Bank of Montreal 2012 Annual Report Download - page 91

MD&A
MANAGEMENT’S DISCUSSION AND ANALYSIS
In December 2010, the Basel Committee on Banking Supervision
published its international framework for liquidity measurement, stan-
dards and monitoring. The framework contains two new liquidity meas-
ures, the Liquidity Coverage Ratio (LCR) and Net Stable Funding Ratio
(NSFR), and five monitoring tools (contractual maturity mismatch,
concentration of funding, available unencumbered assets, LCR by sig-
nificant currency and market-related monitoring). The LCR is the ratio of
the stock of high-quality liquid assets to stressed net cash outflows
over a 30-day time period. The NSFR is the ratio of the available amount
of stable funding (one-year or greater) to the required amount of
stable funding. The LCR and NSFR measures are not yet finalized. An
observation period for the LCR and NSFR commenced on January 1, 2012,
and implementation of the LCR and NSFR is scheduled for January 1,
2015, and January 1, 2018, respectively. BMO is well positioned to adopt
the new framework. The framework and conceptual approach BMO and
the financial services industry typically use to manage liquidity and
funding risk are consistent with the new regulatory approach; however,
the proposed regulatory factors used to determine the amount of liquid
assets that banks will be required to hold are more conservative.
Credit Ratings
The credit ratings assigned to BMO’s short-term and senior long-term
debt securities by external rating agencies are important in the raising
of both capital and funding to support our business operations.
Maintaining strong credit ratings allows us to access the capital markets
at competitive pricing levels. BMO’s ratings are indicative of high-grade,
high-quality issues. Should our credit ratings materially decrease, our
cost of funds would likely increase significantly and our access to
funding and capital through capital markets could be reduced. A material
downgrade of our ratings could have additional consequences, including
those set out in Note 10 on page 140 of the financial statements.
On October 26, 2012, Moody’s Investors Service placed the senior
long-term debt rating of BMO and five other Canadian financial
institutions on review for downgrade. Moody’s noted that following
their review, the senior long-term debt rating for the banks on review
will generally be no more than one notch lower. Moody’s has also
placed BMO and other Canadian bank subordinated debt ratings under
review for downgrade. Moody’s affirmed BMO’s short-term rating.
As at October 31, 2012
Rating agency Short-term debt
Senior long-
term debt
Subordinated
debt Outlook
Moody’s P-1 Aa2 Aa3 Under review
for downgrade
S&P A-1 A+ A- Stable
Fitch F1+ AA- A+ Stable
DBRS R-1 (high) AA AA (low) Stable
Operational Risk
Operational risk is the potential for loss resulting from inadequate
or failed internal processes or systems, human interactions or
external events, but excludes business risk.
BMO is exposed to potential losses arising from a variety of operational
risks, including process failure, theft and fraud, regulatory
non-compliance, business disruption, information security breaches and
exposure related to outsourcing, as well as damage to physical assets.
Operational risk is inherent in all our business activities, including the
processes and controls used to manage credit risk, market risk and all
other risks we face. While operational risk can never be fully eliminated,
it can be managed to reduce exposure to financial loss, reputational
harm or regulatory sanctions.
The three-lines-of-defence operating model establishes appropriate
accountability for operational risk management. The operating groups
are responsible for the day-to-day management of operational risk in a
manner consistent with our enterprise-wide principles. Independent risk
management oversight is provided by operating group CROs, group
Operational Risk Officers, Corporate Support areas and Enterprise Opera-
tional Risk Management. Operating group CROs and Operational
Risk Officers independently assess group operational risk profiles, identi-
fying material exposures and potential weaknesses in controls, and
recommending appropriate mitigation strategies and actions. Corporate
Support areas develop the tools and processes to directly manage
specialized operational risks across the organization. Enterprise Opera-
tional Risk Management establishes the Operational Risk Management
Framework and the necessary governance framework.
Operational Risk Management Framework (ORMF)
The ORMF defines the processes we use to identify, measure, manage,
mitigate, monitor and report key operational risk exposures. A primary
objective of the ORMF is to ensure that our operational risk profile is con-
sistent with our risk appetite and supported by adequate capital. The key
programs, methodologies and processes developed to support the frame-
work are highlighted below. Executing our ORMF strategy also involves a
focus on change management and working to achieve a cultural shift
toward greater awareness and understanding of operational risk.
Governance
Operational risk management is governed by a robust committee struc-
ture supported by a comprehensive set of policies, standards and
operating guidelines. Operational Risk Committee (ORC), a sub-committee
of the RMC, is the main decision-making committee for all operational
risk management matters and has oversight responsibility for operational
risk strategy, management and governance. ORC provides advice and
guidance to the lines of business on operational risk assessments,
measurement and mitigation, and related monitoring and change ini-
tiatives. ORC also oversees the development of policies, standards and
operating guidelines that give effect to the governing principles of the
ORMF. These governance documents incorporate industry best practices
and are reviewed on a regular basis to ensure they are current and con-
sistent with our risk appetite. We continue to enhance governance by
increasing the number of Corporate Support areas that have oversight
over specific operational sub-risks.
Risk and Control Assessment (RCA)
RCA is an established process used by our operating groups to identify
the key risks associated with their businesses and the controls required
for risk mitigation. The RCA process provides a forward-looking view of
the impact of the business environment and internal controls on
operating group risk profiles, enabling the proactive management, miti-
gation and prevention of risk. On an aggregate basis, RCA results also
provide a consolidated view of operational risks relative to risk appetite.
Key Risk Indicators (KRIs)
Operating groups and Corporate Support areas identify KRIs related to
their material risks. KRIs are used to monitor operational risk profiles
and are linked to thresholds that trigger management action. KRIs
provide an early indication of adverse changes in risk exposure.
88 BMO Financial Group 195th Annual Report 2012