FSI magazine | #5 April 2009

‘Maintaining a
competitive internal
market is the only
way forward’

Balancing state aid and Will bank branches High hopes, low 'Banking is the love of The cost
competition survive? expectations my life' of cash
Interview with Irmfried How to reconnect with Foreign retail banking Portrait of Józef Wancer, How the economic turmoil
Schwimann, Director retail bank customers opportunities in China CEO of Bank BPH impacts cash usage
Financial Services (DGC),
European Commission
 FSI magazine | #5 April 2009

In this
issue Colophon
Preface

Towards a
F
News & Research 4 SI magazine is a Deloitte publication for Design
the Financial Services Industry. FSI maga- De Zaak Launspach

new reality
Balancing state aid and competition 6 zine is published three times a year and
Interview with Irmfried Schwimann, Director Financial distributed in controlled circulation in Photography
Services, DG Competition of the European Commission the Netherlands, Belgium, Luxemburg, Imagestore, Piotr Jedwabny, Anna Orzeszko, Małgorzata
Denmark, Germany and Central Europe. Pytel, Johannes Vande Voorde, Maarten Reijgersberg
Will bank branches survive? 12
Contact Illustration
Gains of the credit crisis 17 24 Deloitte, Financial Services Industry Vijselaar & Sixma
Column by Harry Smorenberg Monique Levels
Phone: +31 (0)20 454 74 50 Printing
UCITS risk management under construction 18 E-mail: mlevels@deloitte.nl Offset Service

A
Website: www.deloitte.com/FSImagazine
Only strong and trusted brands will survive 22 n unprecedented global crisis theirThanks
ambitions to in terms of both their geographical
Subscription has now extended its reach to spread
Remcoand Bloemkolk,
their rangePatrick
of activities (banking,
Callewaert, insurance,
Mathias
Foreign retail banking opportunities in China 24 all geographies
If you want a free subscription to FSI and sectorsorofno
magazine, assetChristiaens,
management). AnnelienTheyDe
will all have
Dijn, Joep to get an
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Haico Ebbers,
longer wish to receivethe economy.
this publication, Thejust
discussion
send an e-mail nessHalina
of where the true
Frańczak, synergies
Alexandre are, and
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Patricia Goddet,in
Polish banking leaders caught in the lens 30 to FSImagazine@deloitte.nl.today focuses
Please on statehow
thelong it
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promisesvan to the markets.
Grinsven, Olav Groenendijk, Marketa Honan,
information: organisation, will take
title,forinitials,
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‘Banking is the love of my life’ 34 recover,
name, and what
position, can beaddress,
business done tocity, move it back
postal in coun- Regulation:
code, Vicky Meeus, If all Carl
observers agree that
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Caroline has Vijn,
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Portrait of Józef Wancer, CEO of Bank BPH theand
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helped De to avert the current
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Emeric van it is also
Waes, clearZegers
Caroline that
regulation will be only a part of the solution. There are
34 With regard to the financial services industry, it is bound to be major initiatives on the regulators’ side,
Financial crisis changes the regulatory and 38 Feedback Deloitte
supervisory landscape still unclear
Please to what
send your extent the
questions, commentssector itself
and/or has sta-
suggestions obviously
Laan van at both international
Kronenburg 2 and national levels.
bilised.
to But what is clear at this junction is that both
FSImagazine@deloitte.nl. PO Box 300
The cost of cash 43 the banking and insurance businesses will have to Clients:
1180Clients must by all means regain their place at
AH Amstelveen
absorb and
Editorial digest the negative impact of the severe
board the THE
centre of the debate. This calls for a thorough revi-
NETHERLANDS
Managing reputational risk 48 slowdown
William in the real
Axelsson, economy.
Jean-Pierre Boelen, Yves Dehogne, sionPhone:
of the value+31 proposition
(0)20 454offered
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Pascal Eber, Guillaume Hollanders, Matthew Howell, financial
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(0)20 454 be 55able to find and assume
Solvency II: Dealing with operational risk 54 It is van
Eric equally clear to allDaniela
de Kerkhove, observers that the
Keusgen, Lonebank-
Moeller its new role in the
Website: global economy only by focusing on
www.deloitte.nl
ing andGert-Jan
Olsen, insuranceRos,businesses will have to
Harry Smorenberg, Rob face a
Stout its clients.
Towards a more transparent tax position 58 new reality in the months and years to come. The Missed the latest issue(s) of FSI magazine?
industry is likely to be restructured around four key
Editor-in-chief All observers
Did you miss agree
thethat theissue(s)
lastest financialof services industry
FSI magazine? Justis
Unprecedented action by the IASB 62 themes:
Paul van Wijngaarden facing
senda new reality.
an e-mail to:Some even believe that weand
FSImagazine@deloitte.nl areyou
nowwill
on the brinka of
receive a total
digital PDFtransformation
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38 Ownership: Most banking and insurance compa-
Interview What is certain, at any rate, is that we
www.deloitte.com/FSImagazine andare in for very
download the
niesEldridge
Jon have seen the government entering into their exciting times.
magazine(s).
shareholder and decision-making structures; some
institutions
Editorial have even been or are about to be
contributions © Deloitte, April 2009. All rights reserved.
nationalised.
Paul Groothengel,This will
Ypkeundoubtedly
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Weerd
consequences for the industry itself. Deloitte refers to one or more of Deloitte Touche Tohmatsu, a
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Translation and language editing affiliates. As a Swiss Verein (association), neither Deloitte Touche
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3

48

News &
Research
Risk management in the age of structured products:
Lessons learned for improving risk intelligence
This is not the first time individual
firms or the financial services
industry have experienced a
downturn. But the magnitude
of the losses and the number
of firms involved make this
market collapse different. It is
more important than ever for
the financial services industry
to take stock of the lessons
learned. In its recently released
report, 'Risk Management in
the Age of Structured Products',
the US-based Deloitte Center
for Banking Solutions explains,
with the benefit of hindsight,
how firms can improve their risk
management so that they can
come to a better understanding
of their aggregate risk exposures.
4 5
These lessons fall generally into four areas:
1. Revamping governance, risk oversight and risk
management
2. Integrating both risk and return into decision-making
3. Building capacity to understand and manage risk
4. Revisiting the need for improved transparency and
disclosure
Governance, risk oversight and risk management
A key issue in the credit crisis relates to the role of
senior management and the board. In some cases, it
appears that senior management and the board were
not adequately informed of the risks their firms faced in
structured products and of the aggregate risk contained
on their balance sheets. Risk management culture and
approaches were, in some cases, not sufficiently embed-
ded throughout the organisation. Because of that, risk
and reward perspectives were not brought together in
a way that would have allowed a more accurate, enter-
prise-wide understanding of the firm’s risks. This lack of
understanding across the organisation of the true magni-
tude of its risks laid the groundwork for failure.
Recommendation: A firm should have, in writing, a
clear, detailed, board-approved risk management charter
or framework that defines risk management roles and
responsibilities. This charter or framework should be
clearly communicated throughout the organisation.
Building risk and return into the business practice
Focused as they were on generating revenues, a number
of financial institutions did not fully understand the
structured products that generated the losses. It is time
to build risk and return more effectively into the business
practice.
Recommendation: Senior management – with board
input and approval – should define the institution’s risk
appetite as part of its written risk framework.
Capability to identify, measure, monitor and control
risks
It has been widely reported that management’s response
to the credit crunch was delayed largely because institu-
tions lacked sufficiently sophisticated analytical systems
News &
Research
Global Security Survey 2009
Protecting what matters
and a clear methodology for assessing liquidity risk. It
now appears that valuation and measurement systems did
not fully capture risk at the product level, making it hard
to get a complete view of the financial institution’s aggre-
gate exposure.
Recommendation: A firm should be able to measure the
risks associated with all transactions. To do this, it should
have a consistent set of models, data and related systems
for pricing and risk management that fully captures, to the
extent practicable, all relevant drivers of value and risk.
Moreover, it should have consistent approaches to data,
models, and processes. A financial institution hoping to
compile an aggregated, enterprise-wide view of its risk
must make sure that its technology and data are consist-
ent across business units and across specific risk functions.
Transparency and disclosure
Due to the limitations of the risk management infrastruc-
ture, plus the complexity of structured credit products
themselves, essential risk-related information often did
not reach the right levels or enter into key decisions
regarding risk, at either the business or the corporate
level. And given the problems in internal communication
regarding risk in some firms, it is not surprising that exter-
nal disclosure was incomplete.
Recommendation: The firm should demonstrate clear
intent to provide transparency and appropriate disclosure
at all levels, both internally and externally.
Shaping the new financial services marketplace
'Risk management in the age of structured prod-
ucts' is the first of a series entitled 'Shaping the new
financial services marketplace', in which the US-based
Deloitte Center for Banking Solutions will examine the
rules, regulations, and operating models that evolve
as the industry sails uncharted waters.
For a hard copy of the report, or for more information
about this topic, please contact Frank De Jonghe
(fdejonghe@deloitte.com).
FSI magazine | #5 April 2009
The 6th Annual Global Security
Survey, which benchmarks
IT security and privacy in the
financial services industry, was
published in February 2009.
In 2008, financial institutions saw a decline in the number
of both external (47% vs. 65% in 2007) and internal
(27% vs. 30% in 2007) security breaches. The top three
information security priorities of financial institutions are:
security regulatory compliance, followed by data protec-
tion and information leakage, and access and identity
management.
Some other findings include:
• People are both an organisation’s greatest asset
and its weakest link. But security vigilance is even
more important in hard economic times, when the
increased stress levels can lead people to behave in
atypical ways.
• Even though both internal and external security
breaches at financial institutions worldwide have
declined in number over the past twelve months,
employee misconduct is a growing concern.
• The growing popularity of social networks and the
proliferation of mobile media, such as USB keys, MP3
players and PDAs, all cause an extra load on internal
and external security. These devices present oppor-
tunities for unauthorised download and storage of
confidential information in an unprotected medium.
This is one of the factors that has contributed to the
sudden rise of data protection and information leak-
age as a top priority for financial institutions – tied at
second place with access and identity management.
• The leading drivers for financial institutions to protect
the privacy of their clients' information are privacy
regulatory requirements (79%) followed by reputation
and brand concerns (70%).
For the full survey, please visit www.deloitte.com
(search for: Global Security Survey 2009).
 FSI magazine | #5 April 2009

Balancing
state aid
and
competition What were the greatest challenges and achievements
of the European Commission’s competition depart-
ment (financial services) in 2008?
Even though the support schemes for the financial
sector remain in the hands of the member states,
the Commission provides a framework, through the
We’ve been working very hard in recent months to help implementation of the EU state aid rules, that ensures
EU member states restore confidence in the market and consistency in national responses throughout the EU.
By Jon Eldridge protect their financial stability. Our aim has been to pro-
vide immediate assistance to member states on state aid Our role in establishing a more stable economic environ-
issues in order to help them deal with the problems they ment for the future is, however, limited. What we can do

State aid rules face in the rapidly changing circumstances of the crisis. is to help member states by ensuring that the state aid
rules preserve a level playing field, while at the same time

are at the centre On 13 October 2008, the Commission adopted guidance

on the criteria to be used to assess national measures for
giving them legal certainty and sufficient flexibility to take
timely measures in support of their financial institutions.

of the European supporting financial institutions. In early December we

also published a communication on the recapitalisation What developments can we expect in 2009 and what

Commission’s of financial institutions. This provided detailed informa-

tion on how we would approach bank recapitalisation
are your plans for dealing with them?
In 2009 the Commission is going to be working on addi-

response to the measures. tional financial support measures proposed by member

states, and will also need to review existing measures.

financial crisis, Over the past four months, the Commission has adopted
nearly 40 decisions on state aid in the financial services
We may need to make adjustments in response to events
as they evolve, and make sure that aid continues to be

but as Irmfried sector. These provide clarity and legal certainty for mem-
ber states. We believe our state aid policy represents a
minimised. The Commission will also report to the Spring
European Council on the financial reform package and

Schwimann,
pragmatic and responsible reaction to the evolving market present the initiatives that the Commission is currently
conditions. These decisions cover a range of measures, working on.

