Banks say risk management remediation programs well under way despite challenging environment

Ernst & Young surveys industry’s progress on implementation of IIF recommendations

London, 9 December 2009: Major global banks launched significant remediation programs for risk governance in light of the financial crisis, and most started before the regulators became involved, finds a new report published today by Ernst & Young. But regulatory intervention accelerated the pace of the change programs, particularly in those countries most affected by the crisis.

Risk governance – agenda for change surveys the implementation of the Institute of International Finance (IIF) best practice recommendations and the far-reaching governance and operational changes that banks are pursuing in light of the global financial crisis. Based on extensive interviews with the chief risk officers, chief financial officers and some chief executives of 38 large banks in 20 countries, it analyses the recommendations published in the IIF’s influential July 2008 Market Best Practices report.

Most respondents reported progress on board and senior management involvement in sponsoring the reviews in their banks, with a core focus on the cause of losses. The majority of banks reported a keen interest in measures needed to enhance risk controls and governance with greater reporting requirements around gap assessments and remedial action. Others saw management interest rise sharply on risk management reporting procedures. Governance changes explicitly focused on increasing the role of the board, particularly around stress testing and setting risk appetite. And, where it exists, internal audit is also playing a greater role with the board requiring quarterly gap analysis updates relative to either IIF or other official sector recommendations.
Patricia Jackson, head of Ernst & Young’s Prudential Advisory practice in Europe, Middle East, India and Africa, says: “For many banks, the financial crisis has led to a re-thinking of risk governance. The focus is on a top-down, enterprise-wide approach to risk management with risk reporting to the board moving to a more regular quarterly or monthly basis. Banks are also stress-testing for the implausible as a direct result of last year’s events. No scenario is deemed impossible.”

Remuneration still an issue

Remuneration presented the greatest challenge to banks. Executives are revising the remuneration structure making it more risk-based and including a longer horizon for bonus payouts. However, in the face of market pressure, they are not confident that the changes are workable or sustainable in the medium to long term. Several respondents made the point that it would only take one or two large banks to break ranks and start poaching teams, by offering higher bonuses or less delayed bonuses, for the changes to start to unravel. Several banks said that without some kind of international regulatory pressure the changes would not be permanent or far-reaching.

Two years or longer for changes to take effect

The changes are still work in progress. While most banks acted immediately on gap analysis implementing remedial programs on governance, risk appetite, risk function, stress testing and risk transparency, some banks see time scales varying between 12 to 24 months or even longer to complete.

Jackson says: “Banks frequently highlighted data and systems as the main impediment to progress. Banks have a number of legacy systems that make quick aggregation of data difficult. Some of the new approaches being adopted to group-wide stress testing or risk transparency and improved management information will rely on the development of better systems and data and this will take time. Where different banks or banks and investment banks have merged, integration programs will be drawing on the same resources.

The survey found that the fast-changing path of regulation is making infrastructure planning for the next five to ten years significantly harder for banks, and some are waiting for more regulatory certainty before embarking on widespread systems change.

Resource is a key challenge for banks; they are facing the dual challenge of managing the business through the crisis, while starting large projects and committing resource to strengthen risk management and oversight in the future.

Radwan Hoteit, Ernst & Young’s banking leader for Europe, Middle East, India and Africa, comments: “Some governance issues could be achieved quickly – such as changing roles, responsibilities and reporting lines – while other changes involve major IT redevelopment, the creation of new risk assessment measures and, for some, cultural change. This doesn’t happen overnight and banks will require skilled and trained individuals to resolve such issues. Future new regulations will most probably influence these changes.”

Trends, patterns and lessons learned

Banks were varied in their responses about the degree of change needed to respond to the crisis and subsequent industry and government recommendations:

• Perhaps unsurprisingly, the banks severely affected by the crisis with the largest losses were making the most radical risk management changes;
• Banks in significantly affected G10 markets were also making substantial changes;
• Banks in less affected markets were learning from the problems elsewhere and were reviewing controls and making some changes; and
• Some non-G10 banks were still in the process of implementing Basel II and in particular, the bank-wide risk assessment and capital planning required under Pillar II.

The research also found that countries which had already been through a significant earlier crisis seemed to be less drawn into structured products and were far less impacted by the current financial crisis.

Australia, Brazil, Canada, Egypt and Japan said that their earlier crises of ten to 15 years ago had led to substantive reviews of risk governance and risk appetite which meant they were less exposed to some of the higher risk products in this crisis. Some also mentioned regulatory restrictions, introduced after the past problems, which had left them less exposed to structured products.

Jackson concludes: “The degree of change varies across banks and jurisdictions. The overwhelming area of change is governance and risk appetite. The banks making the most radical changes are those severely affected by losses in the crisis. But it is also clear that, even in financial systems somewhat insulated from the worst of events, banks and their boards are still seeking to learn from this experience.”

The Ernst & Young survey is being published in conjunction with the IIF and as a part of its publication, Reform in the financial services industry: strengthening practices for a more stable system – the report of the IIF Steering Committee on Implementation.

About the survey

The survey was conducted through interviews with CEOs, CROs and CFOs (the CEOs were not involved in all of the interviews). The survey covered 38 of the largest banks in over 20 countries across all the major geographic regions. In addition to the banks surveyed, a further 10 banks contributed views in discussions on the changes being made and impediments being faced. Some banks provided detailed documents covering the self assessment process and the results, as well as remediation being undertaken, to support the interviews.

The breakdown by geographic region was: Europe (44%); Others – Latin America, Middle East and Australia (27%); North America (19%) and Asia (19%).

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