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ABOUT RASB

Learn more about the Risk Accounting Standards Board

ABOUT JIRISQ

Learn more about the Joint Initiative on Risk Quantification, led by RASB and
comprising ACCA, PRMIA and the Durham University Business School.

LEARN MORE ABOUT THE RISK ACCOUNTING METHOD...

…by reading Peter Hughes’ book “Risk Accounting”, available from Amazon.


RISK ACCOUNTING IS A STANDARDISED AND INTEGRATED NONFINANCIAL RISK MANAGEMENT
AND ACCOUNTING FRAMEWORK THAT IDENTIFIES, QUANTIFIES, AGGREGATES, VALUES AND
REPORTS ALL FORMS OF NONFINANCIAL RISK AND ACCOUNTS FOR THE EXPECTED LOSSES
ASSOCIATED WITH ACCEPTED NONFINANCIAL RISKS INCLUDING THE POSITIVE OFFSETTING
IMPACTS OF ENVIRONMENTAL, SOCIAL AND GOVERNANCE (ESG) ATTRIBUTES.




ASK RABOT, THE RISK ACCOUNTING BOT

For more information about Risk Accounting

Call Us



CEOS SUCH AS JP MORGAN’S JAMIE DIMON ARE EXPECTING THE OP-RISK CAPITAL
REQUIREMENTS TO HELP THEIR BUSINESS AND THE ECONOMY.

Jamie Dimon, JP Morgan’s CEO, has long voiced concerns over operational risk (op
risk) capital’s impact on the banking industry. Dimon contends that the current
method of calculating op risk capital is flawed, urging substantial
modifications or elimination. His criticisms center on the regulator’s approach,
arguing it hampers initiative-taking risk management and lacks calibration,
burdening US banks with excessive and underutilized op risk capital.

SUCH CONCERNS UNDERSCORE THE NECESSITY FOR REEVALUATING OP RISK CAPITAL. RISK
ACCOUNTING EMERGES AS A VIABLE SOLUTION, OFFERING A MORE ACCURATE, PROACTIVE
ASSESSMENT ALIGNED WITH EVOLVING RISKS AND SUPPORTING EFFECTIVE RISK MANAGEMENT
STRATEGIES.



ISSUES WITH THE CURRENT OP RISK CAPITAL APPROACH:

 * Reliance on Historical Data: The prevalent reliance on historical loss data
   limits adaptability to emerging risks like cyber crime, potentially hindering
   economic growth.
 * Neglect of Mitigation Quality: Current methods fail to incentivize
   transformative risk mitigation measures, as improvements may not reduce op
   risk capital requirements.



THE ROLE OF RISK ACCOUNTING:

 * Enhanced Operations: Risk accounting introduces standardized risk
   measurement, transparent reporting, and accurate economic profit
   calculations, fostering a proactive risk management approach.
 * Comprehensive Risk Framework: Quantifying and monitoring risk metrics in
   real-time allows banks to assess risk management effectiveness and allocate
   resources efficiently.
 * Improved Mitigation Strategies: Risk accounting facilitates the
   identification, assessment, and strategic management of various risks,
   promoting informed decision-making.



INCORPORATING RISK ACCOUNTING:

 * Forward-Looking Approach: Integrating risk accounting into op risk capital
   calculation ensures a calibrated and forward-looking perspective, considering
   the evolving risk landscape.
 * Cultural Enhancement: By aligning risk and finance, risk accounting
   incentivizes proactive risk mitigation, fostering continuous improvement in
   risk management practices.


AN OVERVIEW OF THE RISK ACCOUNTING METHOD


INTRODUCING THE ‘RISK UNIT’ OR ‘RU’

The ‘Risk Unit’ or ‘RU’ is the new additive metric, unique to the Risk
Accounting method, that is used to quantify and report exposure to operational
risk using three core metrics:

 * Inherent Risk: The amount of operational risk in RUs before considering the
   effects of internal risk mitigation activities and processes (represents
   maximum exposure to operational risk)
 * Risk Mitigation Index (RMI): A measure of the effectiveness of internal
   operational risk mitigating activities and processes on a scale of zero to
   100
 * Residual Risk: The amount of operational risk in RUs that remains after
   reducing Inherent Risk by the RMI (represents actual exposure to operational
   risk)

CALCULATION OF INHERENT RUS

Risk Accounting calculates Inherent RUs based on two factors: (1) Exposure
Uncertainty Factor (EUF), and (2) Value Band Weighting (VBW):



PORTFOLIO VIEW OF OPERATIONAL RISKS

Risk Accounting generates algorithms that convert EUF, VBW and RCSA (Enhanced)
inputs into a portfolio view of operational risk exposures in RUs encompassing:

 1. The reporting and analysis of granular and aggregated exposures by multiple
    categories including group-wide, business line, business organisational
    component, product, and customer.
 2. Direct comparisons of exposure to operational risk through benchmarking and
    ranking within and between enterprises (assuming the above tables and
    associated risk factors are uniformly applied).
 3. Identification and prioritization of risk mitigation action plans with a
    calculation of the projected risk reduction impact of each plan in RUs.
 4. The setting of operational risk budgets and risk operating limits in RUs
    across all vertical and horizontal dimensions of the enterprise with the
    potential for real- or near real-time monitoring of accumulating exposures
    to risk vs. risk budgets and limits.