Director of Financial
including guarantees, asset purchases, pure recapitalisa-
tions and general schemes combining all of the above. The Commission also adopted a temporary framework

Services at the
last year that provides member states with additional
Our main aim has been to achieve the right balance ways of ensuring access to finance for both strong and
between allowing aid to the extent necessary in order to vulnerable non-financial enterprises in order to help the
Commission’s maintain financial stability and seeking to ensure a return
to normal market functioning, while at the same time
‘real’ economy cope with the recession. This framework,
which will apply until the end of 2010, is designed to
competition making sure that state support does not unduly distort
competition between banks and worsen the financial
ensure that member states can offer consistent help to a
wide variety of businesses.

department, tells crisis.

The Commission will also have to examine a second wave

FSI Magazine, What lessons can be learnt from the financial crisis,
and what role can the Commission play in establish-
of recapitalisations this year. It will have to consider how
effective the present recapitalisation model has been and

maintaining a ing a more stable economic environment?

The crisis has demonstrated the importance of the EU
decide how best to deal with banks that need further
recapitalising.

competitive internal state aid rules. Without controls on state aid, govern-
ments would be tempted to support national banking Finally, the treatment of toxic assets and their potential

market is the only institutions to the detriment of their European competi-

tors; strong companies would be penalised and necessary
acquisition by member states will need to be addressed
under the state aid rules. How such assets are treated is a

way forward. reforms might be postponed, all of which would delay

recovery.
particularly complex issue, with direct implications for the
assessment of state aid.

6 7

How do increased state aid measures and widespread
nationalisation of banks impact on the level playing
field, and what are the essential criteria for a well-
balanced European financial services industry?
The financial crisis has undoubtedly led to unprecedented
changes in the EU member states. The situation is evolv-
ing, and so are our rules for dealing with the changing
market circumstances.
The Commission does not question the need for national
support schemes in order, for instance, to avoid bank fail-
ures that could have far worse consequences for the real
economy. However, by applying our state aid policy, we
have been able to maintain a level playing field while deal-
ing with the crisis.
Our state aid policy is based on two fundamental princi-
ples: any distortion of competition must be in proportion
to the objective of the aid, and any state aid measures
should be temporary. Before approving proposed state
aid measures, we ensure that in each case the aid granted
does not exceed what is strictly necessary to achieve
the legitimate purpose, and that distortions of competi-
tion are minimised. If this is not the case, member states
are asked to change their schemes before they can be
approved. The conditions imposed, for example, on the
pricing of these schemes and the review mechanisms in
place to re-evaluate the need for such schemes six months
later ensure that the Commission can help tackle the
crisis, while also avoiding harmful economic imbalances
between banks and member states.
One of the main criteria for a well-balanced European
financial services industry in the future is that banks need
to be adequately capitalised and to be well placed to
provide finance and play an intermediary role in the econ-
omy. In order to arrive at this point, the level and form
of state aid provided may need to vary from one country
to another. We are currently striving to establish a solid
starting point. And the Commission's role is to ensure that
state aid gets us to that point.
8 9
How effective has the Commission’s state aid policy
been, and how can it be improved?
Since the very onset of the financial crisis, the
Commission's role in the field of competition policy has
been to underpin public authorities’ efforts to support
financial stability and sustain lending to the real economy
by swiftly providing a legal framework for applying state
aid rules, in exceptional crisis conditions, so as to ensure
co-ordinated and effective action by member states.
State aid rules are sophisticated enough to cope with the
differences between member states, and strong enough
to cope with the difficulties. We allow national govern-
ments freedom to tackle the root causes of the crisis, but
prevent them from taking action at the expense of other
member states or taxpayers.
The crisis has been a valuable learning experience, both
for the Commission and the member states. If market
conditions change quickly, we have to be ready to adapt
our rules to the changed circumstances in order to pro-
vide an adequate response to member state interventions.
The Commission wants to adopt a ‘collaborative’ rela-
tionship with member states for the approval of state
aid packages. What are the threats to this relation-
ship, and are you optimistic about the future?
We have always tried to maintain a constructive dialogue
with member states in order to ensure that any measures
are shaped in line with our rules. This is the best way to
ensure we can approve measures quickly and avoid prob-
lems at a later stage.
By working as partners when approving state aid meas-
ures, we can make sure that resolving problems faced
by one member state does not have a negative impact
on neighbouring countries. We clearly need a coherent
response if we are to protect our economies and ensure
jobs, stable business conditions and value for money for
consumers.
I am confident that all member states acknowledge the
risk of a subsidy race and the need for a neutral arbitra-
tor to ensure that aid schemes do not unduly distort
competition.
FSI magazine | #5 April 2009
What were the main aims of the communication on
recapitalising banks? Given the legal challenge to
the Belgian government’s role in the rescue of Fortis,
could the Commission have done more to ensure
greater regularity?
The main aim of the communication was to respond rap-
idly to the need for guidance on whether specific forms
of recapitalisation complied with state aid rules. The com-
munication sought to provide a co-ordinated framework,
legal certainty and a possibility for rapid implementation
of the required measures in order to reflect the varying
scope and conditions of recapitalisation schemes.
The communication also recognises that fundamen-
tally sound banks should be included in recapitalisation
schemes so that they do not de-leverage their balance
sheets too much in a short period of time, but also main-
tains the need for caution, so as to ensure that schemes
are properly designed to achieve the objective of lend-
ing to the rest of the economy and avoid distorting
competition.
The communication also requires schemes to include
incentives for redeeming state capital once market condi-
tions return to normal. The Commission is only competent
to assess action taken under the state aid rules. This
means that its role in cases such as Fortis has focused on
safeguarding the above objectives in a situation of great
complexity, involving three different member states, and
of extreme urgency for the Belgian government.
How great a threat is protectionism, and is the
Commission prepared to get tough with member
states that flout EU rules?
Protectionism may be a threat, but we all share a respon-
sibility to avoid falling into this trap, which would result
in a decline in world trade. Finding a solution to the crisis
should, in my view, involve scaling up the regulatory proc-
ess in a way that preserves the dynamism and innovation
that comes from free competition.
Our experience so far shows that members states
acknowledge that a subsidy race is in noone's interest.
They clearly understand that the Commission is deter-
mined to apply the state aid rules. Until now, there has

‘Restructuring the
financial sector is
essential to ensure its
long-term viability’
been no need for the Commission to open the formal
investigation procedure, but in many cases discussions
with member states have resulted in plans being amended
or in the member state providing the Commission with
a series of undertakings before the scheme could be
approved.
What do you see as potential growth areas for the
financial services industry? Does the recent finan-
cial crisis represent an opportunity for innovative
companies?
The financial crisis might represent an opportunity for
banks that have managed their risks well and compa-
nies that have dealt with their problems promptly and
factually. Thanks to the substantial changes that the
Commission has made in the state aid rules over the past
few years, and providing member states meet certain
criteria, states can now give aid designed to meet certain
objectives specifically linked to improving the competi-
tiveness of Europe's economy, without having to notify
the Commission in advance. These include promoting
research, development and innovation and making risk
capital available to SMEs and start-ups.
The Commission has also approved a temporary frame-
work that opens up additional ways for member states
to provide access to finance for businesses in the real
economy and encourage them to continue investing in a
sustainable future. This framework allows member states
to increase the amount of risk capital that can be offered
to each SME to €2.5 million a year, and reduces the
percentage of this capital that must come from private
sources from 50 per cent to only 30 per cent.
Are we likely to see more mergers and greater market
consolidation?
The financial turmoil may have an impact on the global
structure of the financial services sector. In principle,
mergers and acquisitions can make a valuable contribu-
tion to the consolidation of the banking industry, with a
view to achieving the objectives of stabilising the financial
markets and ensuring a steady flow of credit to the real
economy.
If a financial institution falls victim to the crisis, the solu-
10
tion is sometimes for it to be taken over by a more stable
financial institution. Such a takeover will fall under EU
merger control, and the normal merger review principles
will apply. But the Commission will also take account of
the changing market conditions and, where applicable, a
‘failing firm’ defence.
Some member states may be uneasy about the restriction
on aggressive commercial behaviour of banks benefiting
from state aid. This restriction is not designed to hamper
the consolidation of the banking sector, but rather to
ensure that recapitalisations at excessively favourable
conditions do not lead to takeovers to the detriment of
non-recapitalised competitors.
Is there a need for a new EU Financial Services Action
Plan when the old one expires in 2010 and, if so,
what should this new plan focus on?
The Financial Services Action Plan was designed to create
a single market for financial services in the EU. It consisted
of a set of measures intended to fill gaps and remove
remaining barriers so as to provide a legal and regulatory
environment supporting the integration of financial mar-
kets. The Commission will have to assess the need for a
new Action Plan nearer the expiry date of the old one.
What is the outlook for the Single Market? Are
free market principles under threat? What is the
Commission’s long-term strategy?
The current global crisis has forced us to go back to
basics. Few people would dispute that markets must play
a key role if we are to maintain and extend our prosper-
ity. But governments may need to intervene and provide
better regulation, while still maintaining free competition.
This is the only way forward, and it’s the basis of our
long-term strategy.
Given the current financial markets, can EU countries
expect Competition Commissioner Neelie Kroes to be
more lenient?
The Commission accepts that the current crisis is excep-
tional and warrants an exceptional response. Clearly,
however, leniency on state aid rules would risk a disinte-
gration of the European Single Market for banking and
financial services and simply store up problems for later.
FSI magazine | #5 April 2009
As our commissioner has repeatedly explained, state aid
rules are part of the solution, not part of the problem.
I am confident that member states have by now realised
that a co-ordinated response to the crisis is the only way
forward.
Jean-Claude Trichet, Chairman of the European
Central Bank, recently said, 'We need a paradigm
change for the global financial system.' Do you agree,
and what contribution can the Commission make?
Changes are obviously needed if we are to deal with
the root causes of the crisis and avoid facing the same
problems in the future. The Commission is already tak-
ing steps to bring about the restructuring of the financial
sector, which is essential to ensure its long-term viability.
The independent High Level Group on financial supervi-
sion chaired by Jacques de Larosière will report to the
Spring European Council and make recommendations to
the Commission on strengthening European supervisory
arrangements.
The Commission’s Internal Market and Services
Department is also working on a communication that is
likely to address the supervision of the EU financial sector
(responding to the recommendations of the de Larosière
Group), regulation and overview of EU financial institu-
tions and markets, consumer and investor protection,
market transparency, the accountability and integrity of Irmfried Schwimann
market participants and international co-operation. Dr. Irmfried Schwimann is Director of the DG
Competition’s Financial Services unit, dealing with
antitrust matters and state aid. Mrs Schwimann
was previously Head of the Financial Services Policy
unit of the DG Internal Market and Services. Before
that, Mrs Schwimann worked in the unit dealing
with Retail Issues and Payment Systems within the
DG Internal Market and Services. And subsequently
in Commissioner Bolkestein’s Cabinet, where she
was responsible for financial services issues. Mrs
Schwimann studied law at the University of Linz
in Austria as well as political science at the Institut
d’Etudes Politiques in Paris. Before joining the
Commission, Mrs Schwimann worked for the Austrian
Ministry of Foreign Affairs and an Austrian Insurance
group.
11

How to reconnect with retail bank customers
Will
bank
branches
survive?
Every new technology prompts predictions of the
end of retail bank branches. Emerging channels
such as the internet, ATMs, self-service banking, call
centres and mobile phones have always triggered
questions about whether the 8,000 branches
in Belgium and the Netherlands can survive. A
Deloitte survey clearly shows that branches are here
to stay, providing banks adapt their branch and
channel strategies and focus on increasing customer
satisfaction.
12
I
By Patrick Callewaert,
Emeric van Waes and
n uncertain times it is crucial for banks to main-
tain a competitive market position. This may
Alexandre Gangji mean refocusing their customer and channel
strategies. The currently restricted availability
of capital means that both management and
stakeholders are demanding that strategic
decisions are underpinned by fact-based evaluations
of the alternatives. Although large amounts are being
invested in branches, do banks really know what their
customers want? Branch design and layout are clearly
part of the customer experience, but they are not the
most important differentiating factors for customers. The
Deloitte survey summarises customers’ experience and
levels of satisfaction with retail bank branches, while also
analysing the Belgian and Dutch retail markets and draw-
ing conclusions for branch strategies.
FSI magazine | #5 April 2009
Shifting paradigms
The retail distribution landscape is shifting from a branch-
dominated paradigm to one of integration and balance
between multiple channels. Nevertheless, the branch
remains a key channel for Belgian and, to a lesser extent,
Dutch retail banking customers. The new paradigm
demands a fundamental shift in the position and role of
the branch.
Importance of face-to-face contact
Our customer survey confirms that the branch is still
highly valued by Belgian customers. Although Dutch
branch visits are declining in favour of the internet, most
Dutch customers would not apply for complex products
entirely online.
The survey indicates that both Belgian and Dutch retail
customers demand face-to-face contact and will continue
13

