Thursday, July 25, 2013

How to Aggregate Risks Across Your Organization

English: Risk management sub processes
English: Risk management sub processes (Photo credit: Wikipedia)
Companies should develop and maintain strong risk-data aggregation capabilities that take into account correlations within their risk portfolios.
Kristina Narvaez      
&Larry Warner      

For many organizations, gathering risk information from many business units and departments and then creating a consolidated risk report to share with senior managements and boards can seem daunting.
The sheer volume of risk data to be aggregated can overwhelm even the most astute decision makers. That’s especially true because many organizations still manage their risks in silos, separating them into operational units without understanding their correlations. But concentrations of risk can mean that bad events spread quickly across an organization’s silos.
One difficulty arises in managing risks via a silo-based approach is the inability to aggregate those risks across different business units and operational departments, which makes evaluating those risks from a global perspective hard. As a result, risk managers and CFOs struggle with such issues as unstable and weakly founded risk- correlation assumptions, inconsistent risk metrics and differing time horizons for different types of risks.
English: A flowchart pointing out the differen...
English: A flowchart pointing out the different types of risks in Banking (Photo credit: Wikipedia)
Risk have been defined for the financial-services industry by the Basel Committee of Banking Supervision’s 2013 Principles of Effective Risk Data Aggregation and Risk Report published in January 2013 as “the gathering and processing of risk data according to the bank’s reporting requirements to enable the bank to measure its performance against its risk tolerance/appetite.”
Risk aggregation can be applied to more than just an organization’s financial risks. In fact, many organizations outside the financial-services industry have started to use a broader definition of risk aggregation. That definition describes the term as the accumulation of the total risk exposures of various types of risks throughout the organization along with the ability to compare its various risk exposures to the organization’s risk-appetite statement.
Objective Correlatives
While it’s important to understand the effect on the organization of individual risks, it’s rarely the case that two individual risks are either perfectly correlated, and hence can be simply added together, or perfectly independent, allowing the use of a simple approximate formula to combine them.
Because of that, it becomes necessary to design a robust general process enabling the aggregation of risks while allowing for the fact that the outcome for any one risk might depend on other types of risks in the organization.
Ideally, organizations should develop and maintain strong risk-data aggregation capabilities that take into account correlations within their risk portfolios to ensure risk reports reflect risks in a reliable way.
Not by Data Alone
Accurate, complete and timely risk information is, after all, a foundation for effective risk management. But risk information alone does not guarantee that the board and senior management team will get the timely and accurate information they need to make effective decisions.
The right risk information needs to be presented to the right people at the right time. Risk reports should contain correct content and be presented to the appropriate decision makers in a timely manner that allows for an appropriate response.
While organizations may have the ability to easily aggregate financial risks, there are other risks, such as hazard, operational and supply-chain exposures, that represent larger opportunities that can sometime be overlooked.
Effective programs need both quantitative and qualitative data and should recognize the need of both tangible and intangible risks. For organizations with multiple locations, divisions, and /or multinational operations, risk aggregation can present more complicated problems.
Some organizations have effectively tackled it by taking an evolutionary approach that builds upon their existing, internal risk-reporting processes. This has often proven to be a more practical and cost-effective approach that trying to aggregate risks all at once.
For organizations that use workshops, surveys or audits in their risk management practices, extracting both quantitative and qualitative information can lead to a much better understanding of risks and more effective aggregation.While quantitative information is easy to extract and useful in itself, a more thorough review of the data may present management with the opportunity to think more comprehensively about risk. Often, organizations that extract common themes among disparate data can more easily identify emerging risks.

English: A qualitative categorization of diffe...
English: A qualitative categorization of different risks in terms of scope and severity (Photo credit: Wikipedia)
For intangible or hard-to-quantify risks, such as those involving personnel issues, some companies effectively use a practical approach to risk aggregation. This requires a common set of questions to evaluate the scope and potential impact of each risk. For “scope” organizations evaluate as such questions as: How many business units or countries are affected? How many employees do the risk treatments affect? And, how many business processes or functions are affected?
For “potential impact” they may ask: “What could be the potential outcomes of this risk our employees, vendors, suppliers or customers? What impact could an issue have on our brands and corporate reputation? And, what are the potential impacts on sales, expenses, or profits?
These can be rated on a 4 or 5 level scale basis ( e.g. insignificant, low medium, major, or catastrophic ) to determine how critical the risk is to the business. Some organizations use the additional dimension of complexity as an additional risk evaluation tool. For example, they might ask: Is the issue becoming more widely spread?
English: Prioritizing risk and opportunities b...
English: Prioritizing risk and opportunities based on their risk/opportunity management contribution and cost-effectiveness contribution (Photo credit: Wikipedia)
The output of the evaluation of intangible or difficult-to- quantify risks can provide organizations with major insights when it aggregates risks. For example, the inability to find an adequate number of properly skilled and trained technical staff may show up as a risk in China or in Central and South America countries. The resulting inability to properly staff manufacturing facilities can adversely affect production capabilities. Thus, an issue which may be viewed as a nuisance in the domestic job market may be major when viewed on an aggregated basis. In fact, unexpected correlations may be revealed when reviewing these risks on a more holistic basis.
Such practical approaches increase the effectiveness of both risk identification and aggregation by creating a uniformity of approach. That yields better information and reliability.
When used properly, good risk aggregation can help an organization to effectively assume more risk. That’s because they have a better understanding of the breadth of the risks that they are taking on. Using risk aggregation can also lead to a better understanding of the individual risks being taken, a competitive advantage to an organization, and a more efficient and effective risk management program.
Kristina Narvaez is president and CEO of ERM Strategies LLC and Larry Warner is president of Warner Risk Group.

