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Data Centre Strategy

lepus — Tue, 31 Jan 2012 10:19:07 +0000

Introduction

Data centres have grown tremendously in the past decade, both in storage capacity and number. As banks deal with increasing volumes of data, challenges are arising, particularly around location considerations, cost reduction requirements and, not least, increased pressure to be environmentally-conscious. Moreover, the new regulatory framework requires banks to retain unprecedented levels of data for reporting to supervisory bodies, which significantly raises data storage requirements.

Key Findings

Data centre strategies – All of the surveyed institutions have a defined data centre strategy, which is typically the responsibility of the IT Infrastructure or Architecture departments. The strategy is reviewed at least once a year at a vast majority of the institutions. There are formal Data Infrastructure teams that tend to be located centrally, with only a negligible minority of institutions aligning them to business divisions. The data centre strategy is typically executed by a designated Data Infrastructure team at almost all institutions.
Trends in IT investment – Of the institutions surveyed, 52% have seen a significant rise in IT expenditure on data centre upgrades over the last three years, whilst another 24% have seen a slight increase. It is only at the banks with less prominent investment banking operations where investment has either remained flat or has decreased. Institutions that have spent significant sums over the last three years will see falling investment over the next three years as the projects embarked upon have now been completed.
Number of data centres – The preference for many banks is to retain at least one data centre in a central location. The number data centres based in financial centres varies by bank, although tier-1 investment banks tend to have a larger number of data centres in the central location than smaller banks.
Disaster recovery systems – Of the surveyed institutions, 21% have disaster recovery systems right alongside the primary systems. Most institutions, however, have disaster recovery systems within the same data centres but not alongside the primary systems. A further 32% of institutions have even set up separate data centres dedicated solely to disaster recovery.

Conclusion

The business models followed by financial institutions vary considerably, which also influences the data centre strategy pursued. Nevertheless, all institutions share the objective of cost reduction and increasing efficiency. Many firms have recently made significant investment in their data centres, whilst those that have not done so yet, expect a rise in budget for investment over the next three years. With concerted efforts to reduce latency and surging data storage requirements for regulatory reporting, data centres and the approach banks adopt towards them will be a key determinant of future performance.

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Over-regulation in the Financial Services Industry

lepus — Tue, 31 Jan 2012 10:14:50 +0000

Introduction

Although there is an understanding amongstindustry practitioners that regulators needed to act quickly and firmly, there is a perception that regulators have attempted too much in too little time.Essentially, it is believed by some that under pressure to act, regulators have made a series of proposals without fully understanding the implications these will have on theindustry and on the wider economy. There is absolutely no doubt that reform is needed, but regulators must ensure that they are finding the correct balance between protecting the taxpayer and allowing an efficient market to prosper.

Key Findings

Response from banks – A majority of the banks have responded to the great increase in regulation by establishing specialised regulatory teams or having reorganised the existing teams.
Information required by regulators – All of the responding banks commented that the amount of information that regulators are requesting has at least doubled over the last 36 months.
Investment in technology – All of the responding banks commented that they have already invested, or expect to invest, in additional technology to meet demands that have specifically come from the increase in regulation rather than from the business.
Changes expected in the industry – Three respondents were comfortable in predicting that the industry will become more risk averse, with the number of risk professionals increasing, products becoming less complicated and the markets becoming less volatile.

Conclusion

Essentially, the majority of respondents do not think theindustry is being overly regulated, with each confirming that extra regulation is beneficial to the stability of theindustry and the global economy. Each respondent admitted, however, that the extensive nature of regulation is a considerable burden to banks. Another issue raised across the interviewed sample is the fact that neither regulators nor banks themselves know how the sum total of a number of reforms will ultimately affect specific areas of theindustry, as many proposals are still to be finalised. It is expected that these effects will be more readily understood in time, and compliance projects will dynamically realign as the reforms become more defined and well understood and the consequences become clear. One thing that is certain is that the role of regulatory teams at all financial institutions will continue to be a demanding one for the foreseeable future.

