More Risk Management Work Remains

A recent survey demonstrates the need for more work to improve risk management practices at financial institutions across the globe.  Results from the survey conducted by Deloitte show that while great strides are being made in strengthening corporate governance, the supporting risk management infrastructure at many institutions continues to be a work in progress.  The following are some significant findings from the survey of 111 financial institutions across the globe.

• Seventy-three percent of the institutions surveyed had a Chief Risk Officer (CRO) or equivalent position. As an indicator of the role’s importance, the CRO reported to the board of directors and/or the CEO at roughly three quarters of these institutions.


• Only 36 percent of the institutions had an enterprise risk management (ERM) program, although another 23 percent were in the process of creating one. Among institutions with $100 billion or more in assets, 58 percent had an ERM program already in place. The institutions that had ERM programs found them to be valuable: 85 percent of the executives reported that the total value (both quantifiable and non-quantifiable) derived from their ERM programs exceeded costs.


• Roughly three quarters of the institutions had fully completed or substantially completed the work required to identify operational risk types, and to standardize the documentation of processes and controls for operational risk. Yet, only roughly 40 percent of executives considered their operational risk assessments and their internal loss event data to be well-developed. Other operational risk methodology areas, such as key risk indicators, external loss event data, and scenario analysis, were said to be well-developed by 20 percent or less of the institutions surveyed.


• Many institutions may have significant work to do to upgrade their IT risk management infrastructure. Roughly half of the executives were extremely or very satisfied with the capabilities of their risk systems to provide the information needed to manage market and credit risk. In other areas, such as systems for liquidity risk and operational risk, 40 percent or fewer provided ratings this high.

Wheelhouse Advisors is well equipped to address risk management challenges such as these.  Visit www.WheelhouseAdvisors.com to learn more.

TARP Compensation and Corporate Governance Standards Released

The U.S. Treasury released its proposed TARP standards for compensation and corporate governance yesterday. Among other requirements, the standards require members of the company's board compensation committee to sign the following certification.

“The compensation committee certifies that:

(1) It has reviewed with senior risk officers the senior executive officer (SEO) compensation plans and has made all reasonable efforts to ensure that these plans do not encourage SEOs to take unnecessary and excessive risks that threaten the value of [identify TARP recipient];

(2) It has reviewed with senior risk officers the employee compensation plans and has made all reasonable efforts to limit any unnecessary risks these plans pose to the [identify TARP recipient]; and

(3) It has reviewed the employee compensation plans to eliminate any features of these plans that would encourage the manipulation of reported earnings of [identify TARP recipient] to enhance the compensation of any employee.”

TARP recipients should brace themselves for more requirements such as these.  In addition, board members should begin educating themselves about their new responsibilities and potential liability.  Wheelhouse Advisors can help your institution navigate the new requirements successfully.  Visit www.WheelhouseAdvisors.com to learn more.

Missed Opportunity

The Wall Street Journal reported yesterday that the White House is backsliding on its goal to streamline financial regulations.  While not surprising in the highly politicized world of Washington D.C., the compromise may haunt the current administration and others for years to come.  Here is what the WSJ had to say.

The Obama administration is backing away from seeking a major reduction in the number of agencies overseeing financial markets, people familiar with the matter say, suggesting that the current alphabet-soup of regulators will remain mostly intact.

Administration officials had suggested they might push for major regulatory consolidation in the wake of the financial crisis. But now they expect to call for most existing agencies to have broader powers to limit risk-taking by financial institutions, say the people familiar with the planning.

Opportunities to reform and eliminate duplicate activities do not come around very often.  This is truly a missed opportunity of the greatest proportions.  Companies facing changes in regulation among the spaghetti-like structure we have today will need to spend more to comply with conflicting rules that may or may not reduce risk in the long run.

As the great Thomas Edison once said, "opportunity is missed by most people because it is dressed in overalls and looks like work."  That is certainly the case here.

What It Takes to be a Successful CRO

More and more companies are creating the new role of Chief Risk Officer ("CRO") to lead their efforts to manage the growing complexity of risks.  The complexity is increasing as companies begin to rely more on external service providers, make greater use of advanced technologies and operate in different areas across the globe.  To be successful in this mission, CROs must possess the right mix of demonstrated competencies and abilities.  This topic was discussed in a recent article in Business Insurance magazine.  Here is a sample of what they had to say.

In every company, establishing a clear chain of command is vital to success. Risk, as an ongoing companywide issue, requires that the CRO report directly to the chief executive officer and have the flexibility to recruit and manage a small staff globally. The expansive nature of risk management also necessitates that the CRO steward numerous strategic partnerships with internal constituencies and outside strategic partners. He or she should partner with the general counsel, chief operating officer, chief financial officer and the top internal audit officer, all of whom should view the CRO role as a complement to their areas of responsibility.

