Even the largest organizations cannot do everything in-house and must use external resources to save time, foster creativity, improve quality, and be more flexible. This article presents the knowledge process outsourcing framework institutions employ to implement integrated risk management in this dynamic business, market, and regulatory environment.
Outsourcing – and offshoring in particular – opens up new ways to address organizational challenges with implementing integrated risk management. Significant cost savings, access to a global talent pool, flexibility to scale up and down based on demand dynamics, and reduced time-to-market empowers organizations to meet the challenges of changing regulations, markets, and business needs. Figure 1 lists some of the reasons that leading financial services executives are currently considering outsourcing.1
There are many outsourcing models that are beneficial to financial institutions including Business Process Outsourcing (BPO), Information Technology Outsourcing (ITO), and Knowledge Process Outsourcing (KPO). This article delves into KPO, the outsourcing of organizational processes, such as research and analytics that require a high degree of relevant domain knowledge at the outsource provider. When compared to BPO, which is operations focused, and ITO, which is technology focused, KPO provides a holistic approach to streamlining high-end outsourcing initiatives that require relevant domain knowledge, in addition to operational and technological efficiencies. Typically combined with offshoring, the KPO model provides organizational access to a global talent pool and helps institutionalize the knowledge process of risk management.
The global financial crisis demonstrated the gaps in risk management for both corporations and financial institutions. Senior management is increasingly recognizing the need for integrated risk management and a proactive approach to regulations. Integrated risk management is a continuum – integration could happen at various levels. At a minimum, this entails the calculation of economic capital for different types of risk and different units, and then aggregating the risks using an appropriate methodology. A more robust integration would involve aligning the risk management objectives with the overall business objectives and enforcing risk-adjusted performance goals at a policy level. Implementation of an integrated risk management framework poses several practical challenges for even the largest organization. The following section addresses how KPOs could be leveraged to overcome some of the important challenges in moving to an integrated risk management framework.
The exact nature of the implementation challenges varies from one organization to another. This section focuses on a few important challenges faced by most organizations and demonstrates how a KPO acts as a catalyst in overcoming these issues.
The biggest challenge in restructuring existing risk management processes is cost. Organizations have two options: take a piecemeal approach by addressing the immediate regulatory requirements or adopt a proactive approach of integrated risk management. Considering the pipeline of regulatory changes even over the next five years, the latter approach of integrated risk management is likely to be more cost efficient over the long run. Nevertheless, it is still an expensive affair. This is where the biggest benefit of offshoring meets the biggest challenge in risk management restructuring. A study conducted by the Everest Group estimates that the cost savings from offshoring research and analytics is typically between 30% and 60%.2
Restructuring risk management to achieve an integrated approach requires organizations to revisit their risk modeling methodologies. Being prepared for regulatory changes requires banks and other institutions to implement their quantitative modeling in line with the expectations of the regulators. The shortage of in-house talent in quantitative modeling and analytics at banks and other financial institutions is forcing them to look outside. Offshore resources certainly do not provide advisory services on regulatory expectations. An offshoring platform, however, could be leveraged to provide the necessary bandwidth in the implementation of quantitative modeling and analytics. As shown in Figure 2, research conducted by Copal Amba shows that offshoring destinations such as India offer high-level scalability for sourcing quantitative analytics talent in financial services.3 From a risk management implementation standpoint, offshore resources can be used for risk-model development and model validation. Furthermore, the talent mix required for various phases of implementation and aspects of dynamic regulatory changes is drastically different. A KPO platform offers the flexibility to recalibrate the talent mix with evolving needs.
Aggregating risk data across the organization is a pre-requisite for integrated risk management. Database silos and data duplication are not uncommon when aggregating risk data. Nicolas Kunghehian (2013) points out that the devil is in the details – data cleaning and risk data aggregation can be extremely costly.4 There are synergies in centralizing this activity and creating an industrialized process for risk data cleaning and aggregation through a KPO platform. Data management is an essential yet non-core component of risk management. Hence, offshoring non-core data quality support activities frees up the bandwidth of the onshore team to pursue other, more critical business opportunities.
Leveraging offshoring support for technology using an ITO vendor is a well-accepted practice. While enterprise IT is typically outsourced to an ITO vendor, specialist KPO providers better address department-level domain-centric technology needs. Risk technology comes under the latter category. Using an ITO vendor in this case is likely to increase the burden of oversight on the onshore analysts. The risk technology teams at KPO providers are better suited for the integration of legacy systems and off-the-shelf risk solutions tools, and for the implementation of last-mile customizations.