'via Blog this'
Enhanced by Zemanta

Friday, July 19, 2013

Are Earnings Credits a Good Deal?

Keeping cash in bank deposits can offset service fees, but the savings may not be as large as the treasury department thinks.
Bruce C. Lynn

Most creditworthy companies are holding more cash and cash equivalents (i.e. short-term investments) than at any time in the last decade.
What is not so clear is what companies plan to do with all of this liquidity. Some investors have decided that it belongs to them and have sued companies (see Apple) to force them to return some of it. Other companies are content to just invest their “excess” cash in financial assets until that time when investing it in current or future businesses makes economic sense.
But there are fewer safe choices for short-term cash investing, and even the perceived safest choice — depositing the money in a commercial bank — comes with risks and, perhaps more important, costs.
Companies investing excess cash in financial assets, according to the latest Association for Financial Professionals’ liquidity survey, are investing in fewer asset classes. In 2012, most companies used less than three “investment vehicles” (Treasuries, bank accounts, money market funds, for example), the survey found. In 2009 the number of permitted investment vehicles was closer to eight. ...
Evidence of this search for safety over yield is the increase in the use of bank certificates of deposit (CDs) as an “investment” vehicle. According to the AFP survey, 50 percent of companies have cash in bank CDs, ...
Besides, companies still need bank services, and using balances to pay for them has proven effective for companies and banks. ...
As a result of federal monetary policy and the market volatility for short-term loans from the Federal Reserve Banks, financial institutions have taken to using their earnings credit rate (ECR) as a “chip” to get companies to keep deposits in banks. (Earnings credits are applied to a company's average daily balance and are used to pay for banking fees.) Example: I have a client with about $400 million in a top-tier bank. The bank is offering this client an ECR of 50 basis points. This same client is using another well-known bank, but that bank is offering an ECR about a third of that rate for a smaller deposit balance.
English: Category:JPMorgan Chase
English: Category:JPMorgan Chase (Photo credit: Wikipedia)
... In the old days an ECR was actually market-based. Banks used the T-bill as an index. Today ECRs are “administratively” (i.e., relationship) based. Several years ago JP Morgan actually admitted to this approach.
Even at 50 basis points a bank can still make a decent spread by lending the deposits to others, but be careful what you wish for. Some banks will give a large ECR to corporate customers but charge them above-market prices for cash management services, effectively neutralizing some of the largesse. This sleight of hand is relatively easy to do. Example: everyone “knows” what LIBOR is, but who knows the market price for an ECR or a lockbox? Maintaining a bank account? A funds transfer? The large banks offer more 1,500 different cash-management services, so for the customer bidding out cash-management services is a cumbersome method of price discovery.
Logo of the United States Federal Deposit Insu...
Logo of the United States Federal Deposit Insurance Corporation, which incorporates the seal. (Photo credit: Wikipedia)
Finally, both of the banks my client uses continue to charge it 13 basis points for FDIC deposit insurance, insurance they can no longer use with the re-instatement of the 250,000 coverage limit. This cost lowers the “net” ECR. Actually identifying this rate is not easy, given the opaque nature of the cost analyses sent to the customer.

