ERM and the New Era in Banking
AVERTING CRISES BEFORE THEY HAPPEN BY CHRISTINA P. O’NEILL
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ow could someone that smart be in so much trouble?” Karen Casey asked the day after investment banking firm MF Global, an investment firm headed by former New Jersey Gov. Jon Corzine, filed for Chapter 11 bankruptcy. The extent of previously undisclosed positions in European sovereign debt, a $600 million shortfall in customer money, and a practice of underreporting its average quarterly debt load by temporarily reducing its borrowing levels before issuing its quarterly reports preceded Corzine’s resignation from MF Global on Nov. 4. Casey chairs the newly-formed NJBankers ERM Committee and is also senior vice president and chief credit and risk officer at Amboy Bank. Somewhat presciently, she predicted about MF Global on Nov. 1, “I wouldn’t be surprised if what brought it down was a failure in operational risk – a failure of not checking trades, limits and confirmations.” While MF Global apparently misjudged its risk exposure and its operational abilities on a far more glamorous level than most of the nation’s commercial and savings banks, it’s the banking community that is taking enterprise risk management (ERM) seriously, notes Casey.
A TIMELY ENTERPRISE It seemed timely that the New Jersey Bankers Association instituted an Enterprise Risk Management Committee. Established in June, it has 33 bank and associate members (see sidebar, page 27), and is a growing and active group. Its mission statement calls for the review and discussion of Enterprise Risk Management by defining risk functions
(credit, interest rate, market, operational and transactional; compliance and legal; technology, fiduciary and reputation) and the management of responsibilities as they relate to risk under the various models available in the industry – COSO, FDICIA, CAMELs, etc. The ERM Committee is to discuss appropriate oversight roles and responsibilities by a bank’s board, committees and senior management and related ERM topics, such as risk taking capacity, risk appetite, linkage of risk to strategic plans, measurement of risk, performance monitoring and reporting and other related topics. “Many of our member banks are just starting ERM programs, so they are looking for guidance on the best way to start and implement a program from the resources they have internally,” says Casey. The ERM Committee has had two quarterly meetings as of this writing. The agenda items included: • What is a member bank’s ERM structure • What is the role of ERM in a member bank’s organization • What challenges is each bank facing in the implementation • What is the difference between risk appetite and risk tolerance • A case study for implementing ERM • Impact of social media on risk management
WHAT’S YOUR APPETITE? “Risk appetite is becoming a bit of an issue for banks,” Casey says. “The regulatory agencies can say [banks can hold] only so much of a particular product as a percentage of capital, but it’s a very big difference in a
bank if it’s doing one $10 million deal or ten $1 million dollar deals.” The difference in the level of potential instability in markets that used to be steady performers is a critical issue. Risk factors for previously-known investment categories, such as residential mortgages, have changed. Consider affluent Bergen County, where many upper-income residents work in Manhattan in financial services – and where many more moderate-income residents work for large companies that have announced job cuts. While credit scores are important, lenders must also question whether a prospective borrower will still have a job two years from now, Casey says. She cites national statistics showing that mortgage default rates, which used to be less than 1 percent of all loans, now exceed credit card defaults in some markets. Banks should evaluate where they are exposed to risk, where they are sufficiently diversified – and where the next surprise might come from. And such a surprise could come from inside the bank.
CHANGES IN MARKET REQUIRE DIFFERENT APPROACHES Fundamental changes in the market call for a corresponding change in the evaluation of risk and a bank’s appetite for it. An Oct. 10 posting on Bank Safety & Soundness Advisor, published by UCG’s Financial Risk Group, calls for increased and improved reporting systems that provide information to make proactive decisions before a situational change becomes a crisis event for the bank. Additionally, the bank’s executives must move beyond their given areas of responsibility, to ask how an event might continued on page 26
Winter 2012 New Jersey Banker
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