Bank of Montreal 2013 Annual Report Download - page 67

MD&A
MANAGEMENT’S DISCUSSION AND ANALYSIS
Overview
At BMO, we believe that risk management is every employee’s responsi-
bility. We are guided by five core principles that drive our entire
approach to managing risk.
Approach to Risk Management
‰ Understand and manage.
‰ Protect our reputation.
‰ Diversify. Limit tail risk.
‰ Maintain strong capital and liquidity.
‰ Optimize risk return.
Our integrated and disciplined approach to risk management is funda-
mental to the success of our business. All elements of our risk
management framework work together in facilitating prudent and
measured risk-taking, while striking an appropriate balance between
risk and return. Our Enterprise Risk and Portfolio Management (ERPM)
group develops our risk appetite, risk policies and limits, and provides
independent review and oversight across the enterprise on risk-related
issues to achieve prudent and measured risk-taking that aligns with our
business strategy.
Top and Emerging Risks
We are exposed to a variety of continually changing risks that have the
potential to impact our business and financial condition. Therefore, an
integral component of our risk management process is to proactively
identify, assess, monitor and manage a broad spectrum of top and
emerging risks. Our top and emerging risk identification process consists
of a regular forum of discussion with senior risk leaders and from time
to time with subject matter guest speakers, which is then followed by
discussion with BMO’s Risk Management Committee (RMC) and the Risk
Review Committee of the Board of Directors (RRC). Our assessment of
top and emerging risks then informs the monitoring, action plans and
stress tests performed within BMO. This allows us to focus on current
risks and also maintain a forward-looking view of potential risks.
In 2013, particular attention was given to the following top and
emerging risks:
Challenges Linked to the Slow-Growth Economy
The prolonged slow-growth economic environment, combined with low
interest rates and intense competition, including the continued growth
of the shadow banking sector, creates obstacles to the achievement of
our strategic objectives. Quantitative easing has suppressed interest
rates and raised liquidity, leading to large flows of money into debt
instruments, resulting in greater leverage, covenant-light structures and
lower yields. This places pressure on our ability to generate an adequate
return on equity while still operating within the parameters of our
risk appetite.
We are actively focused on managing and mitigating this risk so
that we are able to strike the appropriate balance between risk-taking
and rewards in this slow-growth economic environment. The parame-
ters of our enterprise-wide Risk Appetite Statement have been clearly
articulated across our lines of business and are monitored on an ongoing
basis. We continue to maintain prudent risk management practices,
including close monitoring of all portfolios and underwriting commit-
ments and we apply stringent approval processes for new products
and services.
Further details can be found in our Risk Appetite and Risk Review
and Approval sections on page 81.
Heightened Regulatory Requirements
Regulatory requirements have been increasing in intensity and may
materially shift the prevailing business paradigm. Significant changes in
laws and regulations relating to the financial services industry have
been enacted. These regulatory reforms can impact our operations when
they pose financial costs and strategic challenges and increase reputa-
tional risk. Financial costs result from increasing capital and liquidity
requirements and through the cost of compliance in terms of infra-
structure. Strategic challenges can arise in cases where non-
compliance can hinder our ability to pursue strategic initiatives or
prevent our involvement in certain business activities.
To minimize any potential business or financial impact of this risk,
we continually stay abreast of evolving regulatory changes and monitor
regulatory requirements to ensure that resources are prioritized
appropriately and our views are expressed to regulators. We perform an
impact analysis of capital and liquidity requirements on our business.
Additionally, we are in the process of enhancing our compliance frame-
work to better prepare our organization to handle ongoing and future
compliance requirements.
Regulations and developments specific to the United States are
discussed in the U.S. Regulatory Developments section on page 69.
Canadian Household Debt
High levels of household debt have left Canadians vulnerable to neg-
ative financial shocks, which can emanate from inside and outside the
country. Changes to mortgage practices are slowing activity in the
mortgage market and borrowers are increasingly opting for fixed-rate
contracts.
We closely monitor and review this portfolio, applying prudent and
consistent credit underwriting practices. We have also performed stress
tests under various scenarios ranging from moderate to extreme. In an
extreme scenario, with high unemployment rates, a significant decline
in housing prices and a rapid increase in interest rates, BMO would have
the ability to absorb and manage the related losses.
Further details of our Canadian residential mortgage portfolio can
be found in the Real Estate Secured Lending section on page 84.
Eurozone Challenges
Despite the length of time that the Eurozone has been in the spotlight
and the numerous interventions by various authorities to attempt to
resolve the debt crisis and economic stagnation, there continues to be a
potential risk of economic instability that could spread from peripheral
to core Eurozone countries in the near future.
We are closely monitoring the geopolitical situation in Europe,
including regular review of our direct and indirect European exposures.
Our risk management processes incorporate stress tests to assess our
potential risk, where appropriate. Our total net European exposure was
$7.3 billion as at October 31, 2013 ($7.9 billion in 2012), of which the
majority is to counterparties in countries that are well rated.
Further information on our direct and indirect European exposures is
provided in the Select Geographic Exposures section on page 67.
U.S. Political Gridlock
The U.S. economy is continuing along its path of moderate growth, but
the recovery has not yet fully taken hold and is vulnerable to stalling.
The possibility of renewed political gridlock over the debt ceiling and
budget has the potential to weaken the economy. These ongoing chal-
lenges have a negative effect on consumer, investor and business con-
fidence, which contributes to slower growth and has broader impacts on
other countries, such as Canada, that rely on the United States to play a
leading role in the global recovery.
In light of the potential impact on our business, we continue to
proactively monitor political developments in the United States. We
continually assess our portfolio and business strategies, and
contingency-plan for possible adverse developments.
78 BMO Financial Group 196th Annual Report 2013