Bank of Montreal 2010 Annual Report Download - page 81

MD&A
•
decision-making is based on a clear understanding of risk, accompanied
by robust metrics and analysis;
• business activities are developed, approved and conducted within
established risk limits and should generate a level of return appropriate
to their risk profile;
• Economic Capital is used to measure and aggregate risk across
all risk types and business activities to facilitate the incorporation of
risk into the measurement of business returns; and
• incentive compensation programs are designed and implemented to
incorporate motivation that balances short-, medium- and long-term
profit generation with the achievement of sustainable, non-volatile
earnings growth, in line with our risk appetite.
Risk Appetite
Our risk appetite identifies the amount and type of risk that we are
willing to accept given our guiding principles and our capital capacity.
Senior management recommends our Risk Appetite Statement for
approval by the Risk Management Committee and the Risk Review
Committee of the Board of Directors. Our Risk Appetite Statement is
defined in both quantitative and qualitative terms and, among other
things, requires:
• maintaining strong capital and liquidity and funding positions;
• understanding the risks we face, and managing and monitoring them;
• subjecting new product initiatives to a rigorous review and approval
process to ensure risks are understood and can be managed;
• providing adequate resources for Risk Management, Finance and other
Corporate Support functions;
• targeting a credit rating for BMO of AA– or better;
• identifying, evaluating and minimizing exposure to low-probability
adverse tail event risks that could jeopardize the bank’s credit rating,
capital position or reputation;
• maintaining a diversified and above-average quality lending portfolio
relative to our peers;
• value at risk (VaR) that is not outsized relative to our peers;
• business practices and policies that ensure our reputation is safe-
guarded and protected at all times; and
• optimizing risk-return, to facilitate the efficient and effective deploy-
ment of capital.
Risk Review and Approval
Risk review and approval processes are established based on the nature,
size and complexity of the risks involved. Generally, the risk review and
approval process is a formal review and approval of various categories by
either an individual, group or sub-committee of the Risk Management
Committee, independent of the originator. Delegated authorities and
approvals by category are outlined below.
Portfolio transactions – Transactions are approved through risk assess-
ment processes for all types of transactions, including dual signatory
authorities for credit risk and transactional and position limits for
market risk.
Structured transactions – The Reputation Risk Management Committee
and Trading Products Risk Committee review new structured products
and transactions with significant reputation, legal, accounting, regulatory
or tax risk.
Investment initiatives – Documentation of risk assessments is
formalized
through our investment spending approval process, which
is now reviewed
and approved by Corporate Support areas.
New products and services – Policies and procedures for the approval
of new or modified products and services offered to our customers
are reviewed and approved by Corporate Support areas, as well as
the Operational Risk Committee, Trading Products Risk Committee and
Reputation Risk Management Committee, as appropriate.
Risk Reporting
Enterprise-level risk transparency and associated reporting are critical
components of our framework and operating culture that help all levels
of business leaders, risk leaders, committees and the Board of Directors
to effectively exercise their business management, risk management
and oversight responsibilities. Internal reporting includes Enterprise Risk
Chapters, which synthesize the key risks and associated metrics that
the organization currently faces. The Chapters highlight our most signifi-
cant risks, as well as potential and emerging risks, to provide senior
management and the Board of Directors with timely, actionable and
forward-looking risk reporting on the significant risks our organization
faces. This reporting includes material to facilitate assessments of these
risks relative to our risk appetite and the relevant limits established
within our framework. It also includes material on emerging risk.
On a regular basis, reporting on risk is also provided to stakeholders,
including regulators, external rating agencies and our shareholders, as
well as to others in the investment community.
Risk-Based Capital Assessment
Two measures of risk-based capital are used by BMO. These are Economic
Capital and Regulatory Capital. Both are aggregate measures of risk that
we undertake in pursuit of our financial targets. Our operating model
provides for the direct management of each risk type but also provides
for the management of risks on an integrated basis. Economic Capital is
our integrated internal measure of the risk underlying our business
activities. It represents management’s estimation of the magnitude of
economic losses that could occur if adverse situations arise, and allows
returns to be adjusted for risks. Economic Capital is calculated for various
risk types – credit, market (trading and non-trading), operational and
business – where measures are based on a time horizon of one year.
An enterprise-wide framework of scenario selection, analysis and
stress testing assists in determining the relative magnitude of risks
taken and the distribution of those risks across the enterprise’s opera-
tions under different conditions. Stress testing and scenario analysis
measure the impact on our operations and capital of stressed but
plausible operational, economic, credit and market events. Scenarios
are designed in collaboration with our economists, Risk Management
groups, Finance and lines of business, based on historical or hypothetical
events, a combination thereof, or significant economic developments.
Economic variables derived from these scenarios are then applied to all
significant and relevant risk-taking portfolios across the enterprise.
As stipulated by the Basel II Accord, BMO also conducts stress testing of
regulatory credit capital across all material portfolios using the Advanced
Internal Ratings Based (AIRB) Approach calculation methodology.
We also conduct ongoing stress testing and scenario analysis
designed to test BMO’s credit exposures to a specific industry, to several
industries or to specific products that are highly correlated. These tests
gauge the effect of various scenarios on default probabilities and loss
rates in the portfolio under review. The results provide senior manage-
ment with insight into the sensitivity of our exposures to the underlying
risk characteristics of specific industries.
BMO Financial Group 193rd Annual Report 2010 79