A long time ago, I was working on analytics in a bank, primarily in the area of risk. One project I worked on was about working out which products were profitable to help clean up the product portfolio. The project involved people from both risk and finance. As we worked through the project, it became increasingly clear that it was very difficult for us to reach any conclusions.
The two sets of data – one from risk and one from finance – provided plenty of information to draw firm conclusions about which products were profitable. Unfortunately, the product portfolio splits – and hence the profit and loss data in the two departments – led to very different conclusions. Products that seemed very profitable from the risk department’s perspective were unprofitable from a finance perspective, and vice versa. In the end, no management decisions were made – at least not from our analyses.
Why did this happen? The root cause of the problem was, of course, that there was no common data platform for risk and finance in the bank. The two departments each had its own sources of input data from production systems. The two different processes for data aggregation and filtering led to very different views on profitability. What’s more, nobody could say with any certainty which one was correct.
Why work together?
Traditionally, finance focuses on the area of profit and loss, whereas risk departments look more at the bank from a balance/positions perspective.
As my story shows, there are several reasons why these two departments should work more closely together. Additionally, over the last 10 years, the weight of some very real regulatory requirements has made it not just valuable but essential for risk and finance to work together. These include:
- Liquidity risk measures in the regulatory regimes (LCR and NSFR in Basel III/CRR).
- IFRS 9.
- (EBA) stress testing.
- Balance sheet management.
These are all areas where banks will gain considerable insights and efficiencies by having the risk and finance departments work together on a common (data) platform and with common tools and goals.
IFRS 9 is a good example. It is an accounting standard, but 90% of the work involved relates to data mining and building models. These are tasks that naturally belong in the risk area. In the IFRS 9 space, SAS has been involved in very successful projects with customers who have put the main responsibility for the implementation in the risk department. These customers have typically achieved ECL calculation speeds that are counted in minutes.The root cause of the problem was, of course, that there was no common data platform for #risk and #finance in the #bank. Click To Tweet
We have also talked to banks that decided to run the implementation out of the finance department and are now measuring ECL run times in days. This is basically because they chose to implement the calculations in their finance solutions. In these cases, the banks have very little flexibility in using the ECL engine or its results for anything but IFRS 9 reporting. Stress testing and result analysis is something that happens after the fact rather than as part of the process.
The point of the above is not that risk is better than finance. Instead, it shows that the risk and finance departments increasingly need to work together. It no longer makes sense to consider risk and finance separately. For the moment, they need a common data and solutions foundation. They also need to have a close dialogue about crossover projects and decide in each case how best to spend the resources. In the future, the combined risk/finance landscape is likely to lead to new opportunities, especially in areas like credit management.
To find out more, I recommend this article from GARP on "Risk and Finance: A Necessary Integration," and this white paper from SAS: Adapting to the New Age of Risk Analytics: Integrating Finance and Risk.