Aligning Risk Management with the Business

Online bank ING Direct develops a financial risk mitigation strategy to promote growth

Imagine an orange pumpkin that grows gradually in size and multiplies to fill the land and sky of mainland Italy. This is the abiding image of ING Direct Italia that a set of memorable advertising campaigns has etched into the minds of the Italian public.

The online bank’s strengths include fast approvals, high yields and low costs. The Italian branch is part of the ING banking and insurance group, which has a presence in 50 countries and is sixth-largest in Europe in total assets. It has enjoyed soaring growth since it opened for business in 2001, with more than 700,000 customers, total assets of EUR13 billion (US$17.46 billion), a record number of 70,000 customer contacts per day and an average of 90,000 Web site hits daily.

A prudent risk mitigation strategy
The bank’s aggressive strategy to win new customers is backed by a clever risk management policy that aims to minimize or even eliminate the financial risk for each individual product line.

From the launch of the Conto Arancio (Orange Account, a popular consumer product line), the bank’s risk mitigation policy dictated that liquid funds should be invested on the basis of deposit duration. In other words, the investment strategy set an overall limit for rate risk exposure. The bank then extended its product range with an array of new financial products, from first and second home mortgages to share funds and bonds. The mortgages also incorporated preset rate risk limits within the overall asset and liability management strategy.

Limiting risk for mortgages was more of a challenge for the fixed-rate products than for the variable-rate products. For variable-rate products, the problem was to implement the depreciation cost principle to comply with IAS 39 standards, which establish guidelines for recognizing and measuring financial assets and financial liabilities.

When assessing the effectiveness of coverage for the fixed-rate products, however, the accounting was complicated by risk management and business issues. “The product-related risks were typical of risk management,” says Dario Caprioli, ING Direct’s Area Finance, Legal and Risk Management Manager.

“We needed to cover the long-term fixed rate position imposed by the mortgage,” Caprioli explains. “The fixed-rate mortgage set us the two new challenges of meeting accounting requirements and complying with IAS principles. We had to calculate the market value of the mortgage and the coverage. We also had to evaluate the efficacy of coverage by carrying out an effectiveness test. So we decided to plan a solution that met our own in-house requirements and have it implemented by a blue-chip partner such as SAS, rather than buy an off-the-shelf application and tailor it to our needs.”

Partnering with SAS also made sense because ING Direct was already using SAS Business Intelligence to analyze the statistical and financial surveys it used to optimize resources during promotional campaigns.

A four-step project
ING Direct’s new risk solution was built using the SAS®9 platform and SAS Risk Intelligence. A team of SAS consultants worked with in-house decision makers and business users, including the asset and liability manager – who also acts as a market risk manager within ING Direct – the head of accounting, the treasury support staff and project management resources.

“The problem was so complex,” continues Caprioli, “that we decided to proceed step by step. The result was four subsidiary projects, each addressing specific problems.” Ultimately, the bank relied on SAS to handle:

• Rate risk management.
• Income statement volatility analysis.
• Fair value calculations.
• Depreciated cost estimates.

The bank calculated the correct coverage ratio by determining the number of mortgages that customers obtained within a one-month period and taking the prepayment risk into consideration. Because the bank has to shoulder the risk of the current position value if customers repay loans early, it is essential to monitor early repayment: The effects of early repayment could generate volatility in the income statement.

Managing the prepayment risk means producing reliable estimates of customer behavior with regard to partial or full mortgage repayment. With those calculations in hand, the bank can formulate contracts to allow for early payment forecasts. ING Direct regularly monitors the difference between the true situation and the forecast situation, adjusting coverage ratios accordingly. Once the bank resolves the problem of establishing the true risk management situation, it must then tackle accounting problems. The effectiveness test, which evaluates the efficacy of coverage, is designed to check that the product is also covered from an accounting viewpoint so the bank can understand how prepayment might affect earnings predictions.

Aligning business and risk management
“The solution we have implemented will enable us to calculate the impact on the income statement and to simulate different scenarios in the event of rate changes,” says Caprioli.

The technology can use data from different sources, Caprioli points out. And this has had a significant effect. “We can align business and risk management because we can obtain comprehensive and reconcilable data. This requirement is essential if we are to react promptly to market stimuli and take timely decisions, such as those relating to the monthly bid rate,” Caprioli concludes.

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