The Risk / Capital management Matrix

The Risk/Capital Management MatrixWhere do you fit?How to go for the gold

Capital management and risk management are both fundamental to banking success.By looking at these two dimensions of performance together, you gain a view of your bank’s current position in relation to world-class performance levels. You see the directions your organization needs to move to create more competitive advantage.

Learn how a global bank generated 60+ basis points of organic capital year after year despite economic and regulatory pressure

Two management dimensions drive world-class performance

low RISK MANAGEMENT MATURITY high

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©2014 Fair Isaac Corporation. All rights reserved. 2


Complementary disciplines with intersecting effects…

Virtuous circle ofcomplementary

disciplines

Capital management levers

Riskmanagement

levers

These disciplines have traditionally been thought of and conducted separately. But when they’re both performed well, they become two halves of a virtuous circle.

� Capital management levers: Affect how much capital and funding are available for risk-managed retail lending.

� Risk management levers: Affect how efficiently lending consumes capital. Impact how much capital is required to cover the resulting risk-weighted assets. Largely determine degree to which lending produces profit, return on assets and funding for further investment.


…can be integrated to generate more competitive power

Emerging best practices link capital management and risk management. Push both sets of levers together to improve:

� Capital efficiency, RoRWA (return on risk-weighted assets) and ROE (return on equity)

� Risk exposure estimates for loss reserves

� Portfolio responsiveness to Executive Committee direction

� Capital control

� Accuracy and reliability of portfolio profitability forecasting and stress testing

� Allocation of available capital across competing requirements

Linkingcapital management

with risk management

creates morecompetitive power



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Sharper risk assessments through Big Data analytics:u More insights from unstructured datau Risk/reward balanceu Customer-level decisionsu More comprehensive and adaptive fraud detection

Offset or enhance regional/market conditions through:u Capital planning (3–5 years)

u Basel II/III controls

u Modeled/monitored portfolio-level RoRWA

u Economic impacts built into analysis and planning

Integration

Chart your course to world-class performance

No matter where you are now in the matrix, you can:

� Improve your performance along one or both dimensions.

� Start moving toward the most competitive position of integrated risk and capital management.



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Au Strong capital management/position

u Low risk management maturity

Characteristics:Banks in this quadrant have the capital to pursue market opportunities, but ROE from growth initiatives may be low due to inadequate risk management.

Typically they have higher-than-necessary origination costs, delinquency rates and collection costs along with lower-than-necessary credit usage, revenue and customer profitability.

Next steps Æ

Implement risk-based decision systems across credit lifecycle:

� Rules-driven. Business users create/change decision policy rules.

� Open to analytics. Analytic models and segmentation strategies easily added to decision processes.

� Structured for learning. Systematic champion/challenger testing drives continuous improvement.

Quad A:Improve ability to manage risk in operational decisions

Example


AA Brazilian bank consolidated its risk management after a mergerThe company implemented a single customer management system that performs customer-level decisioning across its multiple portfolios. With the ability to set pre-approved limits across products, the bank has been able to achieve results like these:

Pre-approved limits across all portfolios Customer-level collections

+9%Profitability

–18%Attrition

–60%Probabilityof default

finalnotice

$

10%È from 15–19%

30-daydelinquency rates

$past due

An Asian bank is leaping ahead from mostly manual originations decisions to a state-of-the-art system

The bank will be able to evaluate consumers for all of its products (credit cards, personal loans, mortgages) from a single credit application.

Decision areas:

�Customer-level credit risk assessment

�Fraud detection

�Overall credit limit assignment

�Cross-sell offers

Expected results:

�Improved risk management

�Lower application processing costs

�Higher revenue/profit from new customers

�Stickier relationships that generate more profit over time

X


Characteristics:Banks in this quadrant currently have limited capital to invest in growing their business.

In addition, results from whatever they do invest are likely to be disappointing. As long as risk management is underdeveloped, costs will be higher than necessary and ROE lower than necessary.

Next steps Æ

Implement risk-based decision systems across credit lifecycle:

� For lots of risk-based decisioning power at low cost, build apps/services on a BRMS (business rules management system).

� Interact with customers in low-cost ways through intelligent omnichannel communications (e.g., mobile SMS, voice).

� Use analytics to increase risk/reward differentiation among existing customers.

� Use economic impact analytics to improve capital allocation and reserve estimates.low RISK MANAGEMENT MATURITY high

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Bu Weak capital management/position

u Low risk management maturity

Quad B: Reduce spending to free capital for better risk management


Example

B A South African bank implemented rules-driven decision making in originations and customer managementThe result is lower application development and maintenance costs, plus flexibility to outmaneuver competitors. Changes to policy rules and score cutoffs can now be made by risk management staff, including simulating impact on portfolio profit/loss and deploying the changes, within a matter of days.