Key findings in Belgium
Branches are still visited.
79% of personal and 89% of business customers visit their
branch at least once every 6 months, compared to 59%
and 84% using internet banking and 65% and 44% for
self-banking.
The internet is used for getting information on finan-
cial products, while visiting branches is the preferred
channel for buying and getting after-sales service.
71% of personal and 79% of business customers see the
branch as their preferred sales channel.
Most customers would not carry out complex transac-
tions or apply for complex products entirely via direct
channels.
72% of personal and 65% of business customers would
certainly not apply for complex products entirely online.
Most customers would like their banks to review their
financial positions and proactively propose relevant
offers to them.
80% of personal and 65% of business customers expect
more proactivity from their banks.
Some customers are even willing to pay for face-to-
face contact and professional advice.
23% of personal and 35% of business customers are willing
to pay for professional and personalised advice.
to visit their branches. However, they are not very satisfied
with the services provided by their current branch and
bank.
Better customer service and access
The survey highlights that customers are not satisfied with
branch services and access. The results are surprisingly
• More than 1 out of every 2 customers believe that
similar in Belgium and the Netherlands, although Dutch
customers are more negative about the current perform-
ance of the branches.
• Advice provided at the branch fails to satisfy 1 in
3 customers in Belgium and 2 in 3 customers in
the Netherlands
• Bank do not know their customers sufficiently
27% of personal and 30% of business customers in
Belgium and 62% of personal and 71% of business
customers in the Netherlands are not satisfied with
the quality and promptness of advice provided.
• Access to the branch is too limited
14
FSI magazine | #5 April 2009
Figure 1: Branch and channel strategies
Strategic Positioning Universal Bank Community Bank Discount Bank Direct Bank
Distribution Strategy Integrated Multi-channel Strategy Direct Channel Strategy
Key findings in the Netherlands Integrated Channel Not a Channel
In contrast to Belgium, branch visits in the Branch is part of a multi-channel strategy Branch is a physical presence
Netherlands are declining.
41% of personal and 45% of business customers visit
their branch at least once every 6 months, compared to
93% and 96% using internet banking
The internet is the key channel for getting informa-
tion on financial products and after-sales.
92% of SME customers and 90% of personal customers
see bank websites as the key channel for information.
Only 47% of personal and 30% of business customers
consider the branch to be their preferred sales channel.
As in Belgium, most customers would not apply for Branch Strategy Branch role Branch role
complex products entirely via direct channels. The branch manages customer relationships, provides The branch should be seen as a trust contributor. It is a
70% of personal and 60% of business customers would advice, completes sales of complex products and proc- physical presence that reinforces the branding of the
probably not or certainly not apply for complex prod- esses quality leads stemming from direct channels. Bank.
ucts entirely online.
Very similar to Belgium, most customers would like
their banks to proactively propose relevant offers.
Key succes factors Key succes factors
75% of personal and business customers expect more
proactivity from their banks. • Strong multi-channel capabilities • Key localisation of the branch
• People with right skills (advisors, experts, ...) • Ease and flexibility to make appointments across
• Appropriate selling approach channels
Similar to Belgium, some customers are willing to
pay for face-to-face contact. • Easy access and convenience • Close collaboration with the mobile sales force to
15% of personal and 23% of business customers are enhance reach
willing to pay for professional and personalised advice.
Customers demand
38% of personal and 41% of business customers in Banks will have to address these issues if they are to
Belgium and 27% of personal and 41% of business reconnect with their customers and control the churn.
customers in the Netherlands consider the opportu- According to our survey, more than 10% of personal and
nity for appointments outside office hours to be the
main area in which branches can improve.
over 12% of business customers intend to change their
main banks in the next six months.
face-to-face contact
banks act in their own interests One model does not fit all
and will continue to
50% of personal and business customers in Belgium
and between 50% and 64% of personal and business
Banks need to adapt their branch and channel strategies
according to their strategic positioning. Our analysis has
visit their branches,
customers in the Netherlands think that banks act pri-
marily in their own interests.
identified two groups of banks:
but are not satisfied
well, especially in the Netherlands
1. Universal banks and community banks
Universal banks and community banks need to imple-
with the services
50% of personal and 39% of business customers in
Belgium and more than 80% of personal and business
ment a multi-channel strategy that fully integrates
their branches
provided by their
customers in the Netherlands do not think that their
bank knows their history and current situation suf-
2. Discount banks and direct banks
In the discount bank and direct bank models, the current branch and
ficiently well. branch is seen as a trust contributor rather than a
bank
15

channel: it is used as a window to deliver brand prom-
ises and supplement the customer experience for
highly profitable customers.
Banks need to adapt
Our research also shows that customer needs and hab-
their branch and
its can vary dramatically from one country to another,
certainly between Belgium and the Netherlands. Belgian
channel strategies
customers value the relationships and advice they have
in face-to-face branch contacts much more than their
Dutch neighbours. In the Netherlands, the internet is the
key channel for getting information on financial prod-
ucts, with the branch channel playing a more supportive
role in closing the sale. This dissimilarity means the roles
and strategies for the branches in the Netherlands and
Belgium are different.
About the research
This article is based on the results of a quantitative
survey among 1,400 branch-banking customers in
Belgium and the Netherlands in summer 2008. The
aim of this research was to understand what cus-
tomers expect from their branches and how these
expectations will evolve in the future. It specifically
looked at primary customers’ likes and dislikes about
their branches. The answers to these questions have
far-reaching implications for retail banks in terms
of how they can improve the customer experience
at branches. The research covered all retail financial
institutions operating in Belgium and the Netherlands
and sampled personal and SME business customers.
The survey was conducted before the start of the cur-
rent banking crisis. It would seem safe to assume that
recent events will have further reinforced the threats
identified, such as low customer loyalty and lack of
confidence in banks, and reduced levels of trust even
more.
About the authors
Patrick Callewaert is a partner in Deloitte Belgium,
Emeric van Waes is a director of Deloitte Netherlands
and Alexandre Gangji is a Senior Manager at Deloitte
Belgium.
16
Column
Gains of the credit crisis
D
ay after day, doom scenarios are
paraded past us by a host of lead-
ing economists, now familiar TV
personalities. All repeat the same
message, and it isn’t a pleas-
ant one. Consumers “on strike”,
mounting inventories, zero growth and even total eco-
nomic seizure are what they predict. The year 2009 looks
unpromising indeed. The feed-through of bankers’ woes
to the real economy was fast, far faster than anybody
imagined. The sudden halt of economic activity has taken
us all by surprise and hit us hard.
Still, I’m not so pessimistic. In material terms, of course,
this is no picnic. But in less than a year, the crisis has
worked miracles. Some essential steps have been taken
and new conditions have been created to structurally
reshape our society. Let me mention a few.
From G8 to G20
Justice has come at last for those other powerful econo-
mies around the world. And recognition of the fact that a
country’s say in global affairs is determined not by politi-
cal tradition but by the economic facts on the ground. A
strong signal to the BRIC-countries, this also highlights the
reality that the world is One Open Economy!
New risk perspective
Risk management is no longer a national or regional mat-
ter, but will take place in an international playing field,
where the rules must be strictly and uniformly imple-
mented and monitored. This will leave no room for local
politicking, and provide more protection and transparency
for professional risk takers. Moreover, risk management
has made its way into the top tiers of organisations with
the appearance of independent CROs in company boards.
Sustainability
The mass capital destruction going on at the moment
is obviously unwelcome. But it is sobering, and should
lead to a better balance between quality and quantity,
an awareness that wealth isn’t everything, but stability is!
The same goes for our approach to the climate. The wild
FSI magazine | #5 April 2009
seesawing of oil prices – from $ 120 to $ 42 – is just a
taste of what’s in store as the world’s resources dwindle.
A wake-up call, if ever there was one, that we need to
innovate and to find new, global ways to deal with short-
ages based on fair sharing of energy and food.
Breakthrough projects
Given the gloomy economic outlook, economic stimu-
lus measures are high on the agenda of governments
worldwide. In China, hundreds of billions have already
been earmarked for public megaprojects in infrastructure.
Perhaps President Obama can give the US automotive
industry a boost by making clean energy the norm. This
would greatly speed up developments in hydrogen and
electric car technology. Meanwhile, the Russians, the
Indians, the Chinese, the Americans and the Europeans
are all separately staging trips to the moon, all five
nations in search of the same potentially limitless energy
resources.… Just think how much more they could harry@smorenberg.nl
achieve working together!
More self-reflection
Executives in the financial sector are very much in the
public eye, and the finger is easily pointed. Of course,
things have gone badly wrong. There were rules, but
not enough monitoring. People saw the risks, but were
also blinded by the potential profits. It’s only right that
financials and supervisory authorities should be called
to account. But the individual, the client, cannot be held
entirely blameless. All of us have contributed, directly and
indirectly, to the present stalemate. We’ve been living in
the era of “more and more” and need to begin an era of
“more together”. Of sharing wealth and better balancing
risks and rewards. Not only at home, but also between
groups, countries and continents. Over the years, the
imbalance between rich and poor has only grown. That,
too, is a kind of indebtedness that poses huge risks for the
future.
The current crisis, however serious, may turn out to be a
painful lesson in building a global society on more posi-
tive foundations. A society with more balanced priorities
when it comes to people, planet, power and profit.
17
 FSI magazine | #5 April 2009

UCITS risk management

under construction

T
By Patricia Goddet On 19 August 2008, he consultation is an attempt to
address current limitations in European
the Committee of legislation regarding collective portfo-

European Securities lio risk management, and forms part

of the European Commission’s broader
Regulators (CESR) issued efforts to revise the UCITS Directive,

a consultation paper
adding level-3 measures. In the paper, CESR proposes a
risk management framework and identifies principles and

on risk management elements essential to the risk management process. The

consultation was closed on 17 October 2008. The final
for ‘undertakings for level-3 text was published in February 2009. The princi-

collective investment in
ples will be complemented by a paper on the technical
and quantitative issues related to risk management.

transferable securities’ Legislation

(UCITS). Given the turmoil The current European legislation regarding risk manage-

in financial markets, a
ment for UCITS can be found in the UCITS Directive and
the 2004 Recommendation1. The UCITS Directive discusses

formalised and coherent procedures and internal control mechanisms at asset man-
agement companies (article 5), and risk management in
set of risk management the context of derivatives (article 21). Hence current legis-

principles for UCITS

lation focuses on the use of derivatives, and fails to look at
all the risks embedded in the investment process and the

can only be welcomed. portfolios.

Investment funds and With its consultation paper, CESR aims to introduce gen-

other types of investment

eral principles for dealing with all risks that UCITS investors
could be exposed to. These principles should in CESR’s

products have seen view apply to both asset management companies and
investment companies that have not designated a man-
their risk management agement company (self-managed UCITS). The principles

processes put to test -

relate to four key areas:
1. organising the risk management process

and some of them failed. 2. identifying and measuring risks relevant to the UCITS
3. managing these risks
4. reporting and monitoring

All principles are to be integrated into the company’s risk

management policy, supplemented at the company level
by supervisory principles guiding the review of risk man-
agement processes.

