In addition, we help our clients manage risks created by third-party vendors and have strengthened our … A well-executed, end-to-end risk-function transformation can decrease costs by up to 20 percent while improving transparency, accountability, and employee and customer experience. Finally, some traditional detection techniques, such as rules-based cyberrisk and trading alerts, have false-positive rates of more than 90 percent. Transparent processes help focus attention on the highest-impact activities and reduce the risk that deficiencies in complex processes or controls will go unnoticed. To address this increasingly onerous problem, the bank developed an approach using natural-language processing to reduce the data errors, which resulted in many fewer false positives, saving tens of thousands of investigation hours. 1. Next, these banks make inventories of activities through working sessions with businesses, enterprise functions, and corporate-risk groups, also identifying gaps and areas of duplication. During these pilots, the new process and associated controls are assessed to ensure that the process is running smoothly and that the controls are operating appropriately—including that they are properly matched to risk levels and that there are no gaps in controls. By then clarifying roles and responsibilities across the first and second lines of defense, institutions can improve accountability, ensure full coverage of the risks they face, and reduce duplication of effort. Flip the odds. Meet our Middle East consultants who come from both local areas and across the world, bringing a vast array of skills, experience, and backgrounds. Organizations in search of excellence must develop change strategies that boost operational effectiveness in each of the seven elements. A breakdown in processes is at the core of many nonfinancial risks today, including negative regulatory outcomes, such as missing disclosures, customer and client disruption, and revenue and reputational costs. Banks that have been successful in implementing this target state have then assembled a working group, composed of business and risk representatives, to create detailed recommendations. Unleash their potential. Never miss an insight. Additionally, they miss low-frequency, high-severity events, such as misconduct among a small group of frontline employees. Alongside staff growth, policies, committees, and reports proliferated. While banks have made good progress, managing operational risk remains intrinsically difficult, for a number of reasons. For example, we frequently observe overlapping control and testing environments across the first and second lines of defense. The function is accustomed to react to business priorities rather than involve itself in business decision making. Models of organizational effectiveness go in and out of fashion, but the McKinsey 7-S framework has stood the test of time. Learn about A number of banks are looking to improve their risk-management organizational structures but are unsure how to move beyond making piecemeal changes. Under McKinsey’s projections, global average temperatures could rise anywhere between 1.5 and 5 degrees celsius by 2050 compared to today. Additionally, training, consequence management, a modified incentive structure, and contingency planning for critical employees are indispensable tools for targeting the sources of exposure and appropriate first-line interventions. Policies can be structured to focus attention on the areas of highest risk while removing unnecessary red tape for the businesses. Many self-assessments in the first and second line consequently require enormous amounts of manual work but still miss major issues. Banks can now tap into large repositories of structured and unstructured data to identify risk issues across operational-risk categories, moving beyond reliance on self-assessments and subjective controls. Yet those who adapt … Press enter to select and open the results on a new page. But managers who neglect strategic McKinsey’s Capacity Assessment Grid This grid is a tool designed to help organizations assess their organizational capacity/effectiveness. Digital transformations offer promise well beyond risk, and banking as a sector is undergoing a digital revolution. It is creating significant improvements in detecting operational risks, revealing risks more quickly, and reducing false positives. People create and sustain change. A central policy office can, however, be helpful in building the full inventory of all risks and defining the target policy architecture—an architecture that is unmarred by the previously mentioned gaps and overlaps. Operational risk must keep up with this dynamic environment, including the evolving risk landscape. Included on this page, you'll find detail s on the phase-by-phase implementation plan, operational excellence KPIs, case studies of operation excellence improvements, and much more Institutions have reduced as many as 30 percent of their policies while improving the quality of the remainder (Exhibit 3). The prioritized framework can be visualized in a heat map (Exhibit 4). Many global banks have added thousands to their head count in these areas. Through judicious centralization, banks can improve standardization and trim overlap. However, efforts to improve risk-function efficiency can only draw from the standard set of productivity measures at their peril. Now, seeing potential regulatory stability on the horizon, some banks are seriously considering efforts to decrease the cost of risk management. The standard Basel Committee on Banking Supervision definition of operational (or no… The relationship between operational-risk management and the business can also integrate operational-risk reporting and executive and board reporting—including straight-through processing rates, incidents detected, key risk indicators, and insights from complaints and customer calls. Similarly, controls on IT infrastructure may not prevent a poorly executed platform transition from leading to large customer disruptions and reputational losses. Since the financial crisis of 2008 to 2009, financial institutions large and small have significantly expanded their risk and compliance functions. In capital markets, for instance, some products are more susceptible than others to nontransparent communication, misselling, misconduct in products, and manipulation by unscrupulous employees. As an