ERM Flashcards — Part 6
ERM Implementation
Aug 9, 2017 · 2 min read
Final versions: [Pt.1] [Pt.2] [Pt.3] [Pt.4] [Pt.5] [Pt.6]
- Three part definition of capital: 1. capital should provide sufficient surplus to cover adverse outcomes; 2. with a given level of risk tolerance; 3. over a specified time horizon.
- Three part process of capital management: 1. quantification; 2. allocation; 3. optimization.
- Generic capital model: Used by capital providers and regulators to gain a consistent assessment of capital requirements across different firms.
- Internal capital model: Used to simulate company specific view of the capital needed and can help improve management’s understanding of business dynamics (thus improve decision making).
- Six stages in operating a successful capital model: 1. identify purpose; 2. identify and rank risks; 3. choose simulation approach for each risk; 4. define risk metrics; 5. select modeling criteria; 6. decide on method of implementation.
- Bottom-up approaches for calculating capital requirements: 1. generate stand-alone distributions of changes in the enterprise’s value due to each risk source; 2. combine distributions (allow for diversification); 3. calculate total capital at desired standard for selected risk metric(s); 4. allocate capital to each activity based on amount of risk generated.
- Methods used to calculate capital: 1. probability of ruin; 2. economic cost of ruin; 3. full economic scenarios; 4. stress test method; 5. factor tables; 6. stochastic models; 7. statistical models; 8. credit risk methods; 9. operational risk methods; 10. option pricing theory.
- Economic income created: Quantifies degree to which RAROC exceeds some hurdle rate.
- Capital allocation methods: 1. use of risk measure (apply Euler principle); 2. marginal approach; 3. game theory approach; 4. pro-rata; 5. stand-alone (remaining capital retained in main corporate business line).
- Four major processes to establish in ERM implementation: 1. corporate governance; 2. risk assessment and quantification; 3. risk management; 4. reporting and monitoring.
- Key considerations in scoping an ERM implementation: 1. resourcing (internal v. external); 2. proportionality (to risks and size and sophistication of business); 3. top down or bottom up.
- Key challenges in ERM implementation: 1. lack of risk awareness; 2. inappropriate risk culture.
- Benefits of ERM maturity: 1. loss reduction; 2. uncertainty management; 3. performance optimization.
- Areas to consider when assessing ERM maturity: 1. corporate governance; 2. risk language and culture; 3. competencies and performance management; 4. risk management processes and responsibilities.
- Elements of organizational learning processes: 1. be open to discuss own past mistakes; 2. be able to learn from those mistakes; 3. be aware of mistakes of others; 4. adopt industry best practices.
- Lam’s seven lessons learned: 1. know your business; 2. establish checks and balances; 3. set limits and boundaries; 4. keep your eye on the cash; 5. use the right yardstick; 6. pay for the performance you want; 7. balance the yin and the yang.
