Best Practices in Risk Management and Risk Measurement

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Best Practices in Risk Management and Risk
Measurement

• The UK Financial Services Regulators Perspective
• Charlotte Gerken
• 13 July 2004

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Purpose of this session

• UK
• Regulatory perspective
• Aligning regulatory developments with successful
  risk management

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FSAs objectives

• Market confidence
• Consumer awareness
• Consumer protection
• Fighting financial crime

Focus is on risk of commercial failure not on
risk of failing to make a commercial success
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Regulatory context

• Tiner Report 2001 and update 2002
• Integrated Prudential Sourcebook
• Basel II Capital Requirements Directive
• Individual Capital Assessments (ICAs)

Not a zero- failure regime
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FSA regulatory approach

• Apply principles of good regulation
• Emphasise role of management
• Proportionality
• Competition
• Risk based supervision

No best, but lots of good practices
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Assessment of quality of risk management
Management information
Attitude of management
Governance structure
Corporate culture
People
Approach to decision making
Risk management processes
Quality of implementation
ILLUSTRATIVE
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3 levels of activity within a firm
Risk management
Business managers
Coordinating/challenging risk management activity
Central Risk Management function
Internal AuditRisk /or Audit Committee
Assessing risk management execution
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Measurement

• Journey is rich in insights
• Balancing available capital with tolerance for
  risk of ruin
• Prioritise areas for improving controls
• Appropriate complexity
• No right answer
• Proportionality materiality

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Bringing together management and measurement

• Rules, but mainly Guidance, on Systems and
  Controls
• Arrow process risk assessment, monitoring,
  mitigation and review
• Enhanced capital requirements and
• ICA process for insurers (from 2005)
• Implementing CRD for banks

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Individual Capital Adequacy Framework

• FSA Principle 4 Financial Prudence
• I in ICA underlines management responsibility
• Firms to assess minimum capital not optimal
  capital level under ICA
• Firms to use 99.5 confidence level over 1 year,
  or its equivalent
• Part of Arrow process (post roll out)

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Individual Capital Guidance

• FSA forms a view on whether firms ICA
  calculation is reasonable
• Appropriateness of methodology relative to firms
  size and risk profile
• Quality of controls around modelling
• Reasonableness of central assumptions
• Reasonableness of stress tests and/or use of
  Economic Capital Models

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Many challenges ahead

• Modelling complexity, in particular
• Correlations
• Group risks
• Diversification benefits
• Giving guidance to firms
• Agreeing minimum capital
• Discussing improvements to controls and/or
  de-risking the business

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In summary

• Firms to hold capital appropriate to risk profile
• Regulatory incentives for good risk management
• Regulatory requirements are not the only driver
  of good risk management