Changes in Risk Management Practices after the Crisis: the Hungarian Perspective

1. Changes in Risk Management Practices after the Crisis: the Hungarian Perspective SUERF/MNB conference, Budapest Petra Kalfmann pkalfmann@bankarkepzo.hu 23 June, 2010

2. Goal of study • Evaluation of changesinrisk management practicesduringthecrisis • Self-evaluation of risk management executives • 6 largebanks + 1 mortgage bank • Representing 60% of totalassets • Questionnaire • Role of CRO and risk management organisation • Changesinoperativerisk management practice • Riskawarness of management • Integration of estimatedriskparameters, stress testing and ICAAP intostrategic and operativerisk management • Incentivesystem • Deficiencies and areasto be improved • Personalinterviewwith 4 respondents

3. CRO and organisation • Risk strategy • 5 of 7 has approved strategy by Board • 4 indicated considerable changes • CRO’s role and risk management role • 5 reported strengthening of CRO role • All respondents indicated strengthening of RM organisation in small degree Risk awareness of managements had significantly strengthened since 2008

4. Operative risk management process Business lines Elements to evaluate judgementcriteria amount of required coverage collateral evaluation methodology rating methodology decision-making competencies customer segmentation limit setting monitoring processes and work-out processes • Retail • SME • Large corporate • Project finance 1 – no change 2 – smalldegreetightening 3 – significanttightening

5. Evaluation of changes in risk mgmt practices Institutions commonly reported tightening of risk management processes

6. Evaluation of changes in risk mgmt practices – Retail Risk appetite of institutes decreased, the significant tightening implemented in the judgment criteria and coverage level are not temporary

7. Evaluation of changes in risk mgmt practices – Corporate Monitoring processes, limit setting, judgment criteria and the field of work-out were affected by considerable tightening

8. Evaluation of changes in risk mgmt practices – Corporate • SME • Institutes saw considerable risks in this segment • Significant restructuring and tightening of the loan origination process • Placing a strong emphasis on monitoring and work-out processes • Largecorporate • More considerable tightening inmonitoring processes, work-out and limit setting • Considerable tightening in the judgment, higher decision-making levels • Project finance • Considerably tightened at nearly all respondents without exception

9. Risk reports • Top managers receive comprehensive risk reports on the aggregate risk indices, capital intensiveness and portfolio quality at each respondent bank monthly • Content of the reports varied in case of each institute • 3 banks significant • the others minor changes Higher risk awareness of the bank’s top management is one of the lessons and results of the crisis

10. Application of risk parameters • Application of estimated PD, LGD parametersin: • Risk management process 7/7 • Riskpricing 6/7 • Provisioning 5/7 • CRM (customerrelationshipmgmt) 4/7 Risk awareness appears in the measurement of risks and the conscious use thereof

11. Application of risk parameters • Critics of riskestimationmethods => underestimationofrisk? • Changesinmethodology of • PD 3/7 (2 significant) • LGD 3/7 (1 significant) Partly shows that banks consider the applied methods grounded, mature and robust enough

12. Stress tests • Banksusingstress test instrategicrisk management • Positive 4/7 • ICAAP: results as input in capital planning, the elaboration of the risk strategy and lending processes • Need of reviewofstressscenarios • Positive 5/7 (3 significant) Banks more consciously evaluate potential impacts of extreme situations on risk levels

13. ICAAP Integration of results into risk management processes Changes in methodology of Credit risk Market risk Operational risk Liquidity risk Interest rate risk in banking book Reputational risk Other material risk • Positive 3/7 • Pillar 1 capital is usually higher, so this is considered as effective capital burden Economic capital calculations are not integral parts of risk management processes

14. ICAAP Fallbacks of VaRmethodology Conscious improvement of customer relationship management and regular measurement of itsquality • No capitalallocation • Tightenedlimits • Enhancedreporting • Detection of illiquidpositions

15. Incentive system • Need for incorporating long term incentives was formulated towards management incentive systems in international regulations • Weight of risk-related indecies is between 10-70% • 4 banks: RAROC-type index • 3 banks: portfolio quality and its trend Risk aspects were incorporated intoincentivesystemsin case of each bank

16. Deficiencies and areas to be improved • Self-evaluationonwhatbanks consider • the most important deficiencies in risk management of the past years with consideration to the crisis and • which fields they plan to improve • Independency of risk management • Appropriate IT support • Internalriskmgmtprofessionalcapacity (knowledge, headcount) • Appropriateincentivesystem • Suitability of appliedriskmeasurementmethods • Underestimation of risk • Appropriateriskcontrol • Anyother… 1 – 10 10: largest deficiency and activity to be improved 5 ≤ score: criticalfactor

17. Deficiencies and areas to be improved 5 ≤ score: ˜ 3 ≤ score < 5: ˜ score < 3: green˜

18. Deficiencies and areas to be improved • Additionals mentioned: • Lack and necessary development of management’s risk awareness • Permanent sustainability of a risk conscious corporate culture • Concept of responsible banking • Implementation of the results of Basel II preparations in the risk management process • Need to enhance monitoring processes

19. Conclusion • Risk awareness and sensitivity of top managers had considerably increased since the end of 2008 • Indices related to risk represent a rather considerable weight in the incentive system • Risk management methodologies passed the exam well • Risk management processes became important • Tightenedconditions • Monitoring and work-outefficiencyimprovementinfocus