A top-down mandate and commitment from the CEO and board of directors are necessary to successfully implement integrated risk management. With senior management support in place, a KPO facilitates the change management process in many ways. One of the byproducts of the KPO white boarding and transition exercise is the codification of current processes and data flows. Understanding the existing data flows and interdependencies is an essential step toward implementing change. The offshoring transition managers are experienced in codifying this through detailed process documentation. Second, an integrated approach to risk management places additional demands, such as the need for new statistical data, on business units. The business units will be more inclined to cooperate with the overall initiative if offshore resources are deployed to work with these units, reducing the burden on their own onshore resources. Finally, from experience, the presence of a neutral KPO provider also eases the cultural acceptance for centralization and standardization initiatives.
Offshoring engagements for risk management can be set up to meet an organization’s strategic and tactical objectives. At a strategic level, offshore support can be leveraged for firm-wide initiatives, including the implementation of a stress testing platform for the Dodd-Frank Act Stress Tests (DFAST) or the implementation of an integrated risk management framework.
Tactical initiatives are more commonly supported using offshore engagements. A few examples of tactical initiatives are listed as follows:
- Offshoring support for credit risk analytics for a credit card business
- Portfolio analytics reporting on a commercial lending portfolio
- Credit score card development for SMEs
- Loan risk monitoring and credit underwriting support
- Market risk modeling for an asset manager
- Balance sheet optimization for a corporate treasury
At the heart of offshore support for risk management is the creation of a centralized offshore platform that engages with the firm at a department level. In the true spirit of integrated risk management, ownership is spread across the risk office, finance, and various business units. The same structure is reflected in the offshore model through a department-level engagement structure. The individual team leads will cater to the business units. The overall offshore delivery team would report to a single delivery manager (DM) who will ensure that each unit is aligned with the overall risk management objectives, as directed by a key anchor onshore (typically within the risk office). The interaction between the sub-teams in this centralized offshore platform helps achieve a higher level of standardization. This standardization in turn leads to process automations and higher productivity. An example of a typical KPO engagement model for risk management support is shown in Figure 3.
At the bottom of the delivery pyramid is a composition of multi-functional risk teams, customized according to the strategic and tactical objectives of the firm. Risk business analysts have a combination of risk domain and technology expertise and play a crucial role in process reengineering and implementation of new initiatives, such as catering to a new regulatory requirement. Quantitative risk modelers typically work with various individual business units on the modeling requirements for measuring and forecasting different types of risk and related measures. The offshore resources supporting the various departments can also be pooled to gain synergies, with the exception of some functions like model validation. The offshore model validation team supports the onshore model validation team and the same level of independence should to be maintained offshore as onshore, governed by model risk management guidelines such as the Office of the Comptroller of the Currency (OCC) bulletin 2011-12.5
Other skill sets, such as risk data analysts, risk technologists, risk monitoring operations specialists, and regulatory compliance analysts are assembled as per specific requirements for offshore support in the organization. A steering committee comprising senior risk leaders, econometricians, and other panels of experts will play a crucial role during the initial stages of the engagement to ensure a smooth transition and training. Finally, a governance mechanism is instituted to review the setup periodically at a strategic level and to ensure the seamless execution of the KPO engagement.
Organizations, especially financial institutions, can gain a competitive advantage by taking a proactive approach to regulatory compliance and adopting an integrated risk management framework. The KPO model offers several advantages to implementing these risk management initiatives in a cost-effective manner. A combination of several factors, such as increased demand for risk management support personnel, cost pressures, and the availability of high quality talent pools at offshore locations is leading to the increased use of offshore support for risk management – both at tactical and strategic levels.
1 PricewaterhouseCoopers LLP, Offshoring in the Financial Services Industry: Risks and Rewards, 2005.
2 Everest Group, The Growing Maturity of Offshore Research and Analytics in Financial Services, July 2010.
3 Vijayapalan, K., Top 15 Countries for Quantitative Analytics Professionals, January 2014.
4 Kunghehian, N., Integrated Risk Management: Overcoming Bank Silos to Optimize Stress Testing, Moody's Analytics Risk Perspectives, 2013.
5 Federal Reserve, Supervisory Guidance on Model Risk Management, SR 11-7/OCC 2011-12, April 2011.
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