Reimagining Risk Management: A Guide for Chief Risk Officers

With the increasing complexities of global risks, emerging markets, and the intricacies of financial management, Chief Risk Officers (CROs) have been thrust to the forefront of the financial services industry. Today, more than ever, they face the daunting task of managing their resources efficiently without compromising the efficacy of their risk management functions.

A Changing Landscape: Striking a Balance in Resourcing

Recent economic shifts, particularly the looming threat of inflation, have placed financial institutions under significant pressure. Institutions are not only aiming to tighten their control over global, multidimensional risks but are also looking to achieve overall efficiency. This places CROs in a unique predicament: on one hand, they are being pushed to enhance their resource allocation to cater to both organizational and regulatory demands. On the other hand, they are being asked to do more with less.

Key Insights from a Comprehensive Study

To provide clarity in this dynamic environment, McKinsey undertook a detailed survey involving CROs from over 30 major banks across Europe, North America, and Australia. These banks represent a mix of both local and globally important institutions. The survey delved deep into understanding the structure and allocation of resources for the second line of defense (LOD2) risk functions.

Some primary findings include:

  • There isn’t a direct correlation between adding personnel and achieving better risk management.
  • Risk efficiency and effectiveness are, in most cases, positively linked.
  • With a structured approach, institutions can cut costs by up to 25% while still bolstering risk effectiveness.

The Quest to “Rightsize” Risk Management

For optimal efficiency, CROs are venturing into mapping their risk resources. A key metric, known as risk full-time-employee (FTE) intensity, came to the fore. This metric showcases the proportion of FTEs in the risk function relative to the entire bank’s workforce. The study’s findings revealed a median risk FTE intensity of 2.6%. A closer look at the data also showed a convergence trend. Institutions below this median tended to expand their risk resources, while those above aimed to streamline.

Surprisingly, larger banks showed a lower FTE intensity, suggesting that there are inherent scale benefits that these institutions enjoy.

Allocating Resources: The Diverse Landscape of Risk

Different types of risks demand varied resource allocations. The study showed:

  • Credit Risk Management: Represented the lion’s share of FTEs. Automation, especially in the underwriting process, has led to a decline in FTE allocation in this segment.
  • Market and Operational Risk: Both had an FTE intensity of about 0.25%. Recent regulations and a push towards automation have influenced their trajectories differently.
  • Model Risk Management: This segment is witnessing an upswing as institutions grapple with a multitude of models, from underwriting and market pricing models to emerging ones like climate risk models.

Tools for Reshaping Risk Management

Based on the survey, three primary organizational levers can be utilized by CROs:

  1. Refocusing Responsibilities: A clear delineation between LOD1 and LOD2 responsibilities can drive efficiency. The introduction of new risk domains like cyber and tech security demands that LOD2 is adequately equipped while LOD1 assumes more risk management functions.
  2. Resource Allocation: Decision-making on whether to dedicate resources for specific businesses and geographies or to have teams with a global mandate can drive significant efficiencies.
  3. Near- and Off-shoring: Though underutilized, off-shoring can be a potential avenue for cost savings, especially for institutions based in high-cost regions.

Crafting an Efficient Risk Management Blueprint

Leading institutions share certain traits:

  • Emphasis on a robust risk culture.
  • Investment in digital tools and automation.
  • Seamless risk reporting mechanisms.
  • Enhanced financial-crime processes.
  • Focus on agile decision-making and streamlined governance.
  • Comprehensive strategies for model development and validation.

The Road Ahead

The evolving landscape mandates a more efficiency-driven approach for CROs. As they grapple with rising risks, regulations, and economic pressures, the key lies in leveraging available tools, insights, and best practices. The silver lining? A judicious mix of resource allocation, advanced analytics, and a structured risk transformation program can not only curb costs but also fortify risk management capabilities for financial institutions.

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