Nedbank Group has undergone a paradigm shift in its risk and capital management over the last two years. During 2005 the group took a quantum leap forward, with its Basel II programme being the main catalyst. Further details are contained in the Basel II update included in the capital management and Basel II report.
Worldclass at managing risk is one of the groups aspirations, coinciding not only with the completion of the groups three-year recovery process in 2007, but also with the implementation of Basel II in South Africa.
To be world-class at managing risk in Nedbank Group means:
Understanding, measuring and managing risk is central to everything we do. We have engrained risk management in our business. We understand that banking is about managing risk, not avoiding it. Our risk management methodologies are world-class.
Nedbank Groups approach to risk now embraces risk management as a core competency that allows us to optimise risk-taking, is objective and transparent and ensures that the business prices for risk appropriately, linking risk to return.
When Nedbank Group introduced its Enterprise-wide Risk Management Framework (ERMF), it set three broad risk management objectives:
In this report we seek to demonstrate that meeting these objectives and becoming world-class at managing risk is well on track.
The key achievements in this regard for 2005 include:
Our key focus areas in 2006 include:
Economic capital provides a consistent quantification and comparison of risk across business units and risk types. This also enables a focus on both downside risk (risk protection) and upside potential (earnings). It highlights where the group should grow and diversify or where it needs restructuring in its credit and market risk businesses.
Nedbank Groups Economic Capital Framework now enables various new capabilities and management science at various levels of the organisation.
Nedbank Group, in line with leading international banks, calculates economic capital against four major risk categories and allows for diversification benefits to arrive at the final economic capital requirement of the group. This is compared with available financial resources and used as the basis for capital allocation through the adoption of economic profit as a key financial performance indicator.
Nedbank Group's economic capital model is illustrated below.
Nedbank Groups ERMF concerns the definition of its risk universe and a comprehensive risk governance framework to manage that universe, rather than a consistent and tightly defined risk quantitative framework, which is what our Economic Capital Framework now additionally provides us.
Managing risk is, however, not all about capital. Capital is critical, but only one component in the management and supervision of a bank. Not all risks can or should be quantified and management controls, governance and risk management are as important as the right amount of capital a bank holds. Liquidity risk provides a case in point.
There are a few risks for which Nedbank Group does not believe it is appropriate to capitalise, the key ones being:
Strategic risk is captured within our economic capital allocation for business risk.
Risk appetite is an articulation of the risk capacity or quantum of risk the Nedbank Group is willing to accept in pursuit of its strategy.
Risk appetite can be expressed in terms of quantitative risk measures such as earnings-at-risk (earnings volatility), economic capital and risk limits, and qualitatively in terms of policies or controls meant to limit risks that may or may not be quantifiable.
Nedbank Groups risk appetite is defined within five categories:
The group-level risk appetite metrics quantify the current risk profile of the group and the targets agreed by the board of directors. These targets have been built into the groups three-year strategic planning process and are to be achieved by the end of 2007 (which is in line with the groups three-year recovery programme and the implementation of Basel II in South Africa).
|Group metrics||Definition||Measurement methodology|
|Earnings-at-risk (EAR)||Pretaxation economic earnings potentially lost over a one-year period||Measured as a one-in-ten-year event (ie 90% confidence level)|
|Chance of regulatory insolvency||Event in which losses would result in Nedbank Group being undercapitalised relative to minimum regulatory capital ratios (both Tier 1 and total capital ratios)||Utilises earnings-at-risk and compares with the capital buffer above the regulatory minimum
Communicated as a one-in-x-year chance of regulatory insolvency
|Chance of experiencing a loss||Event in which Nedbank Group experiences an annual loss (on an economic basis)||Utilises earnings-at-risk by comparing with expected profit over the coming year|
|Economic capital adequacy/Implied debt rating||Nedbank Group should be adequately capitalised on an economic basis in respect of its current target debt rating||Measured by comparing the available capital with the economic capital requirement|
The quantitative group measures outlined above are used to set the group risk appetite and report risk exposure at the group and business cluster level. However, the allocation of limits, below the cluster level, to business units within each cluster is primarily driven using economic capital.
A new risk dashboard has been introduced to provide a holistic overview of the groups risk profile and to enable the board to monitor the alignment of this risk profile with its chosen risk appetite, as well as to lend support for other key decisions.
An integral part of the risk appetite framework is the continuous analysis and presentation of risk-relevant information to decision makers throughout the organisation. Stress and scenario testing form an important part of this. While this is currently being done to some extent, the Nedbank Group has not yet implemented a comprehensive macroeconomic stress-testing/scenario analysis framework. This will be completed in 2006.