Eddielogic

– Thoughts on Strategy and Management

Impact of risk management on strategy and the problems in practice

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For the journal of my doctoral thesis supervisor I have prepared an article concerning the practice of strategic planning in German retail banks. Within this article I also focused on the impact of risk management in strategy. Hence I would like t present a small digest.

To discuss further aspects of strategic planning (see this post) within banks, this post will briefly discuss the impact of risk management issues. To fulfil new regulatory requirements banks made large investments in processes, skills and IT in the last couple of years. Due to a lack of resources, in particular smaller banks struggled with those investments.
An important part is the Internal Capital Adequacy Assessment Process (ICAAP; which is founded in the Basel II-framework for financial institutions) by the Committee of European Banking Supervisors, which compares risk profile, strategy and capital.

(Compare Committee of European Banking Supervisors (2004), page 3 ff: In detail CEBS describes the process: “The ICAAP should take into account the institution’s strategic plans and how these relate to macro-economic factors. The institution should develop an internal strategy for maintaining capital levels which can incorporate factors, such as loan growth expectations, future sources and uses of funds and dividend policy. The institution should have an explicit, approved capital plan that states the institution’s objectives and time horizon for achieving them…and the responsibilities for that process.”)

In terms of integration the ICAAP did not cause major problems. In most cases banks have linked their strategic planning with risk assessment systems, which allowed them to integrate risk assessment – more or less directly – within their strategic decisions.

Problems instead did occur in terms of managerial behaviour. Familiarisation of managers with such a structured process – that focuses on risks right at the beginning of a decision – and sticking to this process represented problems sometimes. In the past managers were used to focus more on tactics and intuition in order to launch a new project or business. Due to ICAAP requirements some managers had to gain new methodical skills. Other managers complained that due to those modified planning processes an overvaluation of risks would happen. The shift from focussing on intuition to focussing on figures represented another problem due to a lack of forecasting skills and capabilities.

In summary it can be argued that the new regulatory requirements from risk management did change particular steps within the planning process. Principles of a very early risk analysis have been implemented into banks’ strategy finding in the last years. Major modifications have been made by banks within forecasting techniques and consequence analysis.
However it has to be considered, that due to ICAAP requirements a strong focus which is given to hard data. That implicates the risk not to focus enough on soft data, which are also essential to develop a sound strategy.

 

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