India First Edition

Highlights of McKinsy Report on Indian Banking system

Strong correlation between superior risk management practices and improved financial performance
Mumbai, November 5 2008 – A new report, ‘Superior Risk Management in Indian Banking’ by the Financial Services practice of leading consulting firm, McKinsey & Company was released at the FICCI-IBA Conference on Global Banking in Mumbai. The study presents findings from a proprietary risk-assessment survey carried out at 17 participating banks across three elements (i) credit and enterprise risk; (ii) operational risk; (iii) ALM and market risk. It also included interviews with CROs, Treasury Heads and Risk Heads across these banks.  The findings uncover several interesting insights that are likely to stimulate discussion and influence the evolution of the risk management agenda of Indian banks in the future.

The research reveals that there is a strong correlation between superior risk management practices and improved financial performance. This demonstrates the need for the sector to fundamentally re-orient itself and ensure that sustainable stakeholder value creation is the core rationale for adopting various tools and processes as opposed to mere regulatory compliance.

Other key highlights of the study include:

(i) Risk management has to be the shared responsibility of both the risk management department and business managers as the actions of business managers often affect the kinds of risks taken by an organisation. This needs to be reflected in a variety of ways, including capital allocation, target setting, performance management and incentivisation.

(ii) Clear differences (and similarities) exist across new generation banks and traditional banks*

- The Credit and Enterprise Risk Survey findings suggest that traditional players place relatively more emphasis on subjective and qualitative elements in setting limits and loan pricing, while balancing this with stringent “makerchecker” systems. New generation players on the other hand have imbibed various statistical approaches (such as scoring models, probability of default models, early warning systems and collateral management approaches) and are using “credit TAT” as a tool for customer satisfaction and growth.

- The Operational Risk Survey reveals similar practices and processes across most operational risk dimensions – moreover, at an overall sector level, a high scorecard indicates that all practices and tools are in place

- The ALM and Market Risk Survey findings illustrate that while on the surface, treasury scope, trading strategies and instruments used are very similar across players, there is significant difference in their risk appetite, governance and use of risk measurement tools. New generation players are on par with their global peers, while traditional players are still lagging in key areas such as Funds Transfer Pricing and ALM modeling. Both sets of banks have highlighted the lack of adequate people capabilities as well as the scope/mandate of the mid-office as key concern areas.

(iii) The banking sector has made significant progress by imbibing various best practices across risk modeling; risk-adjusted pricing and portfolio risk management, albeit in varying degrees of sophistication and detail. While this is critical, the next step is to suitably modify the risk mandate. This involves changing the role of the CRO from one of pure “oversight and post-mortem” to that of a proactive “equal business partner”, redefining the scope and functions of the risk department, adequately skilling and staffing the function to successfully play this role and communicating the new role across the organisation.
(iv) Banks will need to continuously refine today’s practices, even though they may be better or on par with best practices, in light of tomorrow’s external environment and internal strategy. Hence, it is imperative to constantly revisit the risk architecture through the ongoing refinement of models, stress testing scenarios, revalidating limits, redesigning customer-facing processes and restructuring of the organisation. This also implies broadening the traditional purview of risk management to include newer practices such as reputational risk, business process re-engineering and concurrent audit improvement.