The Basel II Capital Accord is the latest in a long line of regulatory requirements to emerge in international financial services. While many companies view Basel II as a costly and often confusing exercise in regulatory compliance, an opportunity exists for forward-thinking institutions to turn compliance strategies into competitive advantage.
Basel II offers companies a reason to more accurately measure and better manage risk across the entire enterprise. If approached correctly, these efforts can yield significant returns in reduced capital reserve requirements, increased profitability and greater market share.
To do this, companies must take a more holistic view of compliance by implementing an enterprise risk-management architecture with long-term perspective and enterprise-wide reach. By combining such critical components as business-process and content-management capabilities, this architecture enables companies to proactively monitor and mitigate risk, improve organizational transparency, and achieve business agility that can help firms see that Basel II compliance puts them into a stronger competitive position.
Basel II and other regulatory requirements have introduced increasing complexity into the operations of financial services organizations. Moving forward, most will continue to struggle to meet pending deadlines for the new accord, as well as any amendments and new regulatory requirements that will be introduced. From accessing extensive amounts of historical data to validating risk models and managing complex business rules, today's manual processes and siloed operating environments make compliance efforts challenging for an organization of any size.
The choice is clear: financial services institutions can either struggle with these developing requirements in an ad hoc manner, or use them as a catalyst to improve how they do business. With Basel II, companies that adopt the advanced internal ratings-based (IRB) approach to credit risk and the advanced measurement approach (AMA) for operational risk will reduce aggregate capital requirements and effectively lower the cost of capital to the organization. While accomplishing this will require heightened oversight and systems investment, the bottom- line benefits will include greater profit margins or more competitively priced products and services that enable them to seize market share from the competition. By focusing more broadly on the business benefits of compliance, companies can develop comprehensive products that improve performance while avoiding the risk of penalty.
To transform regulatory requirements into business opportunity, financial services institutions must commit themselves to a comprehensive software that streamlines management for today's regulations and has the flexibility to address future requirements. In implementing a system, companies must focus on aggressively managing and mitigating operational risk, addressing both business process and content issues, integrating all systems, data collection and management, event analysis and response, and comprehensive reporting. This attention to operational excellence pays off in reduced audit or query costs and, more importantly, additional brand protection.
Most large financial institutions are already expected to adopt additional measures to minimize risk factors. It is important to recognize that, in this competitive climate, proactive commitment becomes a requirement for doing business rather than an opportunity to differentiate.
Operational risk, however, offers a wider range of areas for improvement and enhancement, and involve breakdowns in internal controls and corporate governance. Such breakdowns can lead to financial losses through error, fraud or failure to perform in a timely manner. The interests of the bank also can be compromised in some other way-for example, by dealers, lending officers, or other staff members exceeding their authority or conducting business in an unethical or risky manner. Other aspects of operational risk include major failure of information technology systems or events such as fires or other disasters.
Companies will move through three distinct phases in compliance: risk measurement, advanced risk assessment and risk management and mitigation. While these require increasing levels of capability and operational control, companies that want to turn compliance into competitive advantage must focus on the final stage of risk management and mitigation.
In risk measurement, companies will take a top-down measurement approach, which focuses on gathering historical data, establishing a baseline, and using this information to predict future exposure. The second phase marks the adoption of IRB and AMA approaches. Companies will gather and report risk information from the bottom up, taking a more granular view of exposure to accurately represent current market, credit and operational risk. When organizations move to full-scale risk management and mitigation, they will carefully look at the activities and processes that incur the highest incidence of risk events and where the organization sees the greatest monetary exposure. By ranking processes, the company can establish priorities for increasing internal controls and implementing continuous process improvement to reduce overall risk exposure.
Business processes are the key to survival for financial services institutions and play a critical role in ensuring compliance. Proper processes ensure that business is transacted appropriately and also help document an organization's commitment to compliance and reduced operational risk. But compliance cannot be achieved by focusing on process alone. Companies must effectively manage both process and content-or information-to ensure long-term compliance within the ever-changing regulatory environment. By automating, controlling, and accelerating business processes, companies can create fault-resistant compliance frameworks that allow modeling, analysis and continual process improvement. Linking this to the masses of both structured (files and databases) and unstructured data (faxes, e-mail, rich media, voice mail), an effective compliance architecture will automate proper processing, storage, and reporting to meet regulatory needs today and tomorrow.
To be wholly effective, a company's enterprise risk management architecture must unify all corporate systems and create a common access point. Financial services institutions should be able to proactively address compliance issues without having to change existing IT systems or adding on another siloed point solution. Companies should look for a compliance product that offers out-of-the-box integration and that facilitates rapid development of management or audit dashboards, increases transparency of core business process, events, and outcomes, and that delivers critical structured and unstructured information in a framework that facilitates fast, accurate decision-making. The architecture should allow unlimited development and storage of processes with the rapid modification capability of a user-friendly graphical interface and speedy deployment.
As it applies to compliance, business-process management should enable automation of response, as well as ongoing modeling and analysis of risk events. Companies must be able to define triggers, or predetermined events that initiate automated responses that ensure compliance. These responses can range from simple electronic notification to a complex, multi-threaded business process that coordinates response across the organization to mitigate risk at an enterprise level. And by simulating risk events and response mechanisms before implementing them, companies must have the capability to fully test procedures, as well as new products and services, to identify the actions that most effectively minimize risk.
Reporting plays a critical role in compliance. A compliance strategy must include the ability to gather critical metrics throughout a process life cycle to enable insight into core business processes, various risk events, and their impact on operations. Content should be easily integrated into performance dashboards for immediate access by management. This will enable the organization to ensure executive awareness and speed response to risk issues.
With a fully integrated and flexible risk-management framework, banks can expect significant returns, including reduced capital reserve requirements, increased profitability and greater market share.
Christopher McLaughlin is director of financial services marketing at FileNet Corp.
