Analysis and Management of Risk: A Regulator’s Perspective

Michael Ainley

Head of Wholesale Banks Department

UK Financial Services Authority

Risk-Based Supervision in the FSA

• First steps - RATE

• The current system – ARROW

• The future – ARROW 2

RATE• Identify key units• Obtain pre-visit information• Preliminary risk assessment• Undertake on-site visit• Final risk assessment• Prepare supervisory programme• Ensure consistency• Formal feedback to bank (and its home regulator)• Employ relevant tools to mitigate risks• Re-evaluate at least annually

FSA Principles of Good Regulation #3

• The restrictions we impose on the industry must be proportionate to the benefits that are expected to result from those restrictions

Senior Management ResponsibilitiesPrinciples of Good Regulation #2

• Regulator must make clear its requirements and leave senior management space to run the business.

• Senior management must ensure that appropriate systems and controls are established and maintained

• Non-executive directors have a key role

ARROW• Extends risk-based supervision across all

types of financial firms• Focuses on risks to FSA’s objectives• Considers PROBABILITY as well as IMPACT

of risks crystallising• PROBABILITY x IMPACT = Overall score• Scores used to classify firms A-D• FSA uses classification to determine amount

of resources expended on firm• Frequency of ARROW assessments depends

on risks presented by firm

ARROW Risk Mitigation

• Actions must be clear and time-specific• Firms’ boards asked to agree them• Preference is to require firms to take the

necessary action to improve their systems and controls

• May involve further work by FSA, home regulator or outside experts

• FSA’s own systems prompt supervisors to follow up to ensure that actions are completed on time

ARROW 2• To retain the key methodology of ARROW

– risk measured in terms of impact and probability to our statutory objectives

– mitigation proportionate to our assessment of potential harm to those statutory objectives.

• Greater proportionality and consistency in response to risks – applying our resources where they will make the most difference

• Better communication with firms on our assessment of them

• Closer links to theme and sector work• Improved skills and knowledge of supervisory staff• Full compatibility with Basel 2 and Pillar 2

Pillar 2: Banks take centre stage

• Pillar 2 requires the bank to calculate for itself how much capital it needs

• Better credit risk management and internal systems and controls can reduce the capital requirement

Analysis and Management of Risk: A Regulator’s Perspective

Michael Ainley

Head of Wholesale Banks Department

UK Financial Services Authority