Supervision by the competent authorities

Commission Recommendation 2004/383/EC of 27 April 2004 on the
1
CESR proposes that the adequacy and efficiency of the risk
use of financial derivative instruments for undertakings for collective
investment in transferable securities (UCITS). management process be assessed by the

18 19

The risk management
function should also
provide support in the
valuation of illiquid assets,
structured securities and
complex derivatives
competent authorities as part of the licensing process for
the UCITS/company, and subsequently monitored on an
ongoing basis. Any changes to the risk management proc-
ess should also be assessed. The text does not specify any
transition regime. Obviously, already licensed companies
should be brought under this new proposal’s regime in
one way or another. The final level-3 text specifies that
appraisals carried out at the time of licensing the company
may be taken into account.
Governance
All the key principles are to be appropriately documented
and formalised in the company’s risk management policy.
The Board of Directors must approve and regularly review
this policy and will be held accountable for the risk man-
agement process in its entirety. The policy should specify
principles and methods for identifying risks, as well as
measurement techniques and tools deemed suitable for
the UCITS. These measurement techniques should be
both qualitative and quantitative, which might require IT
systems to be integrated with front office or accounting
applications.
Organising the risk management process
In CESR’s view, a sound risk management system places
demands on a company’s organisational structure. Besides
being adequate and proportionate, the risk management
process must be driven by a clearly identified and inde-
pendent risk management function. This risk management
function must perform according to minimum compe-
tence standards and be sufficiently separated from the
company’s front office functions. It must report directly
to the Board of Directors and Senior Management. In a
difficult balancing act, the company must maintain the
separation between the risk management function and
the front office, and at the same time embed risk manage-
ment in the investment process. The risk management
function and the front office are to operate very much in
parallel, enabling dynamic risk management rather than
just checks at predefined intervals.
To meet these organisational requirements, companies will
need people with the appropriate skills, knowledge and
experience, and this will represent a big human resource
challenge for the smaller players. But besides people, CESR
20
views processes and technology as equally important to
the success of the risk management process. Companies
may want to outsource some or all of their risk manage-
ment activities for efficiency reasons, a move that would
at the same time enhance the level of independence
between the operating units. However, this should be pre-
ceded by a thorough due diligence of the party delivering
the risk management services. And, obviously, the Board
of Directors still retains full responsibility. The final level-3
text puts even more emphasis on due diligence, and this
prior to entering an agreement, as well as on the compa-
ny’s responsibility to retain sufficient human and technical
skills to ensure a proper and effective supervision on the
way that the outsourced activities are carried out.
Identifying and measuring risks
The risk management process should define for all UCITS
the material risks arising from their investment objective
and strategy, the trading style and the valuation process.
CESR sees two main categories of relevant risks for UCITS:
financials risks and operational risks. Within financial risks
a distinction is made between market risk, liquidity risk,
credit risk and counterparty risk. Of the operational risks,
which are typically related to trading and settlement and
to valuation processes, only those are relevant that also
affect investors’ interests by their direct impact on the
UCITS’ portfolio. A UCITS may equally be exposed to risks
that emerge only at the aggregate level, such as concen-
tration risk or some forms of liquidity risk.
The identified risks should subsequently be translated by
the Board of Directors into a UCITS risk profile. This risk
profile must be reviewed regularly to allow for possible
changes to market conditions or the UCITS’ investment
strategy. The risk measurement framework as defined in
the policy must depend primarily on the characteristics of
the UCITS. This means that UCITS with a higher risk pro-
file may need more complex measures than plain vanilla,
low-risk ones. The final level-3 text goes even further and
specifies that investments in structured financial instru-
ments are to be preceded by a due diligence concerning
the characteristics and the overall risk profile of the under-
lying assets.
One of the very challenging specifications that CESR
includes in the consultation paper concerns the manage-
ment of model risk. Companies are to deal appropriately
with the possible vulnerability of their risk measurement
framework and submit it to continuous assessment and
revision. All techniques, tools and mechanisms are to be
adequately documented and extensively tested prior to
inception. This should include back-testing to demonstrate
the quality of the model-based risk forecasts, but also
stress-testing to capture the possibility of rare and severe
losses, or to fully understand the underlying assumptions
and so assess the validity range. The final level-3 text
has watered down the back-testing requirement, only
demanding back-testing where appropriate.
CESR also explicitly refers to the link between risk meas-
urement and asset valuation. As with every data tool, it
goes without saying that the ’garbage in, garbage out‘
principle also applies here. Risk measurement can only be
meaningful and useful if it is based on sound and reliable
data. The risk management function should also provide
support in the valuation of illiquid assets, structured secu-
rities and complex derivatives.
Managing risks
The risk management that CESR proposes focuses mainly
on ensuring that each UCITS’ risk profile as defined by the
Board of Directors corresponds with the actual level of
risks incurred by that UCITS. To this end, each UCITS must
have in place a risk limit system that is in line with the
UCITS’ investment strategy and that includes measures to
monitor and control the relevant risks. Indeed, CESR sug-
gests that every transaction must immediately be taken
into account in the calculation of the corresponding limits.
The final level-3 text even adds that these risk limits should
be linked with legal and contractual limits. Moreover, an
audit trail is to be constituted in case limits are exceeded.
For the risk management process to be effective, CESR
insists that the risk limit system must be supplemented
with a procedure for corrective action (triggered in the
event of a breach, to be executed within a predefined
timeframe) as well as a warning system that generates
corrective actions to prevent breaches.
Reporting and monitoring
CESR suggests introducing different risk reports for dif-
FSI magazine | #5 April 2009
ferent levels within the organisation. Senior Management
and the heads of the operational departments should
receive regular internal risk reports. Written reports should
be submitted to the Boards of Directors on the alignment
between the realised risk profile and the target profile of
the UCITS. The risk management process should be sub-
ject to independent internal or external supervision.
CESR’s best practice is challenging from A to Z
In the light of the recent turmoil in financial markets, a
formalised and coherent set of risk management principles
for UCITS can only be welcomed. Investment funds and
other types of investment products have seen their risk
management processes be put to test - and some of them
failed. The proposed framework comes close to what a
good housekeeper’s risk management process would look
like. It is not rocket science; the principles set forward are
well tested in the banking industry.
The final level-3 text has added here and there the
notions of proportionality and materiality. The former
mainly at the level of the risk process and policy, the
latter at the level of risk identification. One could still
question, however, whether all the proposed measures
are relevant to all UCITS, and whether they are always
proportional to the size and complexity of the activities
and organisation of the UCITS management company.
On top of that, the more stringent requirements could
fuel competition between UCITS and other investment
products. Sometimes, similar or indeed the same invest-
ment objectives can be achieved with (retail) investment
products that are subject to totally different regulatory
requirements.
Respondents to the consultation also see a significant
additional burden in funding promoters and investment
managers, without comparable investor benefits, which
only results in longer timeframes and higher costs for About the author
investors. Moreover, the proposed measurement frame- Patricia Goddet is
work introduces challenges to the system, ranging from Manager at Deloitte
reconciliation matters where interfaces exist between Enterprise Risk
accounting and front office systems, to transparency Services, Belgium
issues with vendors of off-the-shelf data tools. None of For more information:
these issues have been addressed in the final level-3 text www.cesr-eu.org
as published in February 2009.
21

Regaining consumer confidence after the credit crunch
Only strong and trusted
brands will survive
The real and fundamental challenge
currently facing the financial services
industry is how to restore consumer
confidence. Yet a lot more than a
traditional, integral branding strategy
will be needed to create strong and
trusted brands. Co-innovation means
ultimately also creating brands in an
open dialogue.
T
By Pieter Vijn he forced nationalisation of once
proud and all-powerful financial insti-
tutions, historically low interest rates
and government backing for hundreds
of billions’ worth of bank loans mean
we are currently witnessing attempts
on an unprecedented scale to rescue the world’s financial
system and, with it, the global economy. Although these
rescue plans are necessary and mainly robust, they do
not address the real and fundamental problem facing
the financial services industry. In other words, the total
collapse of consumer confidence. Indeed the biggest chal-
lenge in the wake of the credit crunch is how to rebuild
the general public’s trust in our financial institutions.
Rebuilding strong and trusted brands
Restoring confidence means that only strong and trusted
brands will survive. Although a brand is an asset that is
hard to measure and truly intangible, corporate history
and compelling academic evidence show that brands have
a very real and positive impact on financial parameters
such as companies’ profits, returns on investment, mar-
ket shares and stock prices. On top of that, strong brand
companies like Coca-Cola, IBM, General Electric, Procter
and Gamble and Wells Fargo have proven they can out-
perform their peers in their innovativeness, their risk
protection capabilities and their ability to attract talent.
22
Rebuilding strong and trusted brands will also force finan-
cial institutions to shift their focus from quarterly results
and short-term profitability – the true evil at the root of
the current financial and economic crisis – towards long-
term, sustainable profitability. Strong and trusted brands
can only be created by investing in customer loyalty (are
your customers willing to forgive you?) and a strong
corporate culture. And both of these take a long time to
create, but can be destroyed overnight. Needless to say,
customer loyalty and a strong corporate culture have a
positive correlation with cross-selling ratios and custom-
ers’ willingness to explore brand-stretching activities such
as those of Tesco Finance.
Restoring the general public’s confidence and rebuild-
ing strong and trusted brands are challenges not to be
underestimated by any financial institution. Nowadays
most stakeholders’ associations with the financial services
industry are purely negative. To them, CEOs and CFOs
have become the personification of unreliability, arro-
gance, greed and a closed community. The captains of
the banking industry are unfriendly, do not care and will
not listen.
Integral corporate branding strategy
The traditional and 'quick' method for turning these
negative images around is to develop and execute an
integral corporate branding strategy, where the goal is
to affirm and strengthen stakeholder identification with
strong and trusted brand drivers such as wise, in control,
caring, straightforward, friendly, desirable, assertive,
generous and innocent.
The first step in designing such a strategy is to perform
a stakeholder analysis. What are the current views of
various stakeholders, such as employees, customers
(current, lost and future), financial analysts, politicians,
trade unions and the general public, on these drivers?
The aim of this analysis is to identify the aspects that will
have most impact in changing perceptions in the desired
direction.
An integral corporate branding strategy is then devel-
oped on the basis of this analysis. What intertwined sets
of internal and external branding and communications
FSI magazine | #5 April 2009
Customer loyalty and a
strong corporate culture
have a positive correla-
tion with cross-selling
ratios and customers’
willingness to explore
brand-stretching activi-
ties, such as those of
Tesco Finance, UK’s larg-
est supermarket bank.
are needed to create positive stakeholder identification
with an affirmation of the trusted brand drivers?
Redesigning business models
Yet although an integral corporate branding strategy is
certainly an essential part of regaining consumer confi-
dence, it will not be sufficient in itself. The only way to
achieve this goal is to redesign business models and cre-
ate true customer centricity.
By implementing multi-channel strategies and creating a
single customer view, the early adopters in the financial
services industry have taken the first steps towards these Rebuilding strong and
new business models. The true challenge for them, and
others, will be to create open structures, where outside- trusted brands will force
in thinking is the norm rather than the exception and
customers are involved in the business operations them-
financial institutions to
selves. Co-innovation and co-creation will be facilitated by shift their focus from
web2.0 technologies such as social networking, peer-2-
peer banking, user communities and blogs. short-term profitability –
You don’t own your brand
the true evil at the root of
The defining feature of these technologies is that they the current financial and
create an open dialogue instead of facilitating top-down
communications. Financial institutions will need, however, economic crisis – towards
to open up if they are to benefit from these opportunities.
A corporate culture of humility and vulnerability and a
sustainable profitability
genuine ability to listen are necessary if equal interaction
with the consumer is to be possible.
These financial institutions’ operations and activities will
be driven by real, manifest and latent consumer needs
and motives. In this way, brands will reclaim their role of
creating sustainable satisfaction and wealth for custom-
ers and other stakeholders, and thus for the society as a
whole in which they exist.
Ironically, creating openness and adaptability as a means About the author
of rebuilding strong and trusted brands will require a will- Pieter Vijn advises companies on corporate brand-
ingness on the part of the brand owners to let go of their ing and innovation strategies. He is also part-time
obsessive control of their brands. Co-innovation means Professor of Branding & Integrated Marketing
ultimately also creating the brand in an open dialogue. Communication at Nyenrode Business University in
Or, as Procter & Gamble’s CEO Lafley puts it, ‘We don’t the Netherlands. Prof. Vijn can be reached at
own the brand, the brand is owned by the consumer.’ pieter.vijn@quicknet.nl.
23
 FSI magazine | #5 April 2009
Foreign retail banking opportunities in China:

