Leveraging Capabilities: Connecting Risk and Finance

I have been working in, or with, financial institutions for about 30 years, primarily in Finance and Risk.

Through that time and even today, I have observed that when Risk and Finance intentionally collaborate, organisations make better and faster decisions, and with more confidence. There remain opportunities to provide greater value to business through collaboration both operationally, and through data/technology design.

This analysis is not intended to challenge current structures and domains, but rather to identify opportunities to collectively provide business with measures and insights that are timely and value-adding.

Finance & Risk are aligned, but not connected

Finance and Risk separately manage the consequences of business activities in compliance with regulatory and other reporting requirements - exposure, performance, and scenario management - reporting their output to the same, or very similar, consumers.

The functions intentionally differ in what they measure and how they represent outcomes. There are, however, opportunities to better connect these perspectives to provide greater insight.

Aligned by design. Connected through insight.

Data Alignment

Finance and Risk share common data domains, but this data is often aggregated and reported at different levels. The use of a common data taxonomy, consistent roll-up hierarchies, and reporting to business at the same level of aggregation would substantially improve the relevance and connectedness of these outputs to business.

Most of the important data is already shared in spirit, but typically not in structure, ownership, lineage, or interpretation.

Output Alignment

Each of Finance and Risk present outputs aligned to the risks they manage, and these are important to how the business manage its activities.

What if these outputs could be ‘fused’ to present a holistic view to the business that is neither Finance nor Risk, but integrated? Combining different measures into a single perspective immediately supports business in their decision-making around clients, products, and markets. Measuring and reporting on earnings relative to the cost of risk, and how a change in fundamentals will impact future earnings is invaluable to the business.

Examples of these integrated measures include:

1.      Risk-adjusted profitability: RAROC or Economic Value Add (EVA) = Profit minus expected loss minus capital charge.

2.      Forward-looking portfolio insights: stressed p&l driven by defined scenarios, and what-if outcome driven by business perspectives, both embedding the cost and impact of risk and capital.

3.      Product pricing insight: determining the profitability of products and/or clients to calculate the true margin after risk, capital, and liquidity cost.

4.      Strategic planning: growth aspirations including constraints of funding, risk appetite and available capital/liquidity. Allocation of scarce resources to achieve maximum outcomes.

What can be done in the short-term?

Align data definitions, attributes and hierarchies to an enterprise standard. This will avoid reconciliation dramas. A shared data store will ensure commonality of data inputs.

Align on how data is represented and at what level of aggregation. Finance and Risk representations are intentionally different. The goal isn’t to force them to be identical, but to translate between them and explain differences.

Establish feedback loops to the business on a regular cadence. While a single set of reports are likely not feasible, combined feedback meetings are well within reach. Aggregate insights represent true value to the business, provided these are delivered in a timely fashion.

In summary

Finance answers the question “how much did we make?” and Risk “how much risk is associated with the financial result?” Combine these outcomes and the question being answered becomes “How do we earn more while making best use of our resources?”

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