Analysis and Management of Risk: A Regulator’s Perspective Michael Ainley Head of Wholesale Banks Department UK Financial Services Authority

Risk-Based Supervision in the FSA First steps - RATE The current system – ARROW The future – ARROW 2

RATE Identify key units Obtain pre-visit information Preliminary risk assessment Undertake on-site visit Final risk assessment Prepare supervisory programme Ensure consistency Formal feedback to bank (and its home regulator) Employ relevant tools to mitigate risks Re-evaluate at least annually

FSA Principles of Good Regulation #3 The restrictions we impose on the industry must be proportionate to the benefits that are expected to result from those restrictions

Senior Management Responsibilities Principles of Good Regulation #2 Regulator must make clear its requirements and leave senior management space to run the business. Senior management must ensure that appropriate systems and controls are established and maintained Non-executive directors have a key role

ARROW Extends risk-based supervision across all types of financial firms Focuses on risks to FSA’s objectives Considers PROBABILITY as well as IMPACT of risks crystallising PROBABILITY x IMPACT = Overall score Scores used to classify firms A-D FSA uses classification to determine amount of resources expended on firm Frequency of ARROW assessments depends on risks presented by firm

ARROW Risk Mitigation Actions must be clear and time-specific Firms’ boards asked to agree them Preference is to require firms to take the necessary action to improve their systems and controls May involve further work by FSA, home regulator or outside experts FSA’s own systems prompt supervisors to follow up to ensure that actions are completed on time

ARROW 2 To retain the key methodology of ARROW –risk measured in terms of impact and probability to our statutory objectives –mitigation proportionate to our assessment of potential harm to those statutory objectives. Greater proportionality and consistency in response to risks – applying our resources where they will make the most difference Better communication with firms on our assessment of them Closer links to theme and sector work Improved skills and knowledge of supervisory staff Full compatibility with Basel 2 and Pillar 2

Pillar 2: Banks take centre stage Pillar 2 requires the bank to calculate for itself how much capital it needs Better credit risk management and internal systems and controls can reduce the capital requirement

Analysis and Management of Risk: A Regulator’s Perspective Michael Ainley Head of Wholesale Banks Department UK Financial Services Authority