CEOs need a risk expert who can act as architect and engineer in building a comprehensive enterprise risk management infrastructure; one that spans all parts of the organization and provides a clear and easy-to-interpret real-time interface for senior management regarding all risk-related activity.

Searches to fill these new roles will be difficult due to the fact that there are few people who have experience in the role and/or the combination of skills to be successful.  However, the right candidate is crucial to establishing a program to manage risks effectively over the long-term.

The Straw That May Break a Bank's Back

Last week, the Financial Accounting Standards Board ("FASB") adopted changes to off balance sheet accounting standards that previously permitted many financial institutions to obfuscate their true financial condition.  The changes will require companies to consolidate special purpose entities onto their balance sheet for reporting purposes.  Here is what BusinessWeek reported on the impact of the accounting changes.

In general, companies transfer assets from balance sheets to special purpose entities to insulate themselves from risk or to finance a large project. Under the change by the FASB, many qualifying special purpose entities will have to be moved back to a company's main balance sheet.

Outside investors often take stakes in those entities, for example, making an investment in a bank's holdings of mortgage loans in exchange for payments from borrowers. Under the new standard, companies must bring back onto their balance sheets any entity in which they hold an interest that gives them "control over the most significant activities," according to FASB. Companies must perform analyses to determine that.

The change could result in about $900 billion in assets being brought onto the balance sheets of the 19 largest U.S. banks, according to federal regulators. The information was provided by Citigroup Inc., JPMorgan Chase & Co. and 17 other institutions during the government's recent "stress tests," which were designed to determine which banks would need more capital if the economy worsened.

The changes take effect at the beginning of 2010 and certainly will require a great deal of work on the part of financial institutions to ensure they have the necessary capital to shoulder the added burden.  In addition, it will require strong quantitative and qualitative analysis to determine the need to bring assets back on the balance sheet.  As a result, this change could prove to be the straw that breaks the back of some banks.

Major Regulatory Change is on the Horizon

The much anticipated regulatory reform proposal from the new Obama administration is nearing completion according to a report today in the Wall Street Journal.  The aim of the proposal is to streamline the byzantine regulatory framework within which U.S. financial institutions have been operating for many decades.  Here is what the WSJ had to say.

Top Obama administration officials are close to recommending that Congress create a single regulator to oversee the entire banking sector, people familiar with the matter said, a departure from the hodgepodge of federal agencies that failed to contain the financial crisis as it ballooned out of control last year.

The new agency is expected to be a major plank in a proposal that Treasury Secretary Timothy Geithner and White House officials send Capitol Hill in a few weeks with the goal of overhauling supervision of financial markets.

The new bank regulatory agency could prove controversial because it would consolidate the Office of the Comptroller of the Currency and the Office of Thrift Supervision and strip supervisory powers from the Federal Reserve and the Federal Deposit Insurance Corp.

The Fed and the FDIC would gain other powers, though, as White House officials want the Fed to be able to oversee systemic risks in the economy. They also want the FDIC to have new powers to take large financial companies that aren't banks into receivership.

While the outcome of the proposal is far from certain, one thing is certain - major regulatory change is on the horizon. Is your company prepared to manage this change?  Wheelhouse Advisors can help.  Visit www.WheelhouseAdvisors.com to learn more. 

New Rules on Pay Practices

This past weekend reports surfaced about new rules on limiting executive pay at financial institutions that received taxpayer assistance. The rules are expected to be promulgated by the U.S. Treasury as reported by Reuters below.  

Treasury Secretary Timothy Geithner is expected to issue rules as early as next week on how bailed-out banks must limit their executives' pay. He is also working on ways to reform the compensation practices of the entire banking industry to discourage a focus on short-term gains and undue risk-taking.

Lucian Bebchuk, a professor at Harvard Law School, and colleague Holger Spamann argue that a banker's pay should be tied to all of the bank's assets, not just to equity, which they say accounts for only about 5 percent of overall assets.

"Banking regulators should monitor executive pay in banks, and prevent arrangements that incentivize top bankers to focus only on the bank's equity, which ... can gain through strategies that are detrimental to the other 95 percent," they write in a forthcoming paper.

Bebchuk and Spamann suggest top bankers should be paid on a "broader set of claims, including deposits and junior debt," which would prod them "to place much greater weight on possible losses in their choice of strategy."

These new rules on executive pay most likely will serve as extra incentive for financial institutions to return taxpayers' money as opposed to lasting changes in pay practices. True changes must emanate from within the financial institutions' corporate governance structure beginning with pressure from the boards of directors.