example, some banks that have mapped their credit-underwriting and adjudication process have discovered efficiency-improvement opportunities leading to freeing up underwriter capacity by more than 20 percent and credit-officer capacity by more than 10 percent. Please try again later. These may include benchmarking, either internally, within a particular The original role of operational-risk management was focused on detecting and reporting nonfinancial risks, such as regulatory, third-party, and process risk. cookies,, manage the considerable associated ethical, regulatory, and operational risks. We strive to provide individuals with disabilities equal access to our website. The operational-risk discipline needs to evolve in four areas: 1) the mandate needs to expand to include second-line oversight, to support operational excellence and business-process resiliency; 2) analytics-driven issue detection and real-time risk reporting have to replace manual risk assessments; 3) talent needs to be realigned as digitization progresses and data and analytics are rolled out: banks will need specialists to manage specific risk types such as cyberrisk, fraud, and conduct risk; and 4) human-factor risks will have to be monitored and assessed—including those that relate to misconduct (such as sexual harassment) and to diversity and inclusion. By helping the business meet its objectives while reducing risks of large-scale exposure, operational-risk management will become a creator of tangible value. Maximizing operational efficiency and effectiveness has never been easy. Some applications are described below: Operational-risk managers must therefore rethink their approaches to issue detection. An appropriately agile strategy for centralization and location should be based on the following principles: Careful decisions about what and how to centralize, what is an appropriate location strategy, and how to inject agility into the risk organization are needed if an institution is to deploy talent efficiently and complete essential risk activities. Using machine learning to identify crucial data flaws, the bank made necessary data-quality improvements and thereby quickly eliminated an estimated 35,000 investigative hours. A small, temporary working group can then remove or consolidate committees according to the design principles agreed upon and the results of the targeted discussions. Digitization and advanced analytics augment and magnify the impact of process streamlining, unlocking potential for full risk-management effectiveness and efficiency gains. each area can boost both effectiveness and efficiency, the true potential comes from tackling them in sequential order. Moreover, selective relocation of resources (offshoring or near-shoring) can expand talent pools. Since the financial crisis, many firms have added committees, sometimes without harmonizing the roles of the new and existing committees. A transaction-processing system, for example, may have reconciliation controls (such as a line of checkers) that perform well under normal conditions but cannot operate under stress. reviewing its effectiveness based on reports and findings on the status of comprehensive operational risk management in a regular and timely manner or on an as needed basis? Operational complexity has increased. Whether in information security, data, compliance, technology and systems, process failure, or even personal security and other human-factor risks, the advanced-analytics advantage is becoming increasingly evident. Bank employees drive corporate performance but are also a potential source of operational risk. Unleash their potential. As for the other challenges, they have, if anything, steepened. The next step is to prioritize the “failure modes” behind the risks, including malicious intent (traditional conduct risk), inadequate respect for rules, lack of competence or capacity, and the attrition of critical employees. Measurement remains difficult, and risk teams still face challenges in bringing together diverse sources of data. 1 Hi, it’s Nicolas from The Family.Today, I’m pursuing my “11 Notes” series focusing on interesting companies in the Entrepreneurial Age, and here’s McKinsey & Company. Developing effective risk-oversight frameworks for human-factor risks is not an easy task, as these risks are diverse and differ from many other operational-risk types. Advanced analytics has applications in all, or nearly all, areas of operational risk. Historically, operational-risk management has focused on reporting risk issues, often in specialized forums removed from day-to-day assessment. Our mission is to help leaders in multiple sectors develop a deeper understanding of the global economy. Reinvent your business. Within reach is more targeted risk management, undertaken with greater efficiency, and truly integrated with business decision making. Our flagship business publication has been defining and informing the senior-management agenda since 1964. Addressing new demands and building new skills requires careful change management and patient leadership sustained over a multiyear time horizon. Joseba Eceiza is a partner in McKinsey’s Madrid office; Ida Kristensen and Dmitry Krivin are both partners in the New York office, where Hamid Samandari is a senior partner; and Olivia White is a partner in the San Francisco office. At large regional banks, the growth rate of the risk function has been as much as twice that of the rest of the organization. Reinvent your business. For example, data scientists in wholesale risk may be asked to write reports or fix technology issues because demand for analytics in their specific area is insufficient to keep them fully occupied. Advances in data and analytics can help. As the potential for human-factor risks to inflict serious damage has become more apparent, however, banks are recognizing that this oversight must be included in the operational-risk-management function. This will involve the adoption of more agile ways of working, with greater use of cross-disciplinary teams that can respond quickly to arising issues, near misses, and emerging risks or threats to resilience. Eliminating today’s digital waste and adopting new technologies are the keys to increasing supply chain operational effectiveness. Experience has shown that banks trying to redesign policies by relying entirely on a central policy office or other administrative unit tended to struggle