High hopes,
low expectations

W
What scope do ith its 1.3 billion inhabit-
ants and strong economic

foreign banks growth prospects, China is

currently a very interesting

have to develop country for foreign finan-

cial institutions. Following

operations in the political reforms of 1978, the banking sector, which

until then featured only one bank, became a dynamic

China, and how market with hundreds of players. In retail banking, China
now boasts four state-owned banks, joint stock banks,

fast can they do city commercial banks, small rural and urban credit unions
- and foreign banks. The state-owned banks have long

so? That is largely dominated the market, but are operationally weak, while
the more advanced joint-stock and city commercial banks

up to the Chinese
are strong, but only in their respective regions. Although
given permission to offer renminbi products in 1996,

government, a
foreign banks were at first only allowed to do business
with foreign firms and foreign individuals. Gradually, they
were allowed to offer a broader range of products and
recent study reveals. from 2006 onwards, they have also been allowed to offer
renminbi products to Chinese consumers. Over the last
Foreign players two years, 30 foreign banks have set up shop in China,
competing directly with Chinese banks in a number of
who already have services, including retail banking for the Chinese popu-
lation. The standard products and services offered by

or aspire to a role banks in China are basically the same as in the rest of the
world, but demand has to date been very much focused

in the Chinese retail on deposits and cash withdrawals. Mortgages, con-

sumer loans and credit cards are still in their infancy. For

banking sector example, only three percent of banking customers have

mortgages. Credit cards are swiftly gaining popularity, but

must be realistic customers use them only as a convenient way of paying

and not as a form of credit.

about what they Opportunities for foreign banks

can achieve in the Despite the relaxation of restrictions for foreign banks in
China’s retail banking market, they have as yet captured

People’s Republic. just a modest market share (2.4% in assets at year-end

2007). Their focus has been on high-end customers in
the wealthiest cities, which makes sense, given their lack
of a branch network. But their low market penetration
is also partly due to rules introduced by the government
to fight ‘uncontrolled competition’. These include capital
By Haico Ebbers and and liquidity requirements, and make life very difficult for
Harry Smorenberg foreign banks.

24 25

Figure 1: Chinese spending power is on the rise
This article is based on a study recently conducted by
Nyenrode Business University’s Europe China Institute and
Smorenberg Corporate Consultancy (see box). The study
shows that the trends influencing and ultimately shaping
the Chinese retail banking sector are:
• the emerging middle class
• the incremental use of technology
• deregulation and the role of the government
• intensifying competition
In particular, the emergence of a Chinese middle class
and technological progress could create opportunities
for foreign banks. To overcome the immense network
advantage of the state-owned banks in China, foreign
banks need to find creative distribution channels to
serve the mass market. This is where technology could
help: you don’t need a branch network for internet and
mobile banking. And as the middle class grows, demand
increases for a wider range of more sophisticated services
and products - which foreign banks are much better at
delivering than state-owned banks. Another advantage
is that China’s emerging middle class is relatively young.
This growing body of young, demanding customers with
a more open mind to new technology creates high hopes
for foreign banks.
Key trends in the Chinese retail banking sector
Booming prosperity and the fast-growing number of
26
households ranking as middle class are trends that will
change the face of retail banking in China. Figure 1 shows
the rapid growth of spending power.
With the emergence of a middle class, retail banking is
gaining importance in China. Apart from the fact that the
middle class is getting bigger, trends within the middle
class are highly relevant in this context. The distribution of
wealth is higher over younger age groups in China than
in developed countries. The country’s one-child policy,
along with growing prosperity, has spawned a genera-
tion more demanding when it comes to service and
convenience. Chinese consumers, the study reveals, are
in general rather disappointed in the service offered by
Chinese banks. Moreover, there turn out to be consider-
able differences within this middle class. All this implies an
increasing need for customer segmentation.
Another key trend the study identifies is technology. In
general, there is a close correlation between technology
used in a sector and efficiency in that sector. State-owned
banks are keen to implement the latest technology in
order to improve their operational efficiency. Other play-
ers in the market are focusing on technologies such as
internet banking and mobile banking to enhance their
accessibility for customers. Although the penetration
of internet and mobile phones is rising swiftly (in 2008,
China became the country with the world’s largest
number of internet and mobile phone users), the use
of internet for banking services is not catching on. The
study shows that this is due to a lack of trust in the safety
of internet. Despite the government’s indication that it
wants to make rural areas more accessible as a big poten-
tial market through internet and mobile banking, this
reluctance among the population to use the latest tech-
nology for banking activities remains a hurdle for foreign
banks. Furthermore, it should be borne in mind that some
technologies that are common in the developed world
have barely begun to conquer China. To some extent, this
is culturally driven: of all payment transactions in China,
83 percent is done in cash.
A third key trend is intensifying competition. This is
reflected in the increasing number of players active in
the Chinese retail banking sector. In the battle for mar-
ket share, technology is a double-edged sword: it can
increase convenience for customers while at the same
time reducing operating costs for the banks. Eventually,
competition will lead to smaller margins for banks operat-
ing in China.
Key findings
So the emerging middle class and the incremental use and
improvement of technology will shape the future of the
sector, but to what extent will this create opportunities
for foreign banks operating in China?
FSI magazine | #5 April 2009
With the emergence
of a middle class,
retail banking is
gaining importance
in China
First, the trends in and features of the middle class make
it necessary to segment the market, and to focus on bet-
ter service and more efficient operations. State-owned
banks, too, now realise that they cannot treat the mass
market as one segment. For example, the Bank of China
appointed a team to conduct a study into the demands,
behaviour and preferences of different segments of the
mass market. Eventually, the product range of these state-
owned banks will cease to differ significantly from that of
foreign banks. There is little that foreign banks can offer
that Chinese banks cannot. Trust in the bank is essential,
and therefore no mass shift of customers to other banks
is foreseen. Meanwhile, regulatory restrictions make it dif-
ficult for foreign banks to expand quickly. Consequently,
foreign banks will remain focused on foreign customers
and high net worth individuals. Some respondents to
the researchers’ survey cite the banking sector in Japan
and the telecom and computer equipment sector in
China as cases in point: foreign players in these sectors
invested huge amounts of money, brought in all kinds of
technologies and all their experience with the purpose of
capturing a sizeable chunk of the middle–class consumer
market, but they all failed. After a struggle of decades,
local companies now control over 95% of the market in
those industries.
Second, although technology makes it possible to enter
the mass market, and a branch network is not essential
27

Figure 2: Influence of the Chinese government on banks and effect of this influence
Internal
Influence of the
goverment
foreign banks
External
Negative Effect of the influence of the goverment
thanks to internet and mobile banking, in China face-to-
face contact is of overriding importance. It relates to trust,
which is everything to the Chinese. While some people
are convinced that internet will be the main platform for
tomorrow’s retail banks, this is not likely to happen in
China in the medium term. Apart from the Chinese prefer-
ence for doing business face to face, another major hurdle
is the government’s firm grip on market forces. For exam-
ple, the competitive advantage of direct banking is a low
price, but because internet rates are fixed, it isn’t possible
to compete on price in China. And this won’t change any
time soon.
Third, Chinese banks are changing. While only five years
ago, all the big banks offered about the same service,
now there is more differentiation. The government is
very much behind this. Its primary drive is to improve the
operations of the Big Four. Competition is needed, the
idea is, but only to a certain level. Meanwhile, branches
in rural areas are being closed, signalling the beginning of
consolidation. All in all, there is strong consensus among
respondents to the survey that in the foreseeable future,
state-owned banks will remain the only banks to cover
the whole of China.
Government as restrictive factor
The above makes clear how important the government’s
role is in the Chinese retail banking sector, and conse-
quently its role in shaping the environment for foreign
banks in China. Government actions are the main reason
why the activities of foreign banks are still relatively mod-
est and why further growth is difficult.
While governments around the world are currently look-
28
state owned banks
non state owned banks
Positive
ing for ways to regain control of the banking sector, China
never lost control of its banks. The Chinese government
has a controlling stake in the country’s four largest banks
and is involved in many joint stock and city commercial
banks. This is not surprising, since the banking sector is
not yet ready for a market-based structure. The govern-
ment uses the four state-owned banks to develop the
country and distribute wealth. There is some movement
towards relaxing regulations and reducing government
interventions in the banking sector, but over the last dec-
ade the pace of deregulation has been extremely slow.
And expectations are that the current financial crisis will
only make it slower.
Many reports on banking in China describe deregulation
as a big opportunity for foreign financial institutions in
the Chinese retail banking sector. The study presented
here does not deny this, but it does show that the impor-
tance - indeed decisiveness - of the Chinese government’s
role tends to be underestimated. After all, the Chinese
government not only manages the sector through regu-
lations, but actually still has a majority stake in the four
largest banks. Moreover, it conducts micro-economic
policy by influencing banks’ management: almost all bank
managers are party members and many top managers
are also government officials. Respondents explained
that in practice, it was common for the management of
Chinese banks to give priority to party/government policy
over pursuing a business strategy of its own. There was
consensus among all respondents that government regu-
lation is the main reason why foreign banks still have only
relatively small operations in China. Figure 2 shows how
different players in the Chinese retail banking sector are
influenced by the Chinese government.
FSI magazine | #5 April 2009
Conclusion
The Chinese retail banking sector is set to grow in size and
relevance, and will certainly offer opportunities for foreign
banks. However, foreign banks should not underestimate
the decisive influence that the Chinese government has on
their freedom to operate and what they might achieve in
the Chinese market. Foreign banks are allowed to operate
in the market and are invited to help develop the Chinese
retail banking sector. As long as they contribute to this
government policy, they enjoy relative freedom. However,
the Chinese government is not likely to allow a large share
of such an important sector as banking to be managed by
non-Chinese parties. Banking is regarded as the backbone
of the Chinese economy, and a key instrument in achiev-
ing economic goals.
Analysis of China’s retail banking sector
Nyenrode Business University’s Europe China Institute
and Smorenberg Corporate Consultancy launched a
joint research project to analyse China’s retail bank-
ing sector and the opportunities there for foreign
banks. Having identified the key trends in this sector,
they asked 15 experts – employees of foreign banks
in China and Chinese banks, as well as independent
Government banking specialists from the academic world and the
consultancy industry – how these trends would influ-
intervention is ence the Chinese retail banking sector and its players.
There was consensus about the key factors shaping
the main barrier the future of retail banking in China: the emergence
of a demanding middle class, deregulation measures
to penetrating and the incremental use of technology will certainly
affect the environment in which foreign banks will
the Chinese retail operate in China. But government intervention
remains the main barrier to penetrating the Chinese
banking market retail banking market, and this will not change in the
medium term.
The study was carried out by Gerard Baan and
Wilbert van den Brink under the auspices of professor
Haico Ebbers and FSI Strategist Harry Smorenberg. An
executive summary is available on the website of the
Europe China Institute: www.nyenrode.nl/ECI.
29
Banking
FSI magazine | #5 April 2009

Mix the talent of young

photographers and the
charisma of CEOs of
major Polish financial
institutions, and what

leaders
do you get? “Business in
focus – 2008 banking
leaders”, a creative
initiative connecting two
worlds: business and art.

caught in T
he project kicked off with a contest
for young Polish photographers. The
three winners were given the challeng-
ing task of portraying 20 CEOs of the
biggest financial institutions in Poland
in two roles: professional and private.

the lens
The double portraits of the banking leaders were accom-
panied by interviews, led by Deloitte FSI partners. The
interviews reveal each CEO’s individual approach to both
business and non-business related challenges.

Remarkable life stories

The CEOs of the Polish financial sector accepted the invi-
tation with great enthusiasm and some curiosity. They
devoted their precious time to giving long, intimate inter-
views, opening wide the doors to both their offices and
their homes. They told remarkable stories from their pri-
vate and professional experience: stories of their struggles
By Sylwia Jackowska and to achieve success, learning from the market and surviving
Halina Frańczak its ups and downs, but also stories of pure joie de vivre,
and of private dreams and ambitions, fulfilled and yet to
be fulfilled. And they participated with real commitment
in the photo sessions, which resulted in original and sug-
gestive portraits of great people seen through the lenses
of young artists. Together, the amazing and unique life
stories and the lively and passionate images constitute a
wonderful album that captures the reality of 2008 bank-
ing and its Polish icons.

