Problem
Case study: CIBC
The Canadian Imperial Bank of Commerce (CIBC) is a full-service financial institution with $270 billion in total assets and 44,000 employees operating around the world. In 2000, the bank generated $12 billion in revenue, earned $2 billion in net income, and achieved a 20.5 percent return on equity (ROE).
The financial services industry in Canada, like that in the United States, had been characterized by consolidation. Many Canadian banks allied themselves with other financial institutions, often through outright mergers and acquisitions, either to benefit from economies of scale or in order to deliver the wide range of financial products that their customers were demanding.
CIBC's critical move in this respect was its 1988 acquisition of majority interest in Wood Gundy-a well-regarded Canadian investment bank. The Wood Gundy purchase signaled CIBC's intention to broaden its financing capabilities for corporate customers. The decision to offer integrated, global financial services and offer an increasingly complex product portfolio (including exotic and structured derivatives) motivated a substantial re-think of risk management at CIBC.
At the same time, Canadian regulators were beginning to think more in terms of enterprise-wide risk management. This culminated in the December 1994 Dey Report, published by the Toronto Stock Exchange (TSE), which recommended that the Board of every firm listed on the TSE take direct responsibility for risk management efforts within their firm and communicate those efforts in the annual report. For banks, in particular, the Canadian banking supervisors were among those who drafted the 1996 Amendment to the Basel Capital Accord, which similarly emphasized firm-wide risk reporting and control.
So CIBC had a two-fold reason to invest in enterprise risk management (ERM). It was becoming more active in the capital markets at much the same time that regulators were looking closely at risk management. Its reaction was to start building an ERM team; its first significant high-profile hire was Dr. Robert Mark, who joined the bank in July 1994 to be the Corporate.
Treasurer as well as look after firm-wide market risk, operational risk, and sections of credit risk which included responsibility for managing credit risk in the trading book. Dr. Mark was promoted to Senior Executive Vice President and became CIBC's Chief Risk Officer in February 2000 and joined the CIBC Management Committee.
Dr. Mark articulated his vision from the very beginning, outlining his plans to build a strong ERM team made up of experienced risk managers with substantial business experience, to work in partnership with, but independent of, the business lines. "I will need your commitment to support my vision," he explained to key senior management and the board during his selection. He pointed out that "[the] objective is to be among the top five financial institutions in the world in terms of managing risk." Dr. Mark emphasized how he was going "to come in and make changes. There's no doubt about that." The board was not put off, and when Dr. Mark joined CIBC, he did so with a mandate to deliver world-class risk management.
Changes and controversy duly followed. Of the team he inherited, none were to be found doing the same job a year later. New executives with significant risk management and trading experience were put in place to implement the new vision. There was also a compensation differential between risk staffers and their colleagues on the business side that had to be evened out in order to attract and retain the requisite talent. Dr. Mark pointed out that his business partners were highly encouraging and supportive of upgrading the quality of risk personnel. In short, the change was nothing less than dramatic.
Today, the firm collects risk data from across the globe and disseminates risk reports through a series of risk management and business committees, illustrated in Figure 16.1. Risk management committees at CIBC establish risk management policies, limits, and procedures, approve risk management strategies, and monitor portfolio performance and trends. The Risk Management Division works closely with both the lines of business and risk management committees to manage CIBC's exposure to market, credit, and operational risks. "One of the keys to success is getting business and risk people to work effectively together," says Dr. Mark, "If you have people from both camps sitting together, agreeing, disagreeing, asking questions, then we all have a clearer understanding of the problems we face, and a clearer path to the answers. Our business partners provided us with invaluable insight as we evolved our risk management function into a world-class team."
The kind of Socratic dialogue that Mark favors isn't always frictionless. There have been occasions when risk management has been obliged to restrict the amount of business that certain units can carry out. "The ability to generate revenues is clearly a function of the volume of business you do," notes Mark. By limiting business, risk management could be cutting into profitability, and individual bonuses-one reason why CIBC links compensation to risk-adjusted return performance.
CIBC has defined several objectives for its risk management program, which include reducing surprises, reducing losses consistent with risk/return objectives, reducing regulatory capital requirements, developing sophisticated risk metrics designed to capture various components of risk, and so on. While risk information and analysis can be highly technical, they must be translated into a reporting structure that is meaningful and relevant for senior management. Mark suggests that the risk management program has succeeded in meeting those objectives.
Mark highlights the bank's reaction to the regulatory and market pressures of 1998. At the start of 1998, the Bank for International Settlements (BIS) implemented a new set of revisions to its Capital Accord-the regulatory standard used by regulators and central banks the world over. The revisions gave sophisticated banks the freedom, subject to regulatory approval, to use their own risk models as a basis for calculating the minimum required regulatory capital against market risk in the trading book (rather than a crude standardized multiplier system). It was a change that banks had long campaigned for.
When the new rules became effective at the start of 1998, CIBC was the only bank in Canada and one of the few banks in the world to receive approval for all aspects of the Accord in 1998. Mark explains: "As a bank, you'd almost have to be crazy not to take advantage of BIS 98. From the get-go, we saw that if we invested in risk management, we'd get capital relief, and the savings were huge."
Later the same year, CIBC's risk management team proved its worth in a very different way. The volatility that swept the globe during the third quarter was a test of fire for banks around the world, largely because almost every market was affected by the turmoil but also because the early warning signs made little sense at the time. "During June and July, we were seeing a lot of highly rare events that we didn't like," says Mark. "Liquidity was drying up in certain areas, correlations were diverging from their normal patterns, and credit spreads were widening." This uncertainty prompted Mark and his team of experienced risk managers, working in partnership with the business lines, to cut limits across the business by 33 percent in an attempt to mitigate exposure to volatility. Soon after the limits were cut, the markets broke. The losses sustained by CIBC were not easily digestible, but it could have been far worse. For Mark, it was a painful experience tinged with a certain amount of professional satisfaction. More than 98 percent of the losses suffered by CIBC during the 1998 market crisis were from positions which risk management had previously identified and placed on a hit-parade of the bank's top 10 risks. "We knew that if we were going to get hit that, it would be attributable to one of those exposures," says Mark.
CIBC has come up against a few challenges similar to many organizations that have faced the task of implementing integrated risk management practices. One issue is that of linking compensation to risk-adjusted performance. This is a key component of ensuring the effectiveness of each business and is a well-recognized practice at CIBC.
Another challenge to the risk management processes comes from one of CIBC's key competitive advantages-its culture. CIBC has long benefited from a culture that is decentralized, diversified, and entrepreneurial. This helps it to keep on its toes and respond quickly to the ever-changing demands of increasingly savvy customers. However, this type of culture can be difficult from an administrative perspective, and is sometimes a challenge to integrate into a system of risk reporting.
To support integrated financial risk management, CIBC has developed models for aggregating risk measures such as market VaR and credit VaR, in order to better capture the intersection between market and credit risk.
CIBC also wants to further develop an integrated and centralized method of collecting data for operational risk VaR. In addition, centralizing data collection within the next year, CIBC is also part of a global initiative to develop an operational loss database in conjunction with the Big Six Canadian banks, the British Bankers' Association (BBA), and the Risk Management Association (RMA).
Task
A. What is the central issue the case is describing?
B. Based on your readings, what problem needs to be addressed?
C. Put yourself in the Chief Risk Officer's chair and describe the considerations you would identify.
D. Agree or disagree with the solution described in the case and provide support for your position.
E. Provide a concise summary of the items you considered and your conclusion.