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Forward-looking Analysis of Credit Risk

lepus — Tue, 31 Jan 2012 10:08:26 +0000

Introduction

In the aftermath of the events of the past three years it has emerged that the Early Warning Indicators (EWIs) which were employed by the banking industry were either insufficiently robust or were ignored by banks. One of the key elements of the post-crisis reform of the banking industry, both from within and externally, has been the implementation of more extensive and stringent systems to analyse and mitigate the various forms of risk.

Key Findings

Strengthening of EWIs – Banks have been assiduous in bolstering both their systems of forward looking analysis and the rigorous use of EWIs. Incorporating ever-increasing numbers of metrics, they are continually trying to refine the models used to forecast credit risk events.
Ratings relevance – The ratings and analysis produced Credit Ratings Agencies (CRAs) such as S&P are certainly taken into account when modelling for credit risk. It is the internal bank ratings systems, however, which take precedence and become the deciding factor in the event of a data conflict.
Fluctuating time horizons – The use of differing time horizons by different banks to forecast risk projections is a function of the business lines operated byindividual banks. Banks whose primary focus is retail banking tend to use longer time horizons for their forecasts, whilst those with a joint commercial focus tend to use shorter time horizons due to the heterogeneity of their loan portfolio.

Conclusion

This report focuses on EWIs for credit risk in particular, which affects all portfolios held by a bank and is arguably the most difficult risk type to manage effectively. It is clear from the events of the past 36 months that there is a very real need for banks to develop not only robust stress testing frameworks but if a bank wishes to survive the forecast economic turmoil, stringent procedures and processes must be implemented to incorporate dynamic and powerful metrics into their EWIs.

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Credit Risk Stress Testing

lepus — Tue, 31 Jan 2012 09:54:31 +0000

Introduction

Stress testing has become the primary indicator of a bank’s ability to withstand tail events and maintain sufficient levels of capital at all times. Although banks generally do acknowledge the importance of stress testing, the stress testing frameworks, in many cases, are still immature. One reason for this is the difficulty gauging the impact of macroeconomic shocks on risk factors in sufficient detail. This is especially true within credit risk, given that credit events normally gestate over a long period of time and their effects can be felt for similarly extended periods.

Key Findings

Stress testing framework – Most banks use hypothetical macroeconomic scenarios defined by the Economics department for credit risk stress testing. The impact of macroeconomic variables on risk factors such as exposure at default, loss given default and probability of default is analysed using regression analysis. Some banks also use scenarios defined by the European Banking Authority (EBA). Stress tests are normally conducted every quarter.
Reporting – The results of stress tests are reported to the risk management and senior management committees and regulatory bodies, at least. One bank has also set up a Board sub-committee to specifically focus on stress testing. Most banks also present a summary of these results to the Board of Directors, typically every quarter.
Stress scenarios used – The stress scenarios typically consider a period of between one and three years, by which time the full impact of credit risk events is assumed to have materialised. They consider a sustained fall in global GDP of around 2 to 3 percent every year.
Credit risk in the trading book – All institutions use hypothetical macroeconomic scenarios, historical shocks or sensitivity analysis to stress test counterparty credit risk. These tests are typically conducted daily. Most institutions do not have formal procedures for stress testing wrong way risk, and are, in fact, still working on measuring wrong way risk accurately.

Conclusion

Since 2008, the use of stress tests to inform the risk appetite has been gaining traction. These encouraging trends also extend to credit risk stress testing in particular. All of the interviewed institutions have established a robust stress testing framework, based on forward-looking hypothetical scenarios that are used to test all risk types. Nevertheless, several challenges still need to be resolved. Whilst the stress scenarios are reviewed regularly by all institutions, it has been difficult to incorporate the anticipated extreme market conditions into the stress scenarios. Stress testing of counterparty credit risk and wrong way risk also remain important areas for improvement.

