Risk & Finance alignment: it’s not just data

Over the years, alignment between Risk and Finance within banks has been a topic of much debate. Driven by both internal and external factors, it has led to vast sums in project spend. Some progress has certainly been made, but adequate alignment remains elusive.

Risk and Finance play different roles for a bank. The core problem when it comes to alignment is to present a consistent Risk and Finance view of the same business portfolios to the same internal and external stakeholders. Seemingly an easy thing to do! However, as source transactions pass through separate Risk and Finance systems and processes they are enriched, transformed, aggregated and adjusted to meet the legitimately different requirements of the two functions. The result is often two views of the same world, through completely different lenses, that are difficult if not impossible to relate to each other.

As an example, the same loan made by a European commercial banking unit of a global bank, to a corporate with a Hong Kong parent, could be presented as follows:

• The Finance view: assets booked in Europe under the Commercial Bank business unit, split by product, on an accounting basis which is adjusted for loan impairments

• The Risk view: exposures where country of obligor is in Asia for a corporate exposure class, split by industry sector and credit rating, on a risk-weighted basis. If a report is presented for Europe, this loan may not even be included as it may be classed as an exposure to a client in Asia.

However, in a world where capital is scarce and returns are low, it is becoming more and more critical for the business to have an aligned view of management information that enables capital deployment decisions to maximise risk-adjusted returns. There are also multiple regulatory changes that are strongly driving the need for alignment between Risk and Finance processes and data: IFRS9 accounting standard for Financial Instruments introduces a forward-looking risk modelled basis for recognising accounting impairments; the Fundamental Review of the Trading Book (FRTB) requires alignment between Risk and Finance models for calculating risk sensitivity and P&L; the BCBS 239 Principles for Effective Data Aggregation and Reporting place more demanding standards on data; and Stress Testing demands increasingly granular data that is consistent and integrated between risk and finance metrics.

To differing levels of success, I’ve seen a number of approaches to solving the issue of data alignment:

• Creating data warehouses that store granular source transactions for use by both functions to relate the different downstream views to each other. Big Data technologies are often cited as a panacea but I am yet to see a successful implementation

• Aligning reference data dimensions and definitions to create a common core, even where data is stored in different systems

• Creating a common processing shared service that uses both or either of the above to deliver data to both functions and serve the business stakeholders

• Merging responsibilities within data management and IT infrastructure by having joint Risk and Finance CDOs and CIOs.

However, by focusing on data alone, leaders tend to miss out on opportunities to drive commonality in broader functional capabilities that can significantly help to align Risk with Finance, and reduce cost in the process, such as:

• MI and analytics: Finance has long been established as the provider of MI and business performance analytics for the business. The experience of designing MI and establishing the infrastructure to produce it could be shared with Risk to share lessons learned and create a consistent look and feel for management

• Business partnering: building on the above, an integrated business partnering capability would allow the business to get a single source of support to drive financial performance on a risk-adjusted basis. This would involve cross-training or rotating representatives between the two functions, and creating a single team capable of providing integrated support for the business, perhaps as part of a portfolio management function. Where these capabilities or teams are absent today we have seen examples of the business effectively creating shadow MI teams that combine Risk and Finance data to meet the business needs

• Modelling: largely driven by the Basel accords that promoted advanced risk modelling and more recently by IFRS9, Risk functions have built strong modelling capabilities, including model governance and model risk management. In my experience, and as noted by the PRA in its feedback on the recent stress testing results, Finance tends to be a few years behind, especially in forward-looking balance sheet and revenue modelling. To leverage Risk’s experience, the Finance function could begin to reuse the model risk management policies and templates for governance forums, and progress to using Risk modellers to help build Finance models. Eventually shared services could be established for model development and maintenance, as the skills and processes are entirely transferable

• Macroeconomics: both Risk and Finance increasingly need a strong macroeconomic modelling and forecasting capability for use in risk modelling and financial planning and forecasting. With its forward-looking impairment recognition requirements, IFRS9 may really force integration here.

Ultimately, achieving alignment will depend on senior leaders in Risk and Finance being able to cut through the tribal politics to establish an owner and a workable operating model. A frequent solution is to take the common services out of both functions and create an Operations function. The recent trend of establishing Service Companies to support Ringfencing has further facilitated this.

It is unlikely that we’ll ever see completely integrated Risk and Finance functions: they have genuine differences in objectives and views of the world. However, banks have a lot to gain from driving alignment between them: first and foremost in driving better business performance on a risk adjusted basis, but also in achieving regulatory compliance and realising operational efficiencies.

Alignment of data will be a fundamental prerequisite to achieving these outcomes. However, only by building common capabilities on top of that foundation will banks realise the full benefits of Risk-Finance alignment; it’s not just data.