1. EXPOSURE UNCERTAINTY FACTOR (EUF) TABLE

EUFs are scaled to a value between zero and 20 reflecting each product’s
operational complexity and the consequent process burden it imposes on the
enterprise. EUFs relative to the activities below, where applicable, are
assigned according to the risk criteria and associated risk factors set out in
the EUF tables and summed for each product:

 * Processing: number of operational touchpoints along the product’s end-to-end
   processing cycle.
 * Lending: the relative time and effort required to liquidate collateral in the
   event of a credit default with reference to the value retention properties
   and price stability of underlying collateral.
 * Trading: the relative time and effort required to unwind a trading position
   with reference to the availability and reliability of market prices and
   rates, and the manner in which the product is traded, e.g., electronic,
   floor, OTC etc.
 * Treasury: the relative time and effort required to fund a product and manage
   associated liquidity and interest rate risk with reference to:
   * Banking book: interest rate type (fixed or floating) and maturity.
   * Derivatives: relative degree of complexity.
   * Transactional and trading book: assume marginal Treasury involvement.
 * Selling: whether the product is…
   * an investment product involving the holding of customer monies;
   * directly linked to a sales incentive scheme; and
   * bundled with other products (e.g., a loan with an interest rate swap);
   * …and the product’s relative degree of complexity from a customer
     perspective.
 * Environment: the product’s relative toxicity, combustibility, and
   biodiversity.

2. THE VALUE TABLE

Ascending $ amounts of daily operational throughput, for each product, are
assigned a Value Band Weighting (VBW).

The value bands plotted against the VBWs produce a logarithmic curve that
depicts how the rate of change in risk decelerates as operational throughput
accelerates, primarily due to enhanced automation that naturally occurs as
production volumes and values increase. 

g

3. CALCULATION OF RISK MITIGATION INDEXES (RMIS) AND RESIDUAL RUS

Two variable inputs are periodically input into Risk Accounting to produce RMIs
and Residual RUs by multiple reporting categories including group-wide, business
line, business component (cost center), customer, product, legal entity, and
location.

 1. The amount of operational throughput, being daily new business transacted
    relative to each product, which can be captured either manually or via
    automated interfaces with accounting systems.
 2. The status of risk mitigation gathered from across the enterprise via risk &
    control self-assessments (see below) captured at pre-selected organizational
    levels, e.g., process, production team, department, division etc.



RISK & CONTROL SELF-ASSESSMENT - RCSA (ENHANCED)

The traffic light ‘RAG’ assessments typically used in RCSAs to report the status
of risk mitigation activities and processes are replaced either by a binary
‘yes/no’ input indicating the presence or absence of compliance with an industry
consensus best practice or through gauging the degree of compliance by reference
to a set of predetermined benchmarks. RCSA enhanced inputs are used by Risk
Accounting’s algorithms to calculate risk mitigation indexes (RMIs) and residual
RUs.



AUDITABILITY

An important feature of Risk Accounting is that Risk Accounting inputs via EUF
and VBW tables and enhanced RCSAs are auditable:

 1. EUFs are set and approved during the product approval and review process.
    Auditors can independently verify that EUFs have been appropriately
    documented, approved, and consistently applied.
 2. Operational throughput and mapping to the Value Table can be independently
    verified by auditors against accounting records.
 3. Given that enhanced RCSAs require either a ‘yes/no’ response or the
    selection of a benchmark from a multiple-choice dropdown box, an auditor can
    independently verify whether responses are appropriate as there is only one
    acceptable response.

Z

RISK ACCOUNTING: DEFINITIONS

Exposure to nonfinancial risks exists where a financial institution fails to
adequately plan, organise, manage and control its internal risk-mitigating
activities and processes. In contrast, exposure to financial risks exists where
a financial institution intentionally creates external financial exposures with
customers, intermediaries and counterparties for a projected return.

Unexpected losses are financial outcomes associated with a financial
institution’s failure to accurately identify, quantify, aggregate and report its
accumulating exposures to financial and nonfinancial risks and, consequently,
cannot know whether such exposures are within risk appetite limits approved at
the Board level. In contrast, expected losses are stochastically determined
accounting estimates of projected financial outcomes associated with accepted
financial and nonfinancial risks where the amount of accepted risk has been
accurately quantified and is within risk appetite limits approved at the Board
level.

l

NOTE

In the recent past, most notably during the financial crisis of 2007/8,
financial institutions of all sizes around the globe suffered material,
sometimes catastrophic unexpected losses. These were invariably due to their
inability to effectively identify, quantify, aggregate and report their internal
exposures to nonfinancial risks. In many instances, the result was extreme
accumulations of unidentified and unreported exposures to nonfinancial risks
that eventually turned into losses. In contrast, external exposures to financial
risks have intrinsic monetary value that can be readily identified and
quantified in natural currency, aggregated and reported. In short, a financial
institution’s amount of exposure to external financial risks is typically known
whereas its amount of exposure to internal nonfinancial risks is typically
unknown.

 



MAINTAINING & IMPROVING THE RISK ACCOUNTING STANDARDS

Risk Accounting Standards Board

The global standards-setting organisation for Risk Accounting is RASB.  The
Board is comprised of leading industry practitioners and academics with a keen
interest in risk exposure quantification solutions research.

THE JOINT INITIATIVE ON RISK QUANTIFICATION

The Risk Accounting Standards Board initiated this initiative as CFOs are
wondering how backward-looking ‘profitability’ can transition to forward-looking
‘sustainability’ as the primary accounting measure of corporate performance.

The joint initiative comprising RASB, ACCA, PRMIA, and the Durham University
Business School believes Risk Accounting provides the answer.

Click here to learn more about this joint initiative.


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