Confusion over total or net costs may lead a company to hold cash or buy bank CDs, thinking the approach will bring both safety and return; however, there is a flaw in this choice.
  • Whether a company needs to keep funds in a bank for operating reasons or whether it buys a CD, it is taking on the credit risk of the financial institution.
  • Deposits at a bank generate an FDIC charge for insurance that cannot be fully used, inflating total service costs and reducing the net ECR to the company.
  • Buying a CD will eliminate the FDIC expense which, in the case of my client, is a large monthly number. But it will not eliminate the credit risk.
  • Buying Treasury bills directly or investing in government money market funds will eliminate credit risk and could yield a larger, safer return.
No good deed goes unpunished. Companies that buy CDs with fixed maturities will have to spend more time on their cash forecasts, so that the cost of being short (overdraft charges, early termination fees) does not become significant. Even money-market funds may not give companies the freedom to redeem at any time, given some of the latest regulations which will soon be imposed on the investment community by the Securities and Exchange Commission.
Speaking of regulations, the death of Regulation Q has allowed banks to pay interest on checking accounts; yet, few banks have really trumpeted this new ability. There may be many reasons for this omission but one that suggests itself is that it is not in a bank’s best interest to get into a highly visible “interest rate arms race” with the competition when its ECR “stealth campaign” is working just fine.
Bruce C. Lynn, CTP, is a managing partner at Financial Executives Consulting Group. He has more than 20 years of 20 years of corporate and banking experience in all aspects of treasury and financial management, including treasury operations, cash management, strategic planning, credit, and treasury systems. He is a Certified Treasury Professional and has an MBA from New York University’s Stern School of Business.
'via Blog this'
Enhanced by Zemanta

Thursday, July 18, 2013

Elon Musk Thinks He Can Get You From NY to LA in 45 Minutes

Autopia |
Elon Musk
Elon Musk (Photo credit: jdlasica)
Elon Musk wants to revolutionize transportation. ... The serial entrepreneur envisions a future where mag-lev trains in enormous pneumatic tubes whisk us from Los Angeles to New York in 45 minutes. Need to be in Beijing tomorrow? No problem. It’s a two-hour ride away.
As crazy as it sounds, Musk is merely updating an idea that’s been around since the early 1900s, and
Image representing Tesla Motors as depicted in...
Image via CrunchBase
 at least one company is working on a functional prototype. But according to Wired sources, his involvement won’t be nearly as hands-on as Musk’s other endeavors at Tesla Motors and SpaceX.
The engineering behind the Hyperloop is similar to the old-school pneumatic tube systems used by banks to suck your deposit to the teller at the drive-through. But naturally, it’s more complicated than that.
A massive vacuum tube — mounted either above ground or even under water — would be combined with a magnetic levitation system used on conventional bullet trains. That means no friction, no wind resistance, no chance of collisions, and insanely high speeds.
Musk described the Hyperloop as “a cross between a Concorde, a railgun and an air hockey table,” at the AllThingsD D11 conference earlier this year. And in an interview with PandoDaily, Musk said the Hyperloop could form a fifth tent pole of modern transportation, joining cars, planes, trains, and boats, adding that because of its low energy usage and ability to get juice from solar power, it could generate more power than it would consume. But up until now, he hasn’t elaborated on his involvement.
Musk’s interest in the idea was sparked after researching California’s new high-speed rail project and realizing that it will be the slowest and — at $70 billion — the most expensive system on the planet. To his mind, there’s a better solution. The Hyperloop is it. And one firm unaffiliated with Musk is in the early stages of development.
ET3, a company based in Longmont, CO, is working on a Evacuated Tube Transport (ETT) system, which it describes as “space travel on Earth.” It uses two tubes — one for each direction — with 400-pound, passenger car-sized capsules that could house six people, each accelerated by linear electric motors. According to ET3, state trips would average speeds of around 370 mph, while international trips would hit that insane 4,000 mph mark. The company, which calls itself an “open consortium,” claims that it’s working with partners in China and has sold nearly 100 licenses for the technology. But ET3′s claims pose more questions than answers, particularly when considering you can buy your own license for the bargain basement price of $100.
But the idea for a vacuum-sealed high-speed transit system isn’t anything new. The “vactrain” conceptwas floated in the early 1910s and a paper written by physicist R.M. Salter and published by the Rand Corporation in 1972 titled the “Very High Speed Transit System,” or VHST, describes something very similar to what ET3 is developing.
But where Musk fits in remains a question. Sources close to the Tesla co-founder and CEO say he believes ET3 is on the right track, but is missing some key components, and that Musk has his hands full with Tesla and SpaceX, and would rather have some involvement in the development, with another entity taking the helm.
That lines up with a few responses Musk made on Twitter when asked about patenting the technology. “I really hate patents unless critical to company survival,” Musk Tweeted. “Will publish Hyperloop as open source.” When asked about partners, Musk said he’s “happy to work with the right partners. Must truly share philosophical goal of breakthrough tech done fast & w/o wasting money on BS.”
We’ll have to wait until August 12th to find out more.
'via Blog this'
Enhanced by Zemanta