Desperately seeking an "enterprise-wide" view of risk

One of the consequences of the current economic crisis is that banks' risk management practices - or lack of them - have been exposed. Like peeling back the various layers of an onion only to find that the inner layer is rotting, the more so-called risk experts have delved into the risk management practices of banks, they have not liked what they have seen.

Something is rotten in the state of financial risk management, and there should be no surprises that banks' siloed view of risk based on asset class or geography has played a rather significant hand in the dire predicament they now find themselves in. Not only do banks not have an enterprise-wide view of risk across asset classes and geographies, they apparently also find it difficult to stop or prioritise payment flows. Few banks it seems had the ability to stop payments going to ailing investment bank Lehman's Brother as it collapsed.

"How many banks have the ability to say I don't have enough cash in nostro A , but there is plenty in nostro B, so I can re-route payments?", asked an executive from complex event processing vendor, Aleri, during a recent webinar it hosted on liquidity risk management.

Not only are banks' risk management systems siloed, the experts say, they also do not speak to liquidity management and collateral management systems. Liquidity management was traditionally seen as the preserve of a bank's treasury department, but Bob McDowall, a research director with TowerGroup in Europe, says that has to change.

McDowall said forthcoming regulation in the wake of the current crisis meant that banks would need to develop the capability to measure and manage liquidity risk on an enterprise-wide basis. Aleri says complex event processing is one technology that can help pull together disparate sources of information together without having to connect to the different silos within banks.

"At any time, banks need to be able to take a view as to what their risks and liabilities are up-to-the minute, not at the end of the day or periodically throughout the day," said McDowall.
He anticipates that banks will need to move from real-time to "predictive" risk management based on analysis of prices and behavioural patterns.

The national financial regulators are also going to have to pull their socks up it seems, as McDowall says that in order to monitor how well banks are managing liquidity risk, they will need to take a more "forensic" approach to risk management and build systems that enable them to share information with one another.

According to Tony White, managing director, product and R&D, Wall Street Systems, "next generation" liquidity management systems will need to provide a quick overview of everything and be tied to front office systems. They cannot be product agnostic as they will need to understand the product if banks want to combine collateral and cash. Liquidity management policies will also need to be reflected in these systems and stress testing of different scenarios will need to be done in minutes not months.

Sounds like banks are going to have their hands full over the next few months, but one wonders how many banks will actually achieve a truly enterprise-wide view of their risk, given that risk management projects have tended not to receive that much support from senior banking executives.

Citi shareholders need reality check

As speculation continues to mount around the future of Citi's various business units, Bob McDowall, a research director with TowerGroup in Europe, remarked that investors needed to understand that banks were a long-term stock pick.

In the last two days, Citi's share price has slumped more than 20% forcing the hand of the bank's board members who are meeting today to discuss options for restoring investors' confidence. Despite talk of an increased injection of capital by Citi's main investor, Prince Alwaleed Bin Talal, Citi's shares continued to fall.

There is speculation that Citi may sell of one or more of its businesses to help shore up capital and investor confidence. Business lines it is likely to consider selling include its investment banking business and special investment vehicles. McDowall said that Citi's global transaction banking, wealth management and international branch network remained relatively good value, so it is unlikely to dispose of those.

But given that now is not a good time to be selling, given low valuations, McDowall said Citi's options were limited. He said governments could not continue to be seen to be pumping money into ailing banks as that would further erode customer and shareholders' confidence in the US financial system.

But McDowall takes a dim view of the pressure shareholders are putting on Citi to deliver more value in the current depressed economic environment. "Shareholders have to understand that banks are a long-term stock peg," he said. "Having had a good feast on banking dividends for the last five years, now it is time for a little bit of famine."

McDowall believes that the much maligned sovereign wealth funds, which have invested in banks like Citi, have a much better attitude towards investing in banking stocks; they tend to take a longer-term view and see the current share price of Citi as an opportunity to buy not sell.

According to a Reuters report, Citi's CEO Vikram Pandit has indicated he wants to hold onto the banks' Smith Barney brokerage business, and said that employees should not focus on Citi's falling share price as it is well capitalised.

A single bank seems likely to take on a merger with a bank of Citi's size - that would be too much to digest, although that may be an option if the government is forced to step in. One also has to wonder whether the US authorities will relax investment restrictions for foreign investors in US banks, given that Middle Eastern investors have demonstrated that they are only too willing to hold stocks like Citi.

