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Trends in Risk Management: Insights from the Joint Forum on Financial Conglomerates

This document presents the findings from the Joint Forum's study on risk integration and aggregation, which aims to enhance understanding of how large financial conglomerates manage risks across various sectors. It highlights trends in systematic risk management practices, emphasizes the role of technology in integrating risk frameworks, and explores the complexities of risk aggregation methodologies. Key challenges and implications for regulation and supervision are discussed, signaling a shift towards more risk-sensitive approaches in financial oversight.

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Trends in Risk Management: Insights from the Joint Forum on Financial Conglomerates

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  1. Perspectives from the Joint Forum Darryll HendricksFederal Reserve Bank of New York Enterprise Risk Management Symposium April 27, 2004

  2. Background on the Joint Forum • Founded in January 1996 by the International Association of Insurance Supervisors (IAIS),the Basel Committee on Banking Supervision, and International Organization of Securities Commissions (IOSCO) with a mandate to: - Study issues of common interest to the parent committees - Develop principles for the supervision of financial conglomerates

  3. Joint Forum Products • The JF has issued several sets of principles relevant to financial conglomerates, including: - Prudent management of risk concentrations in groups - Prudent management of intra-group transactions and exposures - Capital adequacy on a group-wide basis • The JF has conducted several studies of topics of common interest, including: - Core supervisory principles in various jurisdictions - Risk management and regulatory capital issues - How financial conglomerates manage risks on a group-wide basis - Issues related to transfer of operational risk across financial sectors

  4. Study of Trends in Risk Integrationand Risk Aggregation • The JF wanted to build a better understanding of how large complex firms manage risk and how group-level supervision is conducted • A Working Group was created to investigate firms’ practices with regard to: - Firm-wide management of risk, i.e., “risk integration” - Aggregate measures of risk, i.e., “risk aggregation” • The study involved a survey of 31 firms in 12 jurisdictions, covering banks, securities firms, and insurance companies

  5. Findings on Risk Integration • Firms are increasingly taking a systematic and comprehensive approach to risk • Dedicated risk management functions serve various roles, but generally promote common, firm-wide definitions of risk and risk metrics • Actual risk decisions are being made in various manners, ranging from centralized to decentralized - Risk integration does not imply that everything is centralized • Significant information technology expenditures are being made to support an integrated risk framework

  6. Findings on Risk Aggregation • Firms are making greater use of aggregated metrics such as economic capital, stress testing or some adaptation of dynamic financial analysis • Firms feel that an aggregate measure should include all risks, but some risks (e.g. operational) are difficult to quantify in a consistent way • Risk aggregation involves the difficult issue of how to measure correlations across risk types. This leads to the question of how diversification benefits should be allocated among business units • Firms differ widely in the use they make of their economic capital methodologies. They recognize that single metrics have limitations, yet it is challenging to apportion risk-taking without such a metric

  7. Important Challenges for Risk Integration and Risk Aggregation • Ensuring accountability and responsibility while also taking advantage of local knowledge and expertise • Potential conflicts between economic/risk reporting and accounting/regulatory standards • Ensuring an appropriate treatment of legal entity issues • How to use economic capital to make better decisions

  8. Implications for Regulationand Supervision • Regulation and supervision are influenced by, and encourage, the trends in market practices • Supervisors are placing more emphasis on firms’ risk management processes • Supervisors are increasingly working together and sharing information • Multi-sectoral supervisory agencies have been created in some countries • New prudential capital adequacy rules in insurance and banking will be more risk-sensitive

  9. What Next? • Enhanced disclosure. A report, to be published soon, will assess firms’ adoption of the Fisher II recommendations for improving public disclosures made by financial firms. • Credit risk transfer. A study is underway to assess issues associated with credit derivatives activity.

  10. Joint Forum papers may be found at:www.bis.org/bcbs/publ.htm

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