Sample of customer management results:

+13%Profit/active

account

+5%Average

credit limit

+3%Totalsales

+7%Debit

balances

+5%Financecharges

+2%Interchange

fees

A European banking group moved to customer-level collections and integrated economic impact analysis into credit scoring and capital managementThe system enabled the company to implement best practices across all of its banks and products, while supporting local languages, currencies and market-specific needs.

Results include:

120%Daily accounts

worked per agent

70%Cash collected

per net working hour

ÇLoan book growthdespite economic

downturn

X


Characteristics:Banks in this quadrant may have seen strong capital positions reduced by economic stress.

Still, with their advanced risk management capabilities, they can make the most of currently scarce capital and deliver high ROE and RoRWA for every investment they make. By making additional analytic enhancements, they can drive ROE even higher.

Next steps Æ

� Make more decisions at the customer level.

� Add new data sources (text, speech, etc.) and advanced analytics for deeper customer insights.

� Use decision modeling and optimization to identify superior risk management strategies with fewer test-and-learn cycles and to pinpoint the best next action for each customer.

� Begin integrating capital management into risk decisions by incorporating Basel II models/metrics into decision strategies.low RISK MANAGEMENT MATURITY high

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Cu Weak capital management/position

u High risk management maturity

Quad C: Organically boost capital by improving customer profitability

Example


C A European bank standardized and automated risk management as it expanded into additional markets in Europe and AfricaInitial focus: Put right systems in place to improve efficiency in originations and customer management (current accounts, credit cards, loans, mortgages).

Next: Sharpen segmentation with data mining and custom predictive models.

Currently: Use decision modeling and strategy optimization to improve decision performance.

Results include:Ability to set customer-level exposure limits, updated each time any credit product is used.

90%Origination

decisionsautomated

99%+

Overdraftself-cure

ÈLoss

provisions

A UK-based global bank is doing more decision optimization and moving toward enterprise fraud managementOptimization projects include customer-level credit line allocation as well as refinement of pricing and authorizations strategies.

Fraud projects include implementing self-learning outlier models to protect telephone and online banking. Another innovative fraud project delivered:

–70%First-party

fraud losses

FRAUD

X


Characteristics:Banks in this quadrant have ample capital. They also have sophisticated risk management infrastructure and best practices, increasing likelihood of success wherever they choose to invest.

Everyone in the company thinks about how capital impacts the business. Capital- based decision making is the modus operandi, not only in planning cycles, but also in everyday operations.

Next steps Æ

� Move to fully customer-centric operations.

� Implement analytic learning loops to progress faster than competitors.

� Scale up/speed up model generation, deployment, updates, compliance review with automation.

� Fully integrate risk management and capital management.

� Optimize at both level of strategic portfolio management and operational (customer and account) decisions.

Quad D: Build on success with most advanced analytics available


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Du Strong capital management/position

u High risk management maturity

Integration


ExampleD

+25%Authorizationapproval rates

–50%Delinquency

rate

A global banking group generated organic capital of €17 billion (more than 60 basis points annually) in 4 yearsOne reason the bank is so profitable: Enterprise-wide use of the same predictive analytics, decision systems and customer service business model. Across originations, customer management and collections, this approach creates cost and revenue synergies, a high degree of control over risk and capital, and opportunities to invest efficiently.

Another profit driver: Systematic test-and-learn cycles, which constantly drive improvements like these:

A global bank has achieved double- digit growth year after year by propagating use of advanced analytics

As new analytic techniques prove effective, they’re standardized and delivered across the company’s risk management operations. Now the bank is doing the same with decision modeling and strategy optimization. The company’s “optimization factory” speeds and facilitates the deployment of strategy optimization across more than 20 countries.

Another way this company excels is in its ability to systematically transform portfolio-level strategies into operational decisions executed at the segment level, then track and measure the outcomes in terms of capital impact. Currently the bank is exploring pushing execution down to the level of individual account/customer decisions.

X

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Insights #61: Where Do You Fit on the Risk/Capital Management Matrix? Check out our blog:

Banking Analytics Blog

Results from optimizing portfolio strategies become constraints for optimizing

operational customer decisions

ÇÈResults from optimizing

customer decisions become constraints for optimizing

portfolio strategies

http://www.fico.com/en/wp-content/secure_upload//61_Insights_Risk_Cap_Mangement_2876WP.pdf

http://bankinganalyticsblog.fico.com/2012/07/where-do-you-fit-on-the-riskcapital-management-matrix.html

http://www.fico.com/en/wp-content/secure_upload//61_Insights_Risk_Cap_Mangement_2876WP.pdf

http://bankinganalyticsblog.fico.com/2012/07/where-do-you-fit-on-the-riskcapital-management-matrix.html

The Risk / Capital management Matrix

Technology

Transcript of The Risk / Capital management Matrix