Creativity versus the downturn

Józef Wancer, CEO of Bank BPH, is one of the banking
leaders portrayed. Why did he participate? ‘I was fasci-
nated with the idea of fishing for photographic talent
through a photo contest. Moreover, showing banking
leaders from both a professional and a personal perspec-
tive is a great concept. It has generated optimism and
creativity. Something we need more than ever nowadays,
as the financial sector faces a downturn and the media
persist in painting black scenarios.’

30 31
 FSI magazine | #5 April 2009

A creative initiative
connecting two worlds:
business and art

Photos by Małgorzata Pytel

From left to right:
Mariusz Grendowicz, CEO Bre Bank
Jerzy Pruski, CEO PKO PB
Piotr Kamiński, CEO Bank Pocztowy
Włodzimierz Kiciński, CEO Nordea Bank
Sławomir Skrzypek, CEO National Bank of Poland
Sławomir Lachowski, former CEO Bre Bank

Business in focus
“Business in focus – 2008 banking leaders” is an initiative
of Deloitte Poland, realised jointly with the Commitment
to Europe Arts & Business Foundation and the Harvard
Business Review Polska. The portraits of bank CEOs were
exhibited during a vernissage on 25 November 2008
at the Zachęta National Gallery of Art in Warsaw. This
event was attended by numerous chairmen and board
members of Poland’s largest banks and representatives
of the world of finance and culture, including the Polish
Ministries of Finance and Culture. All the photographs
and interviews have been published in an exclusive
album. The proceeds will go towards scholarships
awarded to young, gifted fine art photographers.

More information: www.bizneswobiektywie.pl, Sylwia

Jackowska (sjackowska@deloitteCE.com), PR/Marketing
Manager Deloitte Poland, Halina Frańczak (hfranczak@
deloitteCE.com), Marketing Director Deloitte Poland
or Matthew Howell (mathowell@deloitteCE.com),
Marketing Director Deloitte Central Europe.

32 33
 FSI magazine | #5 April 2009

‘Banking is
the love of
my life’
How did you get into banking? You’ve had wide-ranging banking experience in sev-
You could say I got into banking by coincidence because, eral countries
as a little boy, I wanted to become a doctor. I moved to The American management style taught me that added

Born in a Siberian labour camp in World the United States in 1961, right after my final high-school
exams. I had only five dollars in my pocket and started
value should be the key objective. It’s certainly the key
objective for clients, including those in the banking

War II. Moved to the United States in the

working in a factory. My superiors wanted me to become industry. Banks in the United States do not see large cor-
a mechanic, but instead I joined the army. After military porations as their key clients, but rather retail customers
service I returned to the factory, but I knew then that and small businesses. A typical John Doe has the greatest

early 1960s with only five dollars in his being a mechanic was certainly not for me. That’s why
I started looking for a new job, preferably in an interna-
influence on the domestic economy and life as a whole.
We need to listen to people and understand their needs.

pocket. Now a citizen of the world and CEO

tional organisation. I was hired by the Foreign Operations
Department at Citibank. The department’s job was to That must have been quite a surprise for you, com-
analyse mistakes made by individual employees and com- pared to what you had experienced in Poland?

of Bank BPH. A portrait of a Polish banking plaints filed by clients in Asia and Europe. That job was a
quick lesson in banking for me. Alongside my regular job,
Huge queues to the cash register are what I remember
from the 50s and the 60s in Poland. Customers had no

pioneer, Józef Wancer.

I took university evening classes. That was the most essen- rights, they were just petitioners. I remembered all of
tial period of my life. I was impressed by the individualism this in the 90s when I returned to Poland. No-one talked
of Americans and by them being so driven by success. about customers, but everyone knew the word.

34 35

That reminded me of the 60s in the United States. Each
generation in America has its traditions; changes have to
be implemented step by step. However, the changes that
took place in Poland after 1989 were more radical and
rapid. Some of them happened from one day to the next.
Multinationality has become part of your life. What is
your personal identity?
I regard myself as a citizen of the world. I’ve lived in so
many places that moving to another country is not a
problem for me. I easily assimilate and get used to places,
but I’ve also faced situations that were completely unac-
ceptable to me. As an American soldier based in Germany
I came across extreme racism among soldiers who were
members of the Ku Klux Klan. Moving to the United
States and then returning to Poland was the best thing
that ever happened to me.
36
What are your plans for the future?
I’ve decided to have three more years running the bank,
and then I’m going to slow down. I’m going to remain
active, but I’ll no longer be working ten to twelve hours
a day – that’s something I’ve promised my wife and
children.
What are you going to do then?
I collect documents from the Second World War and have
a small but interesting collection of papers about the lives
of Polish and other European Jews during the holocaust.
I’d like to trace the families of some of these people
and see if anyone is still alive. I would also like to spend
time renovating Asian furniture, for example, particularly
Japanese. My wife says I’m no good with my hands, but
she forgets that I worked in a factory for two years. The
third thing I plan to do is to continue in business as a
consultant or as a member of a supervisory body. I could
do that from time to time, on a project basis. My true
hobby is travelling, though. I’m leaving for China soon,
but I’d also like to go to Tanzania, New Zealand and South
America.
Are you able to maintain the right work-life balance?
Maintaining the right work-life balance is not easy for
me because I’m a workaholic – just like my father was.
However, I’m not really addicted to work. I’ve managed
to combine my work and personal life, mainly because my
family is very understanding. I do my best to spend all my
free time with them. Once I leave the office I just need a
couple of minutes to forget about my professional prob-
lems. To relax, I go for walks on weekdays and ride a bike
during weekends, particularly in the summer. In winter I
go skiing. I exercise every day, as my doctors recommend.
I also enjoy painting, particularly Polish painting from
the 1920s and 30s. Going to auctions is something that
gives me a great deal of pleasure. And lastly I enjoy music,
especially classical music.
FSI magazine | #5 April 2009
What is your recipe for success in banking and your
personal life?
The recipe is like a doctor’s prescription. It depends on
‘My true
the doctor and the patient. First of all, you need to have
a vision and a goal in life. You need to choose your path
hobby is
and know what you want to achieve. Secondly, you have
to be optimistic in both business and your personal life. I
travelling’
was born in a labour camp in Siberia during the Second
World War. My family survived five years of traumatic
experiences. Despite that, my parents were still extremely
enthusiastic about life and still believed it was beautiful.
Another thing you need is trust in other people.
Do you regret not becoming a doctor?
I have a lot of respect for doctors. I admire their knowl-
edge and huge responsibility for human health and life.
But nevertheless, I have no regrets that my career turned
out differently. Banking is the love of my life.
37

I
ncreasingly stringent rules are already in the
process of being implemented. On 1 October
2008, for instance, the European Commission
proposed introducing more demanding capital
requirements for banks. And more is likely to
follow. So, after the dust has settled, what will
the new regulatory landscape look like? We will endeav-
our to shed some light on that question by looking at the
most important recent contributions to the debate about
the future of financial regulation and supervision.
Risk, liquidity and capital management
An early assessment of the ‘lessons learned’ in the wake
of the credit crisis was published in March 2008 by the
An industry that already faces intense regulatory scrutiny is likely to face more
Senior Supervisors Group (SSG), a consortium of regula-
Financial crisis changes the
tors from France, Germany, Switzerland, the UK and the
US. The Group’s recommendations, based on a survey
of 11 global banking organisations and securities firms,
mainly focuses on the improvement of risk measurement
regulatory and supervisory
and management and of liquidity and capital manage-
ment. The report makes a strong case for the need to
enhance risk management in general and liquidity risk
management in particular.
landscape The SSG has identified four risk management practices
that made the difference between firms heavily affected
by the crisis and those able to weather the storm with
lesser damage:
• Effective firm-wide risk identification and analysis
• Consistent application of independent and rigorous
By Gert-Jan Ros, valuation practices across the firm
Frank De Jonghe and • Effective management of funding liquidity, capital and
Caroline Veris the balance sheet
• Informative and responsive risk measurement and
management reporting and practices
When will the financial crisis end? What will be its final impact? Starting from these best practices, the SSG also makes
As the crisis continues to escalate, these questions are becoming
a number of suggestions for the revision of Basel 2, the
framework regulating banks’ risk and capital manage-
harder to answer. However, there is little doubt that the present ment. Proposed reforms include increasing capital charges
for securitised assets and strengthening liquidity risk man-
turmoil will radically change the regulatory and supervisory agement, but also encouraging firms to simply develop
landscape. An industry that already faces intense regulatory
better, firm-wide risk management. Thus, the SSG report
notes: ’In firms that experienced greater difficulties, busi-
scrutiny is likely to face more. ness line and senior managers did not discuss promptly
38
FSI magazine | #5 April 2009
among themselves and with senior executives the firm’s
risks in light of evolving conditions in the marketplace.
This left business areas to make some decisions in isola-
tion regarding business growth and hedging, and some
of those decisions increased, rather than mitigated, the
exposure to risks.’
Since the publication of the SSG report, a number of
the recommended reforms have already been put into
practice. On 1 October 2008, the European Commission
(EC) announced its proposals for changing the Capital
Requirements Directive (the EU version of Basel 2), to
include more stringent liquidity requirements for banks
operating across the EU and improved risk management
for securitised products. Further revisions of Basel 2 are
likely to follow, both on the EU and on the international
level.
Nevertheless, it is at present far from clear whether the
regulatory response in the domain of risk and capital man-
agement will be limited to fine-tuning or re-calibrating the
existing framework, or whether a more substantial over-
haul of the approach is in the cards.
Senior Supervisors’ Group:
‘In firms that experienced greater difficulties, business
line and senior managers did not discuss promptly among
themselves and with senior executives the firm’s risks in
light of evolving conditions in the marketplace.’
Accounting rules
Accounting rules have been hotly debated since the
beginning of the financial turmoil. Bankers have come
to argue that a new bookkeeping rule requiring them to
value their assets at market prices – also known as fair
value accounting – has had a devastating effect on their
balance sheets, and has therefore helped intensify the
financial crisis. Other stakeholders argue that a loophole
in the accounting rules, allowing banks to move large
amounts of assets off their balance sheets, was partly
responsible for the escalation of the crisis.
39