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Country Risk Organisation for Distressed Eurozone Countries

lepus — Tue, 31 Jan 2012 09:50:43 +0000

Introduction

Elevated country risk has historically been associated with developing economies. The 2008 financial crisis has, nevertheless, exposed the vulnerability of many eurozone economies and, hence, a great deal of attention has been paid to the sovereign debt crisis in Europe. Greece, Italy, Ireland, Portugaland Spain (GIIPS) have found themselves increasingly mired in the distressing consequences of the negative global economic climate. With increasing uncertainty about the future of the periphery of the European Union, financial institutions are now looking to redesign their country risk framework by devoting increasing resources to the country risk analysis of distressed industrialised countries.

Key Findings

Organisation of country risk operations – The allocation of responsibilities in the Country Risk department is organised along geographic lines. Four out of six interviewed banks divide the responsibility for various countries amongst analysts by categorising countries into geographical groupings and assigning analysts to each group. Only Bank 2 separates countries into developed and emerging markets.
Review of country risk framework – Although interviewed banks are clearly directing more human resources to assess the country risk associated with distressed eurozone economies, it is unlikely that they will redesign their organisational framework in order to assign a separate group of analysts to focus solely on GIIPS.
Limit settings – Banks have started to set lending restrictions, not only on emerging economies, but also on distressed eurozone countries. Yet, it is very unlikely that GIIPS will be downgraded to emerging market status, and banks still institute more limit settings for emerging markets than for eurozone countries.
Regulatory reporting – The majority of banks have not invested in additional IT infrastructure to contend with the additional reporting requirements for the distressed eurozone countries.

Conclusion

The European sovereign debt crisis has brought about important changes to the country risk framework. Banks are devoting additional human resources to more closely monitor the rapidly unfolding events in both emerging and industrialised countries. Yet, it is very unlikely that distressed eurozone countries will be downgraded to emerging market status. Rather, banks are trying to reduce their exposure to the crisis inEuropeby setting additional lending restrictions to troubled eurozone economies.

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Interest Rate Swap Pricing IT

lepus — Tue, 31 Jan 2012 09:41:12 +0000

Introduction

OTC derivatives, in the form of interest rate swaps, have been affected significantly by the recent wave of financial regulation. Banks will soon be required to execute these instruments on Swap Execution Facilities (SEFs) or Multilateral Trading Facilities (MTFs), and clear them centrally. These SEFs / MTFs will be electronic trading venues that will centralise liquidity and, therefore, increase competition among dealers. In the extremely fast-paced world of trading, this move to electronic trading venues means that the IT infrastructure will become a major determinant of the degree of competitiveness of a bank.

Key Findings

Latency – The refresh frequency for benchmarks at most of interviewed institutions is under one second, and averages around 300 ms. The latency for stripping a par yield curve into a zero coupon curve is typically less than a second as well, but some participants were unable to provide exact figures as the basis is being stripped constantly. The Request for Quote (RFQ) of a custom swap can generally be computed in less than 500 ms.
Benchmark rate calculation and contribution – Using forward curves to calculate IR benchmark rates is the prevalent method, but the approach typically varies by currency. There is more diversity in the approaches towards price contribution, with a curve output, brokers’ feed aggregation and the computation of some tenors as a combination of different strategies emerging as key methods.
Modelling methodologies – Four of the five interviewed banks reconstruct the curves without using approximations. There is a wide variety of methods used to construct the curves, ranging from smooth curves to quadratic curves. At most banks, traders are free to choose from a range of methods. Convexity adjustments are normally made manually by the traders without the aid of models.
Curve servers – The interviewed banks normally generate different curves for pre-trade and post-trade processes. Unique curves are normally produced for each Credit Support Annex (CSA) agreement as well. Curve stripping and pricing are typically performed by the same server.

Conclusion

The Dodd-Frank Act and European Market Infrastructure Regulation (EMIR) will introduce sweeping changes to derivatives trading to improve transparency and reduce systemic risk in the financial sector. With increased competition among dealers on these electronic trading venues, the IT infrastructure in place and the latency experienced by traders will become key determinants of banks’ profitability. This research has shown that major banks have reduced pricing latency to milliseconds, and are bracing themselves for further change in this space.

