Enterprise Risk Management: New Paradigms for Measuring and Reporting Enterprise Risk

1. Enterprise Risk Management: New Paradigms for Measuring and Reporting Enterprise Risk • Presented by Charles McKinney • PRMIA Montreal Chapter • December 2, 2009

2. Today’s discussion • Dawning of a new era • Evolution of business intelligence • Interesting topics for risk managers • Plotting and executing strategy Disclaimer: The information and views contained in this document are solely those of the presenter. Although attempts to provide reliable, useful information were made, no guarantee can be made that the information is accurate, current or suitable for any particular purpose.

3. “Killer apps” in financial services • Killer apps are technologies at the center of value creation • Structured finance enabled risk transfer: • Asset-backed securities • Mortgage-backed securities and CMOs • Collateralized debt obligations • Credit derivatives • If securitization embodied “killer apps,” is a new era of competing on analytics (managing risk) on the horizon? Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

4. Coming back from the brink Market capitalization and total shareholder returns suggest financial institutions may be rebounding from the lows of 2008. Total shareholder returns2 Total banking market capitalization1 U.S. Dollars in Trillions Sources: Thompson Reuters Datastream; Boston Consulting Group Notes 1. Total banking market capitalization refers to market capitalization of banking sectors worldwide. Figures are rounded. 2. Total shareholder return consists of capital gains and free-cash-flow yields. TSR calculated after conversion to U.S. dollars. Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

5. Non-agency MBS market has dried up The market for non-agency mortgage-backed securities contracted severely in 2008, as the financial crisis unfolded. It continues to be dry. Mortgage and asset securities issuance (end of period) Source: Inside MBS and ABS Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

6. U.S. house price depreciation may be bottoming FHFA (OFHEO) House Price Index History for the United States (Purchase-Only Index) Percent Change in the FHFA (OFHEO) House Price Index (Purchase-Only Index) Source: Federal Housing Finance Agency. Note: The FHFA (OFHEO) House Price Index is a weighted, repeat-sales index. It is based onrepeat mortgage transactions on single-family properties whose mortgages have been purchased or securitized by Fannie Mae orFreddie Mac since January 1975. Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

7. U.S. home sales decline may be bottoming U.S. New and Existing Home Sales Source: National Association of Realtors. Latest data are August 31, 2009.. Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

8. U.S. housing affordability appears to be improving According to data from the National Association of Realtors, housing affordability is at an all-time high in the U.S. NAR U.S. Quarterly Housing Affordability Index Source: National Association of Realtors, Freddie Mac. Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

9. U.S. foreclosures are at a record level Foreclosures as a Percent of Total Loans in the U.S. Source: Mortgage Bankers Association Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

10. Further interest rate resets are expected Source: Agora Financial, Credit Suisse (U.S. Mortgage Strategy), Loan Performance, FH/FN/GN. Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

11. Headlines suggest broadening data requirements • Lingering uncertainty about the U.S. mortgage market (as well as other economic forces) highlight the need for quality information • Organizational and regulatory data requirements are bound to grow to encompass external and internal factors affecting enterprise risk Housing Feedback Loop (External Considerations) Internal Considerations • Enterprise risk data: • Credit risk • Financial risk • Market risk • Operational risk (external losses, too) • Financial data • Transaction data • Products and pricing • Customers and markets • Regulatory compliance • Legal considerations Source: International Monetary Fund Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

12. Re-regulation implies new data requirements • Regulatory reporting requirements of financial institutions are on the rise • Certain themes are prominent among the various U.S. proposals and draft legislation to re-regulate financial services: • Expanding regulatory oversight to all financial services institutions • Extending the scope of regulatory oversight for systemically important firms and to ensure financial markets can absorb system-wide stress • Strengthening consumer protection and mitigating predatory practices • Providing governmental actors with new power and better tools to monitor financial institutions, take corrective action and resolve important failures • Raise international regulatory standards and improve international cooperation • These themes imply new requirements to collect, use and share information in the public sector Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

13. Standardizing inter-organizational data • Industry standards for inter-organizationally shared data are common: • CUSIP numbering • Swift messaging standards • Financial products markup language • Extensible business reporting language • Interest in standardizing other types of shared data is building (e.g., universal mortgage identification and data standards in the U.S.) • There is momentum to establish a U.S. National Institute of Finance that would set standards, gather data and provide analytical capabilities to: • Assist with monitoring systemic risk • Perform independent risk assessments of individual financial entities • Provide advice to regulatory agencies and the U.S. Congress Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

14. A new era driven by data and analytics • Coming out of the financial crisis, data and analytics are more important than ever: • Recent events highlight a need for evidence-based management (including counterviews where risk could materialize) • Having greater access to data and making better use of analytics are important tools for managing systemic risk • Financial institutions have the IT foundation to elevate the quality of their data and analytics Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

15. Framing business-analytical gaps • The financial crisis occurred despite significant models, tools and systems to manage risk • Financial institutions did not compete on analytics where enterprise was adequately measured, evaluated, monitored—and integrated into corporate governance, strategy and management Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