Figure 1: Overview of recent EU regulations
UCITS 3 E-Privacy IFRS Solvency II
Directive
CDR Transparency
Directive Directive
2002 2005 2007
Financial
Conglomerates
Directive
SOX Market 3rd AML MiFID Reinsurance Revision of EU Committee
Abuse Directive Directive
Directive
• The above illustration offers an overview, albeit not a comprehensive one, of recent EU regulations influencing the European financial services
industry.
• The timeline indicates when a regulation was or is due to be approved; in blue are regulations now being discussed by the EU.
In response to the worsening of the crisis in the early fall,
the US Securities and Exchange Commission (SEC) and
the Financial Accounting Standards Board (FASB) gave
US financial institutions the green light on 1 October of
last year to disregard the prices paid for assets in a forced
liquidation in computing the ‘fair value’ of their own
assets. This clarification of fair value accounting has since
been accepted by the IASB and the EC. On 13 October,
moreover, the IASB announced a change in its accounting
rules which allows IFRS-compliant financial institutions
to reclassify certain financial instruments in the case of a
‘rare event’. This change – prepared in record time by the
IASB and adopted by the EC two days later – was meant
to create a level playing field for European financial insti-
tutions vis-à-vis their American counterparts, who enjoy a
similar ‘rare event’ exception under US GAAP.
But more changes in accounting standards are under way.
In March 2008, the International Accounting Standards
Board (IASB) and the Financial Accounting Standards
Board (FASB) released a joint discussion paper, “Reducing
Complexity in Reporting Financial Instruments”, which
proposes far-reaching changes to IAS39, the account-
ing rule setting out the requirements for recognising and
measuring financial assets and liabilities. This paper will be
used as a starting point for the reforms to be proposed by
both the IASB and the FASB in the months to come.
40
Revision of
CDR Directive?
Payment Directive
Services on Credit
Directive Agreements
2010
IAS 39? of Supervisors? UCITS 4?
Supervisory structure
In view of the unprecedented severity of the financial cri-
sis, the debate has not stopped at rules and regulations as
such. The structure of financial supervision itself is coming
under discussion. A recent report by the G30 Regulatory
Systems working group, a think tank, frames the upcom-
ing debate over reform of the world’s financial services
regulatory systems in the context of existing structures,
their various strengths and their implicit weaknesses. In
the report, Paul Volcker, Chairman of the G30’s Board of
Trustees notes: ‘It is evident that a number of countries
need to revise and reform financial regulatory structures.’
Paul Volcker, Chairman of the G30’s Board of
Trustees:
‘It is evident that a number of countries need to revise
and reform financial regulatory structures.’
The report assesses the four approaches to financial
supervision currently employed across the globe. It
describes the key design issues of each supervisory model,
illustrates how each has been implemented in practice,
and assesses the strengths and weaknesses of each
approach.
FSI magazine | #5 April 2009
Institutional: A firm’s legal status (for example, a bank,
broker-dealer or insurance company) determines which
regulator is tasked with overseeing its activity from both
a safety and soundness and a business-conduct perspec-
tive. The jurisdictions reviewed that use the institutional
approach are China, Hong Kong and Mexico.
Functional: Supervisory oversight is determined by the
business that is being transacted by the entity, without
regard to its legal status. Each type of business may have
its own functional regulator. The countries reviewed that
use the functional approach are Brazil, France, Italy and
Spain.
Integrated: A single universal regulator conducts both
safety and soundness oversight as well as conduct-
of-business regulation for all the sectors of financial
services industry. The countries reviewed that use this
approach are: Canada, Germany, Japan, Qatar, Singapore,
Switzerland and the United Kingdom.
Twin peaks: A form of regulation by objective, in which
there is a separation of regulatory functions between
two regulators: one that performs the safety and sound- Group of Thirty
ness supervision function and the other that focuses The Washington, D.C.-based G30, founded in 1978,
on conduct-of-business regulation. The two countries is an international body of former central bank gover-
that use the twin peaks approach are Australia and the nors, leading economists and private financial sector
Netherlands. specialists. In the fall of 2007, the Group of Thirty
established a Financial Regulatory Systems working
The US fits into none of these categories. Its structure is group to address the large changes in the world of
functional with institutional aspects, with the added com- financial reviews.
plexity of a number of state level agencies and actors.
The Deloitte Center for Banking Solutions and
The study claims that no simple correlation exists Deloitte’s Regulatory & Capitals Markets Consulting
between the supervisory approach adopted in a jurisdic- supported the G30 study on the structure of financial
tion and effective supervision during a financial crisis supervision. Deloitte representatives participated in
like the present one. Nor does one model appear to be the G30’s Regulatory Systems working group and an
clearly superior to the others in responding to crises. Yet international team of Deloitte’s global regulatory spe-
the integrated and twin peaks approaches reflect more cialists assisted in the research and profiling of the 17
rationally the many changes that have taken place in the national supervisory systems.
financial services business in recent years and might thus
be more efficient and cost effective in the future. For this For a copy of the report please contact Gert-Jan Ros,
reason, they are functioning as a model for reforming gros@deloitte.nl or Frank De Jonghe,
jurisdictions, such as the United States. As the G30 report fdejonghe@deloitte.com.
points out, the US Treasury Secretary’s Blueprint for a
41
 FSI magazine | #5 April 2009
How the economic turmoil impacts cash usage

The cost
Modernized Financial Regulatory Structure will bring the
US supervisory system a lot closer to both the Integrated
José Manuel Barroso,
President of the
of cash
and Twin Peaks models than it is today. Other jurisdictions
might well follow suit.
European Commission,
received Jacques de
The past year, and the
Larosière, Chairman of past few months in
particular, have been
International cooperation the High Level Group on
If the cross-functional nature of modern financial insti- Cross-border Financial
tutions necessitates a more integrated approach to
supervisory oversight, international expansion has similarly
Supervision.
tough for the financial
created a need for closer supervisory cooperation across
borders. According to the G30 report, representatives of sector. Though its
many jurisdictions favour more formal mechanisms for
cooperation and information sharing. In particular, those Recent reports by supervisors, think tanks and
origins are in the US,
interviewed were supportive of the use of ’colleges of
supervisors’ on the international level, focused on large,
other experts
• SSG, “Observations on Risk Management
the subprime crisis has
systemically important financial institutions. Again, these Practices”, March 2008. had never dreamt-of
consequences not only
proposals are rapidly turning from fiction into fact. EU • IASB, “Reducing Complexity in Financial
Commissioner Charlie McCreevy announced a revision of Instruments”, March 2008.
the Capital Requirements Directive on 1 October, entail-
ing the establishment of Committees of Supervisors in the
• US Treasury, “Blueprint for a Modernized
Regulatory Structure”, March 2008. for US Banks, but for
EU. These Committees will have various tasks to enhance
cross-border oversight in the EU, including mediation and
• FSF, “Report of the Financial Stability Forum on
Enhancing Market and Institutional Resilience”, European banks as
drafting of recommendations and guidelines. They will be
given an explicit role in strengthening the analysis of and
April 2008
• IIF, “Final Report of the Committee on Market
well. The financial and
responsiveness to risks that threaten the stability of the EU
financial system.
Best Practices”, July 2008
• “ Volcker-Ferguson Report on Financial Regulatory
economic situation also
Systems” from the G30 Working Group, October affects the amount of
cash in circulation in
Conclusion 2008.
The financial sector is at the eve of what might well
become the most dramatic overhaul within living memory
of the way in which it is regulated and supervised. Under the eurozone - and the
these circumstances, it pays to keep abreast on the
debate about financial supervision. Blueprints now being About the authors related costs for banks.
developed by think tanks, supervisors and other experts Gert-Jan Ros is Partner at Deloitte ERS in the
give a preview of the regulatory reforms we might expect Netherlands, Frank De Jonghe is Partner and Caroline
in the coming months and years. Now is the time to speak Veris is Director at Deloitte ERS in Belgium.
out, and be part of the debate. By Ortwin De Vliegher

42 43

R
ecent events have clearly struck a
blow to the collective psyche and
weakened people’s belief in the
stability and future of the banking
system in general and some banks in
particular. The drastic interventions
by central banks and governments, which even went as
far as nationalising some institutions to rebuild trust, do
not seem to have removed all doubts in customers’ minds.
This public uncertainty has led to massive withdrawals
of deposits from certain banks, with many customers
demanding physical cash. A recent survey analyses the
influence of the crisis on the cost of cash and provides
recommendations how banks can minimise these costs.
44
Part 1: Analysis of the influence of the economic
and financial crisis on the amount of cash in
circulation
The annual growth rate of the amount of euro notes
in circulation has steadily slowed since the euro’s intro-
duction in 2002 till the end of 2007. If we compare
the amount of euro notes in circulation at the end of
the month of December in each year, we see a rise of
22% in 2003 gradually falling to less than 8% in 2007.
Traditionally, the bulk of annual growth takes place in
the month of December, and relates to holiday shopping.
Growth in December 2003, 2004 and 2005 represented
35% of full-year growth. By December 2007, this percent-
age had risen to 60%.
In the light of the historical growth trend of the amount
of euro banknotes in circulation, with most growth tradi-
tionally occurring in December, the latest figures, running
till the end of December 20081, present several surprises.
First of all, during the first nine months of 2008, the
amount of euro notes in circulation rose by only 1%, the
smallest increase for that period ever.
In October 2008, however, the amount of euro notes in
circulation jumped by 6,4%, the biggest monthly increase
since December 2003 and the biggest October increase
ever. The main factor behind this jump was withdrawal of
notes for hoarding purposes: the total value of the 500,
200 and 100 euro notes in circulation grew month-on-
month by a remarkable 8,5% or approximately EUR 25
billion in October 20082, making it the sole reason for the
increase in the annual cash growth rate in 2008.
Finally, the extra amount of cash withdrawn for hoard-
ing in October did not re-enter the banking system in
November or December but continued to be hoarded.
The good news, though, is that November did not see a
new massive withdrawal of cash.
Source: European Central Bank monthly statistics.
1
It is likely that the rise is also partly due to the currency crisis seen in
2
countries like Iceland and Hungary, leading to an increased use of
the euro for domestic purposes and hoarding.
FSI magazine | #5 April 2009
Part 2: The influence of the 2008 economic crisis on
the cost of cash
Existing estimations of the cost of cash
In recent years, two profound analyses gave a good view
on what the cost of cash could be for European banks.
In 2003, the European Payments Council Cash Working
Group estimated the cost of cash for the European Market
as a whole at around EUR 50 billion a year, of which EUR
32 billion is borne by the banking sector. In September
2005, a McKinsey study concluded (on the basis of an
evaluation for nine European countries) that cash costs
banks EUR 21 billion a year, making it the single most
important cost item in their whole payment cycle.
Estimated influence of 2008 economic events on the
cost of cash
The cost of cash for banks is influenced by numerous, very
diverse cost drivers. Many of these are fixed or semi-fixed
and therefore not immediately impacted by economic
events or an increase in the amount of cash. Other
cash-related costs are variable and could be affected by
the 2008 economic events and the significantly higher
amount of cash in circulation. Variable cost drivers that
are most likely to be influenced are the interest rate
received on deposits (at the central bank) and the cost of
Cash in Transit (CIT).
Missed interest revenues linked to cash usage
To simplify the analysis, we initially assume that all banks
withdrawing cash at their national central banks are using
their sufficiently high deposits held on an NCB account.
If cash is withdrawn, banks lose interest revenue on the
ECB-held deposits. This revenue depends on the ECB
deposit rate.
Taking into account all changes in the ECB deposit rate,
we may conclude that the interest rate linked potential
revenue loss has been pretty stable at 2.75% to 3%
for the last 18 months. Only between 9 July and 12
November 2008 did it rise to 3.25%. After 10 December,
the rate dropped to 2%, to be lowered further to 1% on
21 January.
45

