Financial institutions are in the main business of risk management, which is their core competence. Any self regulation approach on their part should go beyond regulatory compliance based risk management. This is for the simple reason that risk management and value creation are two sides of the same coin for them.
Risk is an event or situation which could adversely or beneficially affect the business’s ability to achieve its objectives, maintain a good reputation and meet stakeholder expectations.
Risk Management (Core Competence) is the key factor of value creation or performance in banking and financial services industry. It is about making sure good things happen to form the basis of performance-creating value. Also, at the same time ensuring that bad things do not happen by adhering, in addition to own internal safeguard measures, to regulatory conformance/compliance-protecting value creating measures.
Risk Management (Regulatory), though with differing emphasis, is the main basis of regulation or conformance in banking and financial services industry. Both performance and conformance require risk based capital/economic capital, among other aspects, as key cushion to achieve respective purposes, in fact they are mutually reinforcing. Therefore for the twin aspects of Performance and Conformance, it is Risk Management which forms the stepping stone for Integrated Governance.
Strong Case of Synergy exists for the TWAIN based on the bedrock of Economic Capital, with regulatory capital as the starter and Integrated Governance to harness the momentum.
Managed & Regulatory bound VS Governed cum Self Regulated Institutions
Success lies in creating a model of corporate governance in which the focus is not merely on monitoring managers as in managed corporations but on improving decision making as in a truly governed corporation. The goal should be to decrease the possibility of mistakes and to increase the speed with which they are corrected. Ultimately, the goal of the governed corporation is to make the board function not as a distant referee but as part of a team of decision makers to ensure:
Transparent disclosure, effective communication, and systems that ensure effective measurement of performance drivers, Key Performance Indicators/Key Risk Indicators & accountability are:
1. Relevant code of ethical behavior and protection of company image
2. Effective management of Operational risk
3. Sound internal control framework
4. An objective, well resourced internal audit function
5. Independent, effective external audit
Risk faced by financial services institutions
The risks faced by most financial-services institutions are typically broken down into market, credit, strategic and operational risks. Of these four types of risks such institutions face and allocate capital toward, the management of operational risk is the least advanced and yet in a sense demands most general or principle based approach. In addition we have reputation and liquidity risks to address.
Operational risks according to Basel II/Solvency II: Operational risk is " the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events."
A Survey conducted in 2001 by the insurance company Aon, which polled the UK s top 2000 private and public organizations, showed that” loss of reputation” was seen as the greatest risk followed by “ failure to change.”
Reputation risk may be for working purpose defined as any action, event or circumstance that could adversely or beneficially impact an organizations reputation. Liquidity risk is the risk that a sudden and unexpected increase in liability withdrawals may require a financial institution to liquidate assets in a very short period of time and at low prices.
Financial institutions need to understand the implications of working in this highly regulated environment. Effective and adequate usage of governance, risk and compliance mechanisms are necessary to instill self regulation mechanisms to cast away negative effects of market conditions.
About the Authors:
Dr. Nadadur Janardhan is the Chairperson of Haselfrë Solutions.
Prof. S. Mohan Kumar is a principal at the Haselfrë Office.