to achieve their goals. In recent years, conduct issues in sales and instances of LIBOR and foreign-exchange manipulation have elevated the human factor in the nonfinancial-risk universe. Southwest Airlines, for example, has figured out how to … In recent years, many institutions have seen risk management as off limits for cost reductions. Already, efforts to address the new challenges are bringing measurable bottom-line impact. They must help them adapt to process-driven risk management and understand the potential applications of advanced analytics. The journey is difficult—it requires that institutions overcome challenges in data aggregation and building risk analytics at scale—yet it will result in more effective and efficient risk detection. While enhancements isolated ineach area can boost both effectiveness and efficiency, the true potential comes from tackling them in sequential order. Banks have invested in harmonizing risk taxonomies and assessments, but most recognize that significant overlap remains. McKinsey identifies six financial transaction areas where tasks can be mostly or entirely automated, listed in descending order of automation opportunities: General … Please use UP and DOWN arrow keys to review autocomplete results. Organizational optimization facilitates governance rationalization, which facilitates effective streamlining of processes, which enables digitization and advanced analytics to yield maximal benefit: The sections that follow discuss all four areas, providing detail on challenges, improvement opportunities, and implementation. At many firms, risk policies have become too numerous and therefore difficult to manage. 3 It should be noted that this shall not preclude a corporate auditor from voluntarily seeking a report and While banks have been aware of risks associated with operations or employee activities for a long while, the Basel Committee on Banking Supervision (BCBS), in a series of papers published between 1999 and 2001, elevated operational risk to a distinct and controllable risk category requiring its own tools and organization.11. The level of digitization achieved varies widely across institutions, however. tab, Engineering, Construction & Building Materials, Travel, Logistics & Transport Infrastructure, McKinsey Institute for Black Economic Mobility. December 3, 2019 Many banking operations leaders feel caught in a tug of war, expected to deliver cost savings while customer demands continue to increase. Let ORM stand alone: One of the main functions within an operational risk program is capturing and aggregating operational risk data. A range of emerging risks, all of which fall under the operational-risk umbrella, present new challenges for banks. While making advances in some areas, banks still rely on many highly subjective operational-risk detection tools, centered on self-assessment and control reviews. Using advanced-analytics models to monitor behavioral patterns among 20,000 employees, the bank identified unwanted anomalies before they became serious problems. New forces are creating new demands for operational-risk management in financial services. The operational-risk-management function should help chief risk officers and other senior managers answer several key questions, such as: Have we designed business processes in each area to provide consistent, positive customer outcomes? Our flagship business publication has been defining and informing the senior-management agenda since 1964. Digital risk: Transforming risk management for the 2020s. McKinsey & Company Anika Becker, Alessandro Delfino, Alessandro Faure Ragani, Ulrich Huber, Cinzia Lacopeta Giving senior leaders hands-on, digitally enhanced experience with lean management helps kick-start a transformation. Streamlined processes are less error prone, better controlled, and more conducive to enhanced customer and employee experiences. The objective is for operational-risk management to become a valuable partner to the business. Institutions responded by making significant investments in operational-risk capabilities. Finally, they realign activities to be consistent with lines-of-defense principles. This creates frustration among business units and frontline partners. The model was developed in the late 1970s by Tom Peters and Robert Waterman , former consultants at McKinsey & Company. Faulty moves to make risk management more efficient can cost an institution significantly more than they save. Since streamlining major processes is a big job, institutions would be wise to start in a targeted way, with a few prioritized use cases. At many smaller institutions, the handful of people working on compliance as part of the legal function or on risk as part of the finance function have now grown into full-scale risk and compliance functions with several hundred people. The heat map provides risk managers with the basis for partnering with the first line to develop a set of intervention programs tailored to each high-risk group. No single answer is appropriate for all banks, which have established many different roles reporting to the chief risk officer (CRO) (Exhibit 1). See Basel Committee on Banking Supervision: Working paper on the regulatory treatment of operational risk, Bank for International Settlements, September 2001, Risk can shape that transformation so that it supports risk-management effectiveness and efficiency directly—by making needed data easily accessible, for example. Please click "Accept" to help us improve its usefulness with additional cookies. Please email us at: This complexity (and the ability to control it) doesn’t matter only for controlling costs. Digitization and advanced analytics are indeed the only viable approach for managing many types of nonfinancial risk, including cyberrisk, fraud, and third-party risk, that involve monitoring thousands or even millions of touchpoints. Subscribed to {PRACTICE_NAME} email alerts. Such tools have been ineffective in detecting cyberrisk, fraud, aspects of conduct risk, and other critical operational-risk categories. Progress will require time, investment, and management attention, but the transformation of operational-risk management offers institutions compelling opportunities to reduce operational risk while enhancing business value, security, and resilience. To manage these risks—in areas such as technology, data, and financial crime—banks need specialized knowledge and tools. Establishing