Putting the risk into risk-adjusted profitability

RMA Journal, The,  Feb, 2003  by Peter Nakada,  Brannan Johnston

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* "Sanity check" the results.

* Quickly give senior management something useful.

* Get a better idea of how to prioritize refinements.

*--Keep the end-game in mind

Stay focused on answering the following questions, or your output will end up gathering dust on a shelf somewhere:

* What decisions do you want to make differently?

* What exactly do the reports look like that will allow you to make these decisions?

* What methodologies, systems, and data do you need to produce the reports?

*--Don't reinvent the wheel

Innovation is fun, but costly. Nearly all of the analytics that you need to implement a world-class profitability capability exist--thanks to the bruised-knuckle experiences of the "early adopters." Don't let existing institutional or individual skills drive the project, and don't blow the budget on new ones. Your effort should be to make your firm a "smart follower"--focused on calibrating an existing approach to your organization.

*--Prioritize improvements according to sensitivity

Don't let your profitability project turn into a data project. It would be a miracle if your bank has all of the data necessary to get the "right" result, so take shortcuts where necessary. Once you have your first cut in place, check how sensitive your answers are to changes in the inputs. You can then focus refinements on those areas that have a material impact on the results.

*--Be smart about moving to the relationship level

Profitability measurement at the relationship level is a powerful tool. But pushing P&L and risk-based capital allocations to the transaction level is often a Herculean task. Cut back on scope, not on the quality of risk measurement and capital allocation:

* Selectivity: It's better to know a few key customers very well than to know all of your customers vaguely.

* Timing: You don't necessarily need to monitor your customers all of the time--maybe only when you have to make a new decision.

*--Don't skimp on education

Spend money on explaining the system, not endlessly refining it. Tell line managers:

* What the numbers mean and how they should be used.

* How the numbers are calculated.

* What effect they'll have on the business.

* How they can be influenced.

All authors in this series work for E Risk, a full-service provider of strategic risk management solutions, including economic capital analytics, consulting, and the E Risk Report.

COPYRIGHT 2003 The Risk Management Association
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