Do You Understand Risk?

Why Organizations Need

“a Horizontal View of Risk
in its Totality”
with Sanjiv Talwar & Tom Kimner

SEPTEMBER 17, 2014

Tom Kimner, Head of Americas Risk Practice at SAS, and Sanjiv

Talwar, PhD, Head of Risk Capital and Stress Testing at the Bank
of Montreal, discussed the evolution of capital management and
the organizational and process implications of new regulatory
capital requirements.

www.argylejournal.com
 Why Organizations Need a Horizontal View of Risk

Over the preceding decade, capital management CCAR, Basel III and Dodd-Frank are risk-based
has evolved from both economic and regulatory compliance regimes. Each demands a comprehensive
perspectives. As an outcome of the financial downturn understanding of risk, which is not always easy to achieve
in more recent years, regulators have taken a stronger given the complexity of many financial institutions.
stand on capital management as they more closely Organizational complexity — structures, processes
monitor banks’ capital and associated processes to and systems — has been shaped by size and the drive
guard against systemic risk on both a regional and for efficiency. This has led to functional silos housing
global basis. pockets of deep knowledge and technical expertise.
There is a shift in focus toward regulatory capital The larger the institution, the more specialized and
management — for example, increased capital buffers as vertical the functions are. With compartmentalization,
part of Basel III, quantitative/qualitative measurement the horizontal view of how the separate organizational
and management as part of CCAR and the inclusion entities fit together can be obscured. This is further
of liquidity measures. As a result, more banks are compounded as workloads hamper efforts to engage in
asking how they might capitalize on horizontal work. With the exception
the investments they’re making for of senior management, few may
regulatory compliance to meet their CCAR, Basel III understand how a large financial
institution really functions. All of
ongoing day-to-day management and Dodd-Frank... these factors contribute to a lack of
and decision-making practices.
Each demands a understanding of material risk across
To do this, institutions need to comprehensive the organization. In other words, a
fully develop the construct of risk-
based capital and use a risk-reward
understanding horizontal view of risk in its totality
is needed, as individual pockets may
framework more effectively. This of risk, which is not appear material.
requires a holistic view of capital not always easy
— from the perspective of capital to achieve given What are some of the more difficult
demand to capital distribution,
including a view on how to build this
the complexity hurdles to address with the new
programmatically through a more of many financial regulations?
robust performance management institutions. First and foremost, let me say that the
process. sheer volume and velocity of regulation
Many banks have made significant is daunting. One of the challenges
investments in technology, but proactive risk when you are responding quickly to supervisory
management and capital optimization also require demands is that you have to keep moving forward —
investments in people — training, development of even if you don’t have a complete picture of the problem
analytic and modeling skills and critical thinking. Some you’re solving, let alone the “end game.” This poses a
would argue that the lack of investments in these areas real challenge for any institution that’s significantly
was contributing to the Great Recession. investing in a rapidly evolving requirement. Senior
executive and board support is essential to mitigating
funding and execution risk. Compounding this is a very
TOM KIMNER: Given some of the major small talent pool for which institutions are competing.
enhancements to regulations like CCAR, Basel III and The supply shortage is a serious issue, and the ripple
Dodd-Frank, what are some of the organizational and effect of delayed work and resulting consequences is
process implications of meeting these strengthened very concerning.
regulatory capital requirements?
Second, don’t underestimate the importance of clearly
SANJIV TALWAR: Coming out of the financial articulated end-to-end processes. Much of how we do
crisis, regulators expressed concern “that many financial things is based on tacit knowledge. Codifying knowledge
companies simply failed to adequately identify the is a disciplined, cross-organizational strategic exercise
potential exposures and risks stemming from their firm- and is something everyone needs to improve on. Job
wide activities.” rotations through business and risk functions can help

