How ERM automates the management of banking risks

Evgeny Scherbinin, CEO of Prime Source

In any industry, the start of the year comes with an assessment of how the risks awaiting the business will affect the targets set for the next 12 months.

The investment bank Morgan Stanley, for example, notes in its 2020 global risk report that over the past 12 months 20 central banks around the world have eased monetary policy. “The weighted average interest rate may hit a seven-year low as early as March 2020. Easing trade tensions and progress in the talks between the USA and China — together, these two factors will be powerful growth drivers,” the investment bankers' report says.

In other words, risks are not only potential failures but also opportunities for growth. And the bigger a business becomes, the more often its top management has to deal with risks, which intensify as the company grows. Risks are especially relevant for bankers, who face ever more regulatory requirements on how they run their business. The overall backdrop of Kazakhstan's banking market today is shaped by several major developments that involve every player in the country's financial industry.

First, Kazakhstan is adopting the international financial reporting standard IFRS 9, which governs the accounting for financial instruments and the calculation of provisions in line with forward-looking market indicators. Second, Kazakhstan is completing its asset quality review of banks (AQR), which covers the adequacy of asset and collateral valuations and the related provisions in order to make banking risks more transparent. Third, demand is emerging in Kazakhstan for a new approach to considering corporate risks, namely the integrated risk management system known as ERM (Enterprise Risk Management). The third of these, moreover, follows from the first two.

ERM is a comprehensive, integrated risk management system for achieving business objectives: reducing unexpected earnings volatility and increasing enterprise value.

A modern banking ERM framework consists of seven components, each of which has to be designed and linked to the others so that they work as a single whole.

Component one. Corporate governance means establishing clearly defined responsibilities for the board of directors and senior management in terms of organizational processes and effective company-wide risk management.

Two. Line management means aligning business strategies with corporate risk policy when seeking new business and growth opportunities. The risks of business operations must be fully assessed and factored into pricing and profitability measures as the business strategy is executed. In particular, expected losses and the cost of risk capital must be built into the price of a product or into the required return on an investment project.

Three. Active portfolio management. This concept is applied to all risks within the organization in order to aggregate them, account for their effects and monitor concentrations.

Four. Risk transfer means reducing unwanted or concentrated exposures and hedging risks within the portfolio. To reduce unwanted risks, management must continuously evaluate derivative, insurance and hybrid products and choose the most effective alternative among them.

Five. Risk analytics means quantifying risk for further analysis and reporting. For example, if management wants to reduce risks, risk analytics can be used to identify the most effective way of achieving a particular objective.

Six. Technology and information resources improve data quality in support of analysis and reporting processes.

Seven. Stakeholder relationship management increases risk transparency in the company's relations with its key stakeholders, which is essential for credit ratings as well as for external analysis of the company's performance and for credit decisions.

Brought together into a single system, all these components allow a bank's management to assess its risks properly before taking any business decision. The components, however, are only a framework that has to be filled with data. And at that stage further problems may arise, such as outdated or inaccurate data, decentralized sources of information and the like.

Nevertheless, ERM broadly solves the problem of the fragmented perception of different types of risk at the level of individual business units. Under the new approach, risk managers and all interested units of the company can assess risks across the entire enterprise.

Kursiv newspaper, No. 4 (828), 6 February 2020