Paradigms by the dashboard light
Nicholas Pratt examines how risk dashboards and scorecards are being used to make complex risk data accessible to regulators, senior management and corporate clients
It is possible to pinpoint the day, if not the hour, that risk management suddenly leapt from the depths of the middle office to the middle of the boardroom. 12 September 2008 – the day that Lehman Brothers defaulted – will live long in the memory of anyone involved with financial risk. Of course banks and regulators will insist that risk management was a central concern prior to the events of September 2008 but subsequent efforts to improve risk governance and management suggest otherwise.
A central feature of these efforts has been the use of risk dashboards and scorecards. These tools had been used for many years in the operational risk world as a means to graphically illustrate non-quantitative exposures but are now being applied to the numerical world of market, credit and liquidity risk.
The reason for this, says David Renz, director of risk advisory at SunGard Ambit Risk and Performance Management, is because there is a greater need to access data at a high level. “The regulators are looking for a lot more output in order to assess whether banks are following best practice. And this is the same information that senior management would need to manage the bank’s strategy.”
Regulators are employing risk dashboards as a way of helping them to achieve their macro-prudential aims of preventing systemic risk. The US Treasury has established The Office of Financial Research which will oversee a data repository used to capture every single securities transaction. Meanwhile the European Central Bank (ECB) has set up the Euro Systemic Risk Board (ESRB) and its statement of objectives includes the development of “a set of qualitative and quantitative risk indicators (risk dashboard) to identify and measure systemic risk”.
ECB president and chairman of the ESRB, Jean Claude Trichet, referred to the ongoing development of the dashboard in June when the Greek debt crisis emerged. Asked if the crisis and the risk of contagion among Europe’s banks would be something that would show up on the ESRB’s dashboard, Trichet replied: “On a personal basis I would say, yes it is red.”
Of course it is likely that the finished dashboard will offer deeper analysis of systemic risks than a rudimentary traffic light and this in turn will create a greater compliance burden on the banks. “Regulators want to avoid the bad effects of excessive leverage and have more influence on banks’ behaviour. To do that they have to align the origination of credit itself with financial stability and using macro-prudential tools, consequently influence how banks are originating their loans,” says Renz. “This calls for greater information and access to everyday figures.”
There is an advantage to the banks in this change in regulatory policy from a micro-prudential to a macro-prudential approach; the objectives of the central banks and the strategies of the banks’ senior managers should be broadly the same. This means that data compiled for the sake of compliance should be of use to both parties.
In a world of principles-based regulation the data compiled for compliance is largely unusable for banks, but when banks have to defend their own business models to the regulators, then that data is of huge use internally. Similarly, banks need a rapid supply of information from the central banks in terms of changes to interest rates, capital ratios or supervisory policy, says Renz. “It is an exchange of information and using dashboards will make that process easier.”
As well as using risk scorecards and dashboards to meet their regulatory requirements and keep senior management informed, banks are also using these tools as core components in the risk services offered to their corporate clients. “The risk scorecard is in principle a very rich risk management tool,” says Yuri Polyakov, head of risk solutions at Lloyds TSB Corporate Markets. “The challenge for many clients is being able to bring all of their various risks together so that they can get an overall view of their exposure. A risk scorecard is a useful means of providing this view so we support the general idea.”
But there is also a potential weakness in the relevance of scorecards, says Polyakov and the pursuit of the bigger picture can potentially detract from the management of specific risks. “You can have a risk scorecard at various levels, from FX risk to risk budgeting. It is a way to consolidate various risks. For example, we provide a scorecard for the integrated risk assessment facing clients and we also provide a scorecard approach for the integrated risk budgeting and then the findings can be discussed. But the challenge is to make sure each risk scorecard is relevant.”
There is also the computational challenge of using dashboards to reflect increasingly complex and data-rich risk information. “Reporting used to focus on profit and dividends but now it is more focused on capital ratios and risk exposures,” says Francyn Stuckey, head of strategic solutions delivery, Emea for Bank of America Merrill Lynch’s global treasury solutions team. “It is a more sophisticated process that involves looking at greater exposures.”
This is a big change from the pre-Lehmans days when risk management was just a process, says Stuckey. Now it is a business driver. “It is more proactively managed. It is less static and more strategic and that means there is a greater emphasis on the quality and timeliness of the information provided.”
Fortunately technology such as XML caters for an increased level of information to be included in reporting. But, says Stuckey, the data also needs to be accessible and labelled so that it can be pulled out as needed, whether it is by currency, sovereign status or any other field. This is where technology such as Web 2.0 is helping. “A key advantage of Web 2.0 is how it structures data,” says Stuckey. “Previously databases were hardcoded but new technology makes it easier to extract data and makes it more accessible. There is more to do though. Many banks have legacy issues and the modelling work needs more development. But it starts with the data and the ability to aggregate that data.”
Technology development has also helped overcome what has long been the biggest hurdle in risk reporting – the task of bringing together risk information from numerous different sources and databases into one place. As SunGard’s Renz says: “Pulling that data together in the first place is technology intensive. If you have a good technology stack and a data warehouse, this becomes easier. But if you have multiple systems, then the enrichment of the data becomes a challenge.”
Technology has simplified the task of pulling in data from multiple sources, says Renz, thanks to the development of online analytical processing (Olap) hypercubes. These tools have become more prominent in the past three to four years and are more suited to analysing and structuring data from multiple sources than the relational databases that preceded them.
“Most modern risk applications come with an Olap hypercube as the basis for risk reporting,” says Renz. “It then becomes easy to consolidate data from different applications. Without Olap hypercubes, pulling data from a database requires someone to write SQL code but with an Olap hypercube you do not have to do this. So it lessens the need for programmers and lowers the total cost of ownership.”
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