clear, measurable performance objectives, with close tracking of performance, will help identify issues with the revised process. While some banks have begun or even completed (especially in Asia) full-scale transformation efforts, others are still considering when, where, and how to begin. McKinsey empowers organisations to significantly increase both productivity and effectiveness of core processes through offerings that encompass everything from digital diagnostics to plant transformations, order management Analyzing functions within each business unit, operational-risk leaders can then identify those that present the greatest inherent risk exposure. Select topics and stay current with our latest insights, Transforming risk efficiency and effectiveness. Our mission is to help leaders in multiple sectors develop a deeper understanding of the global economy. Finally, until recently, operational risk was less easily measured and managed through data and recognized limits than financial risk. Even after clarifying roles and responsibilities, banks can discover inefficient resource and talent allocations resulting from overly segmented resources. The areas where the function will help execute business strategy include operational strengths and vulnerabilities, new-product design, and infrastructure enhancements, as well as other areas that allow the enterprise to operate effectively and prevent undue large-scale risk issues. Through the four-part transformation we have described, operational-risk functions can proceed to deepen their partnership with the business, joining with executives to derisk underlying processes and infrastructure. A clear and streamlined organizational structure serves as a starting point for end-to-end risk-transformation efforts. Using this as a basis for applying the principles described above will yield an organization that is more responsive to the business, with a consistent, logical structure guided by principles, discharging its oversight responsibilities effectively and efficiently. Together, analytics and real-time reporting can transform operational-risk detection, enabling banks to move away from qualitative self-assessments to automated real-time risk detection and transparency. At the same time, such simplification can help lay the groundwork for more effective digitization. Even institutions in the early stages of maturity can adopt three “no regrets” ideas to begin to capture the benefits in efficiency and effectiveness that digitization offers: The opportunity for improvement in risk manage-ment efficiency and effectiveness is significantly higher at institutions undertaking a full digital transformation. While some banks have focused risk improvement in one or two particular areas, experience demonstrates that the greatest gains belong to institutions that carefully sequence efforts across organization, governance, processes, and digitization and analytics. Use minimal essential “As average temperatures rise, acute hazards such as heat waves and floods grow in frequency and severity, and chronic hazards such as drought and rising sea levels intensify,” McKinsey said. In the past, HR was mainly responsible for addressing conduct risk, as part of its oversight role in hiring and investigating conduct issues. For example, one global bank tackled unacceptable false-positive rates in anti–money laundering (AML) detection—which were as high as 96 percent. Against these challenges, risk practitioners are seeking to develop better tools, frameworks, and talent. McKinsey and Company in a report stated that digitalisation will enable Nigerian banks to achieve between 25 and 40 per cent cost-reduction. 2 McKinsey on Risk Number 2, January 2017 Welcome to the second issue of McKinsey on Risk, the journal offering McKinsey’s global perspective and strategic thinking on risk. Taken together, these factors explain why operational-risk management remains intrinsically difficult and why the effectiveness of the discipline—as measured by consumer complaints, for example—has been disappointing (Exhibit 2). A rigorous review of the committee structure can improve governance while cutting the time dedicated to committees nearly in half. Although such a committee review at a large bank can take four to six months, institutions can begin by developing a set of design principles and using them to understand the existing challenges. Organizational optimization facilitates governance rationalization, which facilitates effective streamlining of processes, which enables digitization and advanced analytics to yiel… Meanwhile, the cost and effort of policy administration and management are likewise reduced. Never miss an insight. The organization can begin implementing its new committee structure, to test and refine results and to demonstrate real change in action. The second was the effectiveness of action during the crisis — specifically, the way they were able to build operational flexibility into their business, as well as cut operating costs. Looking into the underlying complaints and call records, the manager would be able to identify issues in how offers are made to customers. For example, by automating data capture and improving its decision engine, one bank was able to achieve straight-through processing for 70 percent of loans, reducing cost of origination by 70 percent and the time needed to make decisions to under a minute. collaboration with select social media and trusted analytics partners Institutions attempting a transformation can discover that nearly all policies merit some adjustment, if not total rewriting, to better reflect risk appetite, improve clarity, and achieve the right level of detail. All too often, responsibilities can overlap both across and within the lines of defense, compromising the ability to streamline governance and processes. Successful organizations begin by establishing principles for which type of activities fall into which lines of defense. In addition, a global bank, experiencing extremely high false-positive rates in AML monitoring, identified data errors as a root cause of the issue. Please try again later. McKinsey & Company Saptarshi Ganguly, Holger Harreis, Ben Margolis, Kayvaun Rowshankish Significant improvements in risk management can be gained quickly through selective digitization—but capabilities must be test hardened before release.

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