2
 Why Organizations Need a Horizontal View of Risk
cut through complexity by increasing awareness and
building knowledge.
Responsiveness and timeliness is critical and shouldn’t
be overlooked. Achieving this requires process
alignment and agile systems.
The quantitative components of capital management
can be delivered programmatically. By that I mean
that much activity can be automated provided it is
underpinned with sound models. Certainly model
risk management is a key consideration and must be
supported with overarching governance spanning
validation, controls and transparency of model
assumptions and weaknesses.
Has technology enabled any of this work?
There are many moving parts that
have to be synchronized for effective
capital management. Risk and finance
systems with appropriate data
While we’ll
integration are essential. A few years continue to need
ago, vended technology was not quantitative
well equipped to provide a solution, experts, we need
but that is changing. An integrated
to complement
risk, finance and treasury systems
architecture — with appropriate data
that skill set with
integration — is needed to support critical thinking,
capital management, including problem-solving,
the ability to aggregate data from reasoning and
multiple loss-estimation models. This
will expedite processing and enable
analysis.
transparency and repeatability — and
shift the effort from production to
value-added analysis.
Can technology ever take the place of skilled analysts?
And how do human judgment, critical thinking,
evaluation and overrides fit into the picture?
Technology is not a panacea; yet all too often there
is a view that it can supplant critical thinking. This
is dangerous thinking because it can lead to blind
acceptance of model output and lull users into a false
sense of security. Models are calibrated on history and
do not predict how the world might change, or how
human behavior could change under a certain set of
circumstances. Therefore, judgment and analysis are
crucial, as is a deep understanding of model assumptions
and parameters. The future is unpredictable and model
results must be interpreted with great caution and
augmented with qualitative assessments.
How are organizations evolving their risk-based
capital frameworks to more fully incorporate the
risk-reward trade-offs that need to be made beyond
regulatory compliance?
Strategy, risk appetite and business model shape an
organization’s capital needs and balance sheet. Given
the changing regulatory landscape, more and more
institutions are evaluating risk-based capital through
multiple measures: regulatory capital, economic capital
and stress capital. Regulatory capital is the minimum
amount of capital required by regulators. Economic
capital is an internal assessment of risk capital based
on statistical modeling of a tail event. Stress capital
is the level of capital required to
withstand the impact of severely
adverse conditions. Each framework
imposes constraints in terms of
capital allocation choices. While it
would not be realistic to manage
strategy based on a severe tail event,
these measures help an institution
determine the appropriate level of
capital to hold to maintain market
and regulatory confidence and
absorb losses in the event of adverse
economic conditions.
Are organizations well positioned
in terms of staffing skills to meet
more stringent regulatory requirements? Are there
specific skills required, and are there market gaps
in those skill sets?
Let’s be clear. There is a war for talent. Increasingly
banks need to view themselves as knowledge-based
industries and recruit and reward based on that premise.
The work we do is changing. While we’ll continue to
need quantitative experts, we need to complement
that skill set with critical thinking, problem-solving,
reasoning and analysis. And we need to place a higher
value on cross-functional, collaborative teams if we’re
to break down the functional silos I referred to earlier.
Many institutions have openly criticized the
growing cost of regulatory compliance. Are there
3
 Why Organizations Need a Horizontal View of Risk

ways to apply risk management technology and Thomas Kimner

human resource investments to improve business
As Head of Americas Risk Practice and Global Risk
decision management?
Products at SAS, Thomas Kimner is currently responsible
One of my current accountabilities is stress testing. The for executing the vision for SAS risk solutions and sales
Bank of Montreal is investing heavily in building stress support activities. He also serves as chairman of the
testing capability. This spans people, processes and Risk Governance Board — a global committee that sets
systems. We view it as much more than a compliance overall strategic direction for risk. Kimner has testified
exercise. We see stress testing as a strategic, value- before the Financial Services Committee of the United
adding input to assessing, anticipating and preparing States House of Representatives and regularly speaks at
for uncertainty. risk conferences and other SAS-hosted events.
I like to think of stress testing, or scenario testing, as a Prior to joining SAS, Kimner spent the bulk of his
forward-looking simulation, similar to a flight simulator. career at Fannie Mae, where he served in various senior
For those managers with limited exposure to tail events, management roles spearheading corporate initiatives to
it is a useful tool to contemplate and rehearse — without more effectively manage risk and financial reporting. He
recourse — a playbook of strategic moves. This practice has also worked at a leading Washington DC policy and
should improve forward-looking thinking and timely consultancy institute and a federal housing regulatory
recognition of adverse, or opportune, events as they agency.
unfold and foster more rapid adaptation to market
Kimner graduated summa cum laude with a bachelor’s
conditions.
degree in finance and magna cum laude with a bachelor’s
degree in economics from the University of Maryland,
Sanjiv Talwar, PhD where he also earned his Master of Science in computer
systems management.
As Head of Risk Capital and Stress Testing at the Bank
of Montreal, Sanjiv Talwar oversees the determination
of capital demand — including economic capital,
regulatory capital and stress capital — for the enterprise.
In addition, he is accountable for risk analytics.
Talwar also has leadership responsibilities for CCAR,
DFAST and ICAAP, and maintaining relationships with
regulators in multiple jurisdictions.

Previously, he was Senior Vice President at OCBC

Bank in Singapore, where he held market risk oversight
responsibilities for the trading and banking books,
asset/liability management, product control and
model validation. Prior to joining OCBC, Talwar was
Senior Vice President at CIBC in Toronto, where he was
responsible for Basel II regulatory capital and economic
capital for all banking book assets. His experience
also includes leadership positions at Commerzbank
Securities in London, where he served as Head of
Quantitative Research and Financial Engineering and
Head of E-Commerce. Talwar holds a PhD in aerospace
engineering from the University of Illinois at Urbana-
Champaign.

122 W 26th St, 2nd Floor

New York, NY 10001 www.argylejournal.com
(646) 839–0012 MAIN
SAS and all other SAS Institute Inc. product or service names are registered trademarks or trademarks of SAS Institute Inc. in the USA
and other countries. ® indicates USA registration. Other brand and product names are trademarks of their respective companies.
107392_S129660.1014