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Research Aggregators

lepus — Tue, 31 Jan 2012 09:36:49 +0000

Introduction

The recovery from the global recession has become especially precarious in the aftermath of the Eurozone sovereign debt crisis and fiscal tightening in the Western world. Given these uncertain times, expert analysis and novel ideas are being diligently sought by investors. Opportunities in the financial sector, however, often also bring challenges. The format in which this research should be distributed is one such challenge, as a variety of formats have now emerged, including research aggregators, which consolidate research from various sources into one point of access.

Key Findings

Distribution channels currently being used – An average of 60% of the surveyed institutions provide research via email for several different types of research. The uptake of email push for research distribution is extremely low, however, averaging only 10% across all research types. Research Aggregators are only used by 25% of the sample in this research. A majority of the respondents stated that their clients prefer to receive all types of research by email. Research aggregators, on the other hand, are the preferred channel according to an average of less than 20% of the respondents. The proportion preferring email push rise above 10% only for equity and emerging market research.
Use of research aggregators – Only slightly over half of the institutions use research aggregators. The minority that uses research aggregators, however, are primarily major universal banks with prominent investment banking arms. Bloomberg is by far the most widely used research aggregator, being the aggregator of choice for 80% of the surveyed institutions. Thomson Reuters is used by 50% of the institutions. Research aggregators that direct the clients to the institution’s own website, such as Market Hub, are less favoured.
Purpose of providing research – Research at 39% of the participating institutions is intended to be a service to existing clients only. Nevertheless, a notable majority of institutions also use research to expand the client base, but this is not the sole purpose. Nearly all of the banks where research is only seen as an additional service to existing clients do eventually expect more business from them. When intended as a marketing tool as well as a service to existing clients, the latter is a marginally more important consideration than the former.

Conclusion

The rising dependence on flow trading for revenue growth means that investment banks must produce research of the highest quality to strengthen their relationship with prospective clients. In addition, they must also keep abreast of new technologies that can be used when delivering research to clients. This report shows that whilst a number of banks do provide their research through multiple channels, clients still overwhelmingly prefer standard email and banks’ own web portals.

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Corporate Service Delivery to Mobile Devices

lepus — Tue, 31 Jan 2012 09:30:01 +0000

Introduction

Efficient mobile communications are increasingly driving the success of modern business as the workforce becomes more mobile and we store ever more corporate data in the cloud. Whilst this brings huge business benefits in terms of improving efficiency and productivity, the safe use of mobile devices to access corporate cyberspace requires a deeper understanding of the security risks involved. Supported by the proliferation of high-end consumer technology such as smartphones, tablets and netbooks, the adoption of personal, mobile technology in the corporate environment is increasingly common.

Key Findings

Corporate policies – Banks are finding that Blackberries have better security than the iPhone for corporate usage and, therefore, most have them as their preferred device. Staff are issued the phones based on their role and/or seniority, and there are various tariff packages and spend guidelines in place.
Uses – Other than for phone calls, emails and Internet browsing, mobile devices are not being used in the corporate environment as much as they are for personal use, for security reasons. There are, however, various applications that are being introduced.
Risk and security – Technology has advanced beyond the security required to use it effectively in the corporate environment, although the latter is catching up. Banks are keen to build security so that personal and corporate usage can be combined, reducing costs.
The future – The use of two mobile devices will become normal, with professionals using three or more devices. Capabilities to make applications, services and information available coherently across devices, including middleware, synchronisation and self-provisioning solutions are important here. Cloud computing, being considered by some, will allow more applications to be connected.

Conclusion

It is hardly surprising that this new generation of powerful, personal mobile devices has entered the enterprise space. Employees look to them as business aids and, in some cases, as replacements for traditional computing tools such as laptops and desktop PCs. Indeed, some business leaders argue that personal devices used for corporate activity can actually lower costs for the organisation, particularly if the employees are purchasing the devices, software and accessories themselves. Compliance regulations, however, are restricting the pace of the growth of applications being used, and it is less of a business requirement than a ‘nice to have’ device to increase flexibility in the workplace.

