consulting and operating model design to systems integration and large-scale technology delivery, and outsourcing and change management services. These services are supported by proven assets and methodologies. Typical steps involved in an IRPM engagement involve: Understanding and setting strategic goals and drivers Target operating model design and implementation System design and implementation Periodic review and enhancement to the IRPM model as business needs change

Figure 6: Accenture risk management and enterprise performance management capabilities Strategy and Governance
Vision and Value Target Setting Target Operating Model Maturity Assessment Policy and Appetite

Process Excellence and Integration

Enterprise Risk Management Risk Management - Credit Risk, Market Risk, Operational Risk, Supply Chain, Sustainability, Technology Risk and Finance Integration Embedded Risk Culture Basel Solvency Stress Testing Fraud and Financial Crime Compliance Management Liquidity Risk Management Risk-Adjusted Performance Management Risk Analytics Scenario-Based Modelling Risk Architecture and Data Management Risk and Finance Architecture Reviews, Technology Strategy Risk and Finance System Implementation (Packaged and Custom Software) Risk and Finance Test Managed Services Risk and Finance Application Maintenance and Support Finance and Accounting Process Outsourcing Risk Process Outsourcing Enterprise Performance Management Outsourcing Risk and Finance Analytics Application Outsourcing Infrastructure Outsourcing

Regulatory Reform

Performance Insight and Execution

Technology

Outsourcing

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About the authors

Jordan Griffiths Senior Executive Finance & Performance Management jordan.griffiths@accenture.com Derek Sheerin Manager Finance & Performance Management derek.sheerin@accenture.com

About Accenture
Accenture is a global management consulting, technology services and outsourcing company, with approximately 211,000 people serving clients in more than 120 countries. Combining unparalleled experience, comprehensive capabilities across all industries and business functions, and extensive research on the worlds most successful companies, Accenture collaborates with clients to help them become high-performance businesses and governments. The company generated net revenues of US$21.6 billion for the fiscal year ended Aug. 31, 2010. Its home page is www.accenture.com.

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