Head of Credit Risk Modeling and Measurement Group
Low-risk strategy delivers top-level returns
Bank Leumi uses SAS to achieve for superior shareholder returns
Achieving strong performance in both a stressful and a business-as-usual economic environment is a universal objective in banking. Yet many underestimate the role that effective credit risk management can play in getting them there. Bank Leumi of Israel has progressed further and faster in this positive direction than most other financial institutions.
Many states help to build banks, but Bank Leumi helped to build a state. Israel's leading bank, with a domestic market share of 30 percent, was established in 1902 in London, 46 years before the state of Israel was declared, and has always been central to the project to create a homeland for the Jewish people. Today it is a multinational operation with five major subsidiaries in the United Kingdom, the US, Switzerland, Luxembourg and Romania, 13,000 employees worldwide and approximately ILS 331 billion (US$90 billion) in total assets.
SAS gives us the power to analyze a variety of concentration risks from many different perspectives, enabling us to take decisions to bring the portfolio into balance.
Bank Leumi uses SAS® Credit Risk Management to execute its strategy of focusing on low-risk, high-return segments. Its target is to maintain an overall capital ratio of 14-14.5 percent – the highest in Israel. At the same time, it delivers superior shareholder returns. Over a five-year period to August 2010 these were 16 percent higher than the Tel Aviv banking index and significantly higher than those of global developed-market indices such as Morgan Stanley Capital International (MSCI, which Israel belongs to following a developed market status in May 2010). Evolving an effective approach to credit risk management combined with portfolio management are among the critical success factors.
Integrating risk management
"We do not take a passive regulation-centric view of credit risk management," says Boaz Galinson, Head of the Credit Risk Modeling and Measurement Group at Bank Leumi, "because that does not necessarily add real value to the business. Rather, we see our role as providing information that will help the business to make the right decisions."
According to Galinson, risk management analysis must be integrated into the business. A key lesson that should be learned from the credit crisis is that risk management should be able to answer questions raised by senior trade officers and should not be left on the sidelines. Bringing added value to the business is part of the philosophy of Bank Leumi's Chief Risk Officer, Dr. Hedva Ber, who focuses on real-time risk management.
Bank Leumi has developed a clear competitive advantage in managing the risk profile of its commercial and corporate credit portfolio. This is a far more complex challenge than in retail banking, where the methodologies are better established and the metrics more widely understood. Corporate portfolios are less homogenous because they reflect a wide variety of business needs. Moreover – and this is one of the key differences in practice – concentrations of credit risk (i.e., the risk profile of a group of connected obligors, a sector, a geography or a significant obligor) can have a big impact on the bank's total portfolio. The situation is particularly challenging for a bank whose commercial and corporate portfolio mainly consists of untraded companies that have no external credit rating.
Developing a credit risk methodology
Bank Leumi therefore decided to develop its own commercial and corporate credit risk methodology and an advanced risk architecture specifically designed to support it.
"There is no system on the market that can meet all of the generic business requirements for both credit rating and portfolio management, let alone those that are specific to an institution such as Leumi," says Galinson. This being the case, the planning stage was crucially important for setting out requirements to ensure that nothing would be overlooked during the implementation. Leumi therefore needed a vendor that was not simply a software provider, but rather a partner with deep experience of building best-fit solutions for credit risk management. Another equally important requirement was to build a single credit risk database that would support all of the functionalities of the credit risk management system. "These two criteria clearly pointed to SAS as the partner of choice," says Galinson.
To meet the need for a robust single risk management database the bank deployed the SAS Detail Data Store (a data model), which ensures consistency in the flow of data. Data that is updated or refreshed by one function is immediately ready for use by all the others; information is optimized on a continuous basis.
Following the ratings process in a structured way
Bank Leumi developed a lab for building statistical models that would generate risk parameters, such as probability of default (PD), loss given default (LGD) and exposure at default (EAD). These parameters feed into the credit rating module, which is based on 20 types of credit rating questionnaires and three workflows, enabling credit officers to follow the ratings process in a structured way, entering rates such as the risk of the sector based on forecasts from Bank Leumi's Economic Unit. Each completed questionnaire reflects the PD for an individual obligor. One of the beauties of the SAS solution is that Leumi can rerun all of the credit risk questionnaires to get the new PDs should the sector risk, financial ratios or any other forecasts then change.
"The real power of this solution lies in its integration across all the modules," says Galinson. "Sector risk simulation is very complex, with multiple factors at play. The strong modeling and scenario analysis and stress-testing capabilities available in SAS allow us to evaluate the credit risk of the obligor/portfolio, while the SAS Detail Data Store enables us to feed the results of one analysis to the next. Consequently, SAS gives us the power to analyze a variety of concentration risks from many different perspectives, enabling us to identify weak points in the portfolio and to make decisions on how to bring it back into balance."
The next big step for Bank Leumi is to optimize its risk-adjusted return on capital (RAROC) modeling. "This integrated solution enables Bank Leumi to manage on the basis of RAROC, which brings much greater discipline to lending decisions, ensuring that reward is consistently and accurately linked to risk, thereby maximizing real returns," says Galinson.
An evolving credit risk management strategy combined with effective portfolio management were critical success factors if Leumi was to achieve its objectives of superior shareholder returns in a competitive environment and with high capital reserves.
Greater discipline in lending decisions based on Risk-Adjusted Return on Capital (RAROC) and enhanced ability to manage concentrations, helping to reduce the bank's risk while ensuring higher than average returns.