Data management projects still a hard sell

Front office trading applications and risk management have garnered a lot of media attention during the recent credit crunch. But one ingredient that feeds both front office trading applications and risk management, data, which is the "lifeblood" of most companies, is still getting short shrift when it comes to funding.

Data governance and quality should be right up there on the list of things that financial service providers need to work on because if they are taking in poor quality data then they are going to be spitting out poor trading and risk management decisions based on erroneous data.

But it seems data management in general is not at the top of most banking CEO and CFO's agenda, at least that is the impression I got sitting in on a panel discussion on the funding process for data management in a turbulent financial market at FIMA Europe 2008 in Olympia, London.

While most companies recognize that data is a "strategic asset", getting funding for data management projects appears to be as difficult as pulling teeth, according to the esteemed panel of EDM, client and customer accounts operations heads from Citi, HSBC and Dresdner Kleinwort.

And while the credit crunch has shone a light onto the once mysterious backwater of reference data management - regulators are likely to start enforcing standards around data quality and management - data specialists do not expect funding for major reference data projects to get easier any time soon.

"It is difficult to get management buy-in [when it comes to data management]," said Sally Hinds, global head of EDM, HSBC investment bank. One trick, said Hind was to ask for the same budget as 2007 so it didn't look like reference data management was gobbling up even more of increasingly scarce budget resources.

Hinds stressed that the EDM department within HSBC was relatively new and that the recent global market turmoil highlighted that data still resided in many different, often siloed locations, and that sometimes there were mismatches between front and back office views of data.

"Citi is incredibly siloed," said Julia Sutton, global head, customer accounts operations for Citi. "We are trying to break down these silos, but it is difficult." Sutton said as her function was placed within the capital markets division of the bank it was viewed with mistrust by other business lines. And whilst her business has senior management buy-in, she said there has been a major influx of new management recently. "They haven't been there long enough to know how important it[customer data] is to them," she said.

Sutton said her department had to try various methods in order to get funded. In the end instead of getting funding from the individual business lines, they obtained funding centrally as the customer data it manages crosses various business lines including global banking, investment banking and treasury.

Instead of managing data in silos, enterprise data management or EDM, encourages firms to move to an enterprise-wide data management fabric. But it appears that the reality on the ground for most firms is still very much silo-based. "We have a long history of acquisition, but a short history of integration," said Sutton. Hinds of HSBC said it is working on a project called, "one HSBC", which aims to reduce [data] duplication across asset management, investment and private banking.

Sadly it seems, the only thing that seems to truly motivate most banks to embark on major reference data management projects is the threat of regulatory oversight. Most of the panelists agreed that regulations such as Basel II and MiFID had provided them with opportunities to get projects funded.

Summit told Citi may not be profitable for several years

The transition for Wall Street Banks, Goldman Sachs and Morgan Stanley to bank holding companies, will be "painful", Oppenheimer & Co analyst Meredith Whitney told Reuters Global Finance Summit held in New York, London and Hong Kong recently.

Whitney also said that Citi, which was one of the casualties of the subprime crisis, was unlikely to be profitable for several years and needed to reinvent itself, either by buying another US retail bank or losing some of its businesses.

While Citi's Global Transaction Banking business continues to be profitable, Whitney said that opportunities for cross-selling to clients across Citi's myriad financial services businesses, was not happening because the bank had not invested enough in "integrating different units' computer and risk management systems".

She also stated that losses in the bank's consumer loans business in emerging markets such as Mexico and India were rising and that an accounting rule change would bring credit card loans packaged into bonds back onto Citigroup's balance sheet forcing the bank to set aside an additional $7 billion to $10 billion to cover loan losses, Reuters Global Finance Summit reported.

Citi lost its bid for Wachovia Bank, the US's fourth-largest bank by market value, to Wells Fargo in early October. The deal would have helped to increase its deposit base, which is considered crucial in these credit challenged times. Reuters Global Finance Summit reported that Citigroup relied more on borrowing in the bond market than competitors, particularly in the US, which increased its funding costs.

"If they want to grow their US business, they're going to have to fund it differently," Whitney told the Finance Summit.

Having lost the Wachovia deal, Citi is believed to be seeking other acquisitions.