16. Definition of business intelligence • Deriving and refreshing knowledge to manage the firm: • Transforming raw data into meaningful, useful information • Equipping managers to monitor and control the enterprise • Enabling managers to make fact-based decisions • Challenging views with new information • Business intelligence describes management information systems that support planning, decision making and performance management • Business intelligence is evolving to emphasize business analytics: • There is a focus on investigating past performance to gain insights that drive business planning, resource allocation and risk management • The technologies, skills, applications and practices for business analytics integrate and mine and variety of data to gain new insights • Business analytics implies new management paradigms, which exploit data, facts and insights for competitive advantage (e.g., Tom Davenport’s research) Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

17. Business intelligence is a growing software market • The business intelligence market is forecast to more than double in size • Business analytics and other emerging BI solutions will fuel that growth Source: Adapted from Forrester Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

18. Evolving to “smart business intelligence” Business intelligence capabilities are following an evolutionary path. Reporting functionality was the starting place. With a focus on business analytics, “smart business intelligence” is a desired future state Source: Forrester Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

19. Reporting encompasses traditional applications • Traditional “business intelligence” solutions support report production and ad hoc queries (i.e., decision support) • Reporting solutions consolidate data elements, often into a data mart that is accessed by commercial software tools Source: Wherescape Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

20. Analytical tools equip users to answer questions • Business intelligence tools enable users to: • Answer questions through the analysis of data • Present the answers in a visually compelling format • Routinely reproduce the analysis with updated data • A “dimensional model” organizes data that is analyzed • Analysis is limited to the data elements accessible by the business intelligence solution, unless custom queries are also used • These data must reside in a structured format Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

21. The business intelligence landscape is complex • After years of implementations and upgrades, many institutions do not have a unified business intelligence architecture. Instead, there is a set of IT solutions • Business intelligence software has become more complex to assimilate heterogeneous data sources and accommodate diverse methods of data analysis and information delivery Source: Forrester Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

22. Data acquisition Data integration withwith quality control Analytical tools and applications Presentation tools andapplications Data distribution with privacy controls Metadata Management Operational Processes Unifying data sources for business analytics • Today many institutions are unifying their data sources, so business analytics that are based on a wide array of external and internal data types can be achieved • These efforts are closely aligned with initiatives to rationalize data architecture and improve information quality (e.g., master data management) • Some institutions are planning to bring unstructured content into the BI environment A robust information model, data dictionary and business requirements drive unification Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

23. Competing on analytics is the future • Strategies and execution based on analytics are common today: • Automated underwriting in the mortgage industry • Credit scoring in the United States and around the world • Custom promotions, pricing and loyalty programs • National defense and homeland security • Business analytics are used in enterprise risk management: • Risk dashboards • Modeling and forecasting • Testing approaches • Data mining • Future competitive strategies will exploit business analytics in an integrative, comprehensive fashion Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

24. IT paradigms for business intelligence are changing • A new paradigm of “in database analytics” embeds business intelligence in processes (moving away from departmental business intelligence applications) • This paradigm tightly couples database and analytics processes by moving business intelligence functions into the enterprise data warehouse • Any new IT paradigm requires cost/benefit analysis and evaluation by business users Traditional Setup for Predictive Analytics “In Database Analytics” Paradigm Source: Forrester Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

25. User-built applications can be effective • User-built applications are often appropriate, such as when: • Researching and prototyping new model applications • “Time to usability” is critical, and the SDLC is too slow • Flexibility is required (e.g., multiple model versions) • Capacity planning and change management are important Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

26. Information quality is an unmeasured challenge • Financial institutions are beginning to measure information quality at an enterprise level and in an inter-organizational context to drive quality improvement • Information quality appears to be a lever for reducing risk, especially where transaction processing and models use nonstandard reference data Measurement of Information Quality Internal Data Quality Counterparty Data Quality External Data Consistency Intrinsic Data Quality Internal Data Consistency Data Quality at Delivery Accuracy of The Data Data Volatility Impact of Information Quality Recourse for Information Quality Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

27. Unstructured data is an untapped gold mine • Unstructured content represents as much as 80% of an institution’s data • Tools to convert unstructured content into a structure for analysis is an emerging area of interest (e.g., web analytics, forms processing, loan file reviews) Turning Unstructured Information into Business Intelligence Borrower Income Wages & Salary Business Income Interest Received Etc. Social Security Nbr Borrower SSN Co-borrower SSN Property Street Address Zip Code Appraised Value Loan Points and Fees Source: William Inman (adapted) Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era

28. Assessing business intelligence for risk • Periodically assessing business-analytical capabilities, in the context of strategies to measure, monitor and report risk, is a good idea. • Things to consider: • Current capabilities and any shortcomings • Availability and reliability of BI input factors • Flexibility and scalability of the IT platform • Architecture of future BI capabilities for risk • Requirements for unifying enterprise data • Leveraging past investment (e.g., Basel II) • Time and cost to address current gaps • The current environment offers many opportunities to improve the business intelligence capabilities for enterprise risk management Evolution of Business Intelligence Topics of Immediate Interest Plotting and Executing Strategy Dawning of a New Era