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Very Large Databases in Investment Banking

lepus — Tue, 31 Jan 2012 09:24:19 +0000

Introduction

The 2008 banking crisis exposed the inadequacy of many financial institutions’ IT infrastructure in supporting risk management processes. Data was commonly stored in numerous disparate repositories which did not interface with each other, that inevitably led to the expensive replication of data. Fortunately, banks are now trying to ameliorate the situation by investing in very large databases (VLDBs) that can feed downstream systems with more consistent and accurate data.

Key Findings

Enterprise-wide data systems – Four interviewed banks currently have an enterprise-wide database which shares information across the bank. Yet, at three of the banks, installing an enterprise-wide database did not eliminate the need for siloed data systems at business unit-level. Rather, business units build their own data system in order to attend to their specific business unit needs.
Functions supported by VLDB – With one exception, all of the interviewed banks are using VLDBs to support risk management activities. This is understandable given the sheer volume of data risk managers need to analyse quickly and accurately.
Data storage strategy – Banks are actively searching for an alternative technology to improve storage capacity. Data compression is used ubiquitously by the banks. Banks are still reluctant to embrace cloud computing due, mainly, to security concerns surrounding this new technology.
Database technology providers – The data technology market is in a state of flux with several new entrants offering innovative products. Oracle, IBM and Microsoft, however, continue to be the market leaders and, indeed, are used by the interviewed banks in their data platforms.

Conclusion

Modern banking is a technology-intensive business which involves the processing and storage of a vast volume of data. Transforming this data into valuable information for managers is a key challenge when the data resides in various disparate systems. This research indicates that banks are now overhauling their data management systems. By centralising key information, banks aim to improve consistency of regulatory reporting, reduce data-access latency, solve issues relating to data proliferation and increase the functionality of their data storage systems.

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Integration of Risk and Finance

lepus — Tue, 31 Jan 2012 09:20:23 +0000

Introduction

Pervasive failures of risk management within the banking industry and the resulting devastation strongly imply that some functions, such as Finance, cast a disproportionate influence over the banks’ business strategies. Nowadays, however, the clout of the Risk function relative to other departments over business-critical endeavours is quickly increasing. As many of the responsibilities of Finance and Risk overlap, several institutions have prioritised the demolition of silos to foster a collaborative environment.

Key Findings

Reporting line for the CRO – 58% of the 96 respondents in the online survey stated that the CRO reports directly to the CEO. The CROs at a further 29% of banks report both to the CEO and the Board of Directors. At only one tier-2 European bank does the CRO report to the CFO.
The necessity of integration – 46% of the respondents believe that integration should be pursued only selectively in areas where the responsibilities overlap most strongly. 28% of respondents advocated complete integration, while 26% stated that integration is either unnecessary or infeasible.
Areas of collaboration – Risk-adjusted performance monitoring and capital management are the two areas where Risk and Finance cooperate the most. At a number of banks, new products are also approved after sufficient consideration of the opinions of Risk. Compliance and limit setting, on the other hand, involve the least amount of joint input.
Integration of systems – 23% of the respondents have completely separate systems for each department, with no overlap in any particular area. Another 49% of respondents also have separate systems but there is sharing in some areas. Only 25% of the surveyed institutions, primarily composed of small banks, have a single integrated system for both departments.
Future plans – 59% of the respondents have recently pursued, or are planning to pursue integration projects, while 41% of the sample has no such plans. At half of the banks that are currently pursuing integration, the projects have been jointly funded by Risk and Finance.

Conclusion

To reap the benefits of holistic, risk-adjusted measures of performance, as the current regulatory environment demands, banks must integrate Risk and Finance to the greatest possible extent. The importance of these benefits is acknowledged by nearly all of the surveyed institutions. In several areas, cooperation is currently limited, but may rise appreciably when the Risk and Finance systems are integrated. This objective is strongly desired by a large number of banks, who have initiated several projects to this end.

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