Missed interest revenues
could raise the cost of cash
for banks by EUR 3 billion
a year
It is important to bear in mind that the opportunity cost
of missed interest revenues on ECB deposits was only 1%
at year-end 2003, when the EPC study was performed.
Taking also into account that this study estimated the
inventory cost of cash carried by the banking sector at
EUR 6.9 billion a year, that only recently the ECB rate
dropped to historical lows and that, of the EUR 760 bil-
lion in banknotes currently in circulation, approximately
75 to 85% is in the hands of the public3, we could esti-
mate the increase in the cost of cash for banks linked to
missed interest revenues at up to EUR 1.5 billion a year.
Obviously, however, the opportunity cost for all banks
will be based on higher interest rates than the base rates
offered by the National Bank. While the 12-month euri-
bor rate was 3% early 2009, some banks still pay higher
rates on the interbank market. Thus we think it is safe to
assume that missed interest revenues could raise the cost
of cash for banks by EUR 3 billion a year.
The cost of Cash in Transit (CIT)
The cost of Cash in Transit operations for a bank depends
on two things: the price per drop and the number of
drops performed.
Price per drop
In most cases, CIT operations are performed by special-
ised external firms working under long-term contracts
at a fixed price, which is only periodically reviewed. This
means that any change in the cost base of the CIT opera-
46
tors would not immediately affect prices paid by banks
and retailers. In a few countries, however, an automatic
(wage-linked) indexation of CIT prices is imposed by law.
Still, this does not mean that the underlying cost base and
the commercial need for price increases were generally
perceived as a necessity in these countries. Indeed, our
interviews with many CIT operators and banks still per-
forming their own CIT operations led us to the opposite
conclusion. The general rise of inflation and specifically
fuel prices during the first half of 2008 not only stopped
but reversed during the second half of the year. Therefore,
it had no significant, lasting effect on the total cost base
of CIT operations.
Number of performed drops
Most banks and CIT operators confirmed that the ongo-
ing trend of decreasing the number of drops per branch
slowed, but nevertheless continued during 2008. There
was an uptick in October when many banks ordered extra
CIT drops, but the rise did not continue during the rest of
2008 and did not ultimately impact the overall decline.
Looking at the very limited increase of the cost per CIT
drop on one hand and a steadily decreasing number of
drops on the other hand, we may conclude that the cost
of CIT for banks did not change dramatically during 2008
3
and shows no significant departure from the findings in
previously performed studies on the cost of cash.
Part 3: Recommendations for the future to minimise
the cost of cash
Cost-of-cash optimisation key in banks’ 2009 cost
efficiency strategies
Our interviews confirmed that most European banks do
not need to be convinced of the importance and impact
of the cost of cash. However, they clearly underestimate
the potential savings, high Net Present Value and very
short pay-back period of most cost-of-cash optimisation
projects. We are convinced that, given recent economic
events and the current general strategic focus of banks on
cost efficiency, cost-of-cash optimisation programmes are
not only more beneficial than ever, but even among the
most manageable and strategically relevant programmes
to run in 2009.
To make these programmes a success, banks should
not only strive to minimise CIT drop frequencies or the
amount of cash in branches and ATMs, but should also
work to optimise
• existing cash processes and procedures
• internally and externally performed operational cash
services
• branch concepts
We are convinced that even banks that have already per-
formed partial cost-of-cash programmes will benefit from
a new, integrated analysis of the cash chain.
Campaigns to bring increased amounts of hoarded
money back to banks
The sharp increase in the amount of euro notes in circu-
lation in October 2008 was mainly concentrated in the
biggest notes used for hoarding. Our second recommen-
dation toward banks is to try to bring this money back
into the banking system. There are several reasons to do
so:
• The extra amount of hoarded money has a significant
influence on costs borne by banks
The ‘Future of Cash’ report
• Attracting new deposits is one of the most interesting
2006, Agis Consulting: average ways for banks to overcome liquidity shortages and
of approximately EUR 1200 improve their Tier 1.
held per inhabitant of euro-
zone in 1999.
FSI magazine | #5 April 2009
Conclusion
The ECB statistics make it clear that 2008 has been a
remarkable year with regard to physical cash. The rise in
the amount of euro notes in circulation was historically
low till September 2008. In October 2008, however, the
financial crisis led to an unprecedented 6,4% month-on-
month rise in the amount of euro notes in circulation. The
increase was most marked for 100, 200 and 500 euro
notes, suggesting that the amount of hoarded money
rose by approximately EUR 25 billion during the crisis.
The statistics for November show that this money did not
immediately flow back into the banking system.
We have demonstrated that the estimated total cost of
cash probably grew by EUR 1.5 to 3 billion a year, only
taking into account the effect of rising missed interest
revenue. Considering also the great benefits of cash opti-
misation programmes, we are convinced that running
such programmes should be a key priority for all banks in
2009, and a key feature in the cost optimisation strate-
gies they are currently busy with. Furthermore, we are
convinced that specific actions are needed to bring the
increased amount of hoarded money back into the bank-
ing system. Successfully running a campaign to attract
deposits will boost the liquidity position and even improve
the competitive position of some banks in the deposit
area.
About the author
Ortwin De Vliegher is Senior Manager at Deloitte
Consulting Belgium and co-founder of the ‘Future of
Cash’ networking and knowledge-sharing platform
for all those involved in the cash cycle
(see www.futureofcash.org).
47

Managing reputational risk
Reputational risk
S
everal surveys confirm that reputational
risk has emerged as a major concern for
is one of those
many executives and risk managers in the
FSI industry. The increase in reputational
risk is for the most part attributable to the
risks that are increasing dominance of intangible assets.
In today’s economy, intangible assets such as brand, intel-
hard to measure,
lectual capital, strategic relationships and the ‘licence to
operate’ account for 70% to 80% of a company’s market
value1. This is certainly the case in the financial services
even though industry, where the ability to underwrite new business is
heavily reliant on the standing of the firm, a fact that was
it should be
dramatically underscored in last year’s takeover of Bear
Stearns. Despite the increased awareness of reputational
risk, most (if not all) organisations will admit that they
addressed in the struggle to manage this risk.
ICAAP process.
Defining reputational risk
An important obstacle in the management of reputa-
tional risk lies in the absence of a commonly accepted
Nevertheless, definition. The Basel II Accord recognises the existence
of reputational risk but does not define it. It simply states
it deserves a
that it is excluded from the definition of operational risk,
but includes it in the scope of risks to be considered under
Pillar II.
comprehensive The Committee of European Insurance and Occupational
Pension Supervisors (CEIOPS) has defined reputational risk
risk management
as follows2: 'The risk of potential damage to an undertak-
ing through deterioration of its reputation or standing
due to a negative perception of the undertaking’s image
framework. among customers, counterparties, shareholders and/or
regulatory authorities.'
By Mathias Christiaens 'It takes 20 years to build a reputation and five minutes to
and Frank De Jonghe ruin it. If you think about that, you’ll do things differently.'
Warren Buffet
CEIOPS goes on to say that reputational risk should be
regarded as less of a separate risk, than one consequent
on the overall conduct of an undertaking. Similarly, The
Economist Intelligence Unit referred to reputational
risk as 'the risk of risks'3. Indeed, each credit, market or
operational loss event has the potential to harm your
48
FSI magazine | #5 April 2009
organisation’s reputation as a second order impact.
What’s worse, the damage inflicted to a firm’s reputation
could well prove to be more significant than the first order
impact, the underlying loss itself.
A striking example is Northern Rock. The origin of the
bank’s problems presumably lay in its inadequate liquid-
ity risk management. It failed to address its dependence
on money market funding, which dried up in the context
of the global credit crunch. This problem, however, was
addressed when the Bank of England provided a liquidity
support facility, helping the bank to fund its operations
during the period of turbulence in financial markets whilst
the bank could take the required actions to resolve its
structural problems. At the end of the day, however, the
bank was not affected as much by its liquidity problems as
it was by the erosion of consumer confidence (remember
the headline pictures of people lining up on the streets
waiting to withdraw their funds). The bank run initiated
a vicious circle of ever-increasing liquidity problems. In
the end, the reputational damage was to blame for the
downfall of the bank.
Notwithstanding the fact that the majority of reputational
damage can be described as a second order impact, a
number of reputational risks can nevertheless be clas-
sified as ‘independent risks’, meaning that reputational
damage could be considered a first order impact. These
independent risks can often be associated with ethics.
Organisations that do not abide by high ethical standards
and that ignore principles of market conduct are vulner-
able to losing their customers’ trust and confidence. In
short, each organisation has a social responsibility that
it cannot ignore and that it must address in its corporate
governance.
Link between capital adequacy and reputational risk
A fiercely debated topic is whether a financial institution
must consider making provisions for reputational risk.
Naturally, setting aside capital to absorb unexpected
losses attributable to reputational damage requires a
quantitative risk assessment. For reputational risk, such
quantification will prove to be difficult due to a lack of a
generally accepted measurement method. In anticipation
of a market consensus about this, many firms are
49
 FSI magazine | #5 April 2009

The reputation is
at risk as soon as
expectations of the
firm’s performance
exceed underlying
reality
currently arguing that the assessment of reputational different aspects of corporate performance. A firm’s repu- are likely to increase the expectations gap with customers, Likelihood Severity
risk is above all a qualitative assessment based on expert tation is determined by how the stakeholders perceive its causing them to lose their trust and respect. Balancing High Likely to occur at High Regulator, clients,
judgment. performance in each of these aspects. The reputation is between the different stakeholder expectations is one of least once per year public opinion
at risk as soon as expectations of the firm’s performance the main challenges of reputational risk management. impacted, loss of
clients
This point of view seems to be supported by the exceed underlying reality. In order to avoid damage to its
Committee of European Banking Supervisors, which has reputation, the firm should try and close the gap by either Once the stakeholder expectations have been identified, Medium Likely to occur once Medium Regulator or client
stated that setting a capital requirement is only one tool improving performance or by managing the expectations the organisation should make an effort to identify the every few years impacted, few cli-
ents lost
made available by the Capital Requirements Directive4. down to more realistic levels. incidents that, should they occur, would cause it to fall
Supervisors recognise that while capital has an important short of these expectations, and therefore damage the Low Very remote proba- Low Regulator or client
bility of occurrence impacted, no cli-
role to play in the mitigation of risks, it may not always be Customers Suppliers firm’s reputation. The following techniques can be used
ents lost
the sole or best solution to mitigating risk. For less quan- to identify both stakeholder expectations and potential
• Product quality, value • Volume of business
tifiable risks (such as reputational risk), the focus of the • Service • Sound management & reputational events:
ICAAP could indeed be more on a qualitative assessment, • Trust, respect operations • Media analysis (television, newspapers, magazines,
risk management and mitigation. • Financial stability blogs, message boards, etc)
Employees Regulator • Interviews with front-line employees (i.e. those
Whether financial services firms have quantified their employees that are frequently in contact with sup-
• Pleasant workplace • Timely reporting
reputational risk or not, it seems fair to conclude that environment • Sound corporate pliers, customers, investors, bankers, etc and are
supervisors will expect all financial firms to be able to • Fair compensation, knowl- governance therefore well aware of the issues raised by these
demonstrate that they have implemented a compre- edge building • Transparent stakeholders)
hensive set of procedures and internal controls aimed at • Equal opportunities communication • Brainstorming with management
reducing reputational risk to a minimum. Investors Community / Society • Industry research
• Return on investment • Community
Does this mean that quantifying reputational risk is a use- • Earnings growth involvement Due to the dynamic nature of stakeholder expectations,
less effort? No! On the contrary, the ability to quantify • Regulatory compliance • Fair treatment of this step must not be viewed as a one-off effort. Every
reputational risk is helpful in prioritising and presenting people organisation must continuously monitor changes in stake-
• Respect for
the sources of reputational risks to senior management. holder expectations.
environment
A firm that is able to combine the best of both worlds,
i.e. is able to understand its exposure to reputational risk Assessment
through quantification and is capable of dealing with the Failure to take actions aimed at closing the expectations Having identified the events that could damage the firm’s
risk through reputational risk management, has a clear gap will be detrimental. Sooner or later, the inability to reputation, each event needs to be assessed in terms of
competitive advantage. perform in accordance with the stakeholders’ expecta- the likelihood that it will occur and the severity of the
tions will be revealed. Not only will the organisation then reputational damage which may result if it occurs. Risk
Prevention is the best remedy face severe reputational damage, it could also find itself at rating scales can be used both for the assessment of likeli-
Effectively managing reputational risk can be achieved the other end of the pendulum, with its reputation falling hood and severity. The table provided here is a simplified
by applying the well-known framework of identification, short of its actual performance. Hence our earlier asser- approach.
assessment and management. tion that reputational risk is a second-order risk.
When combining the likelihood and the severity, a risk
Identification Closing the expectations gap, however, could in itself score is obtained. This score can help to prioritise the risks
To identify potential events that may negatively affect its expose the organisation to reputational risks. If, for and to aid in decision making (see adjoining table).
reputation, a firm must first acknowledge that its reputa- example, the performance of a firm fails to meet investor High Medium High High
tion is owned by the stakeholders. Every organisation expectations, management could be tempted to focus In addition to a qualitative assessment, firms could also Medium Low Medium High
has a multitude of stakeholders: investors, customers, too exclusively on boosting its financial ratios (e.g. market opt to perform a quantitative assessment of their reputa- Likelihood Low Low Low Medium
employees, management, board of directors, regulators, share, earnings growth, ROI, etc), at the expense of its tional risk. The objective of such quantitative assessment
Low Medium High
suppliers, the community in which the firm operates, etc. ethical standards. Actions such as aggressive selling could is to measure the impact of reputational damage in terms
These stakeholders have an array of expectations covering perhaps decrease the gap with investor expectations, but of reduced operating revenues due to loss of clients, Severity

50 51

increased compliance and other costs to restore confi-
dence, and perhaps the increase in the cost of capital as
a result of the reputational event. An array of techniques
exists, such as:
• E xamining a firm’s stock price reaction to the
announcement of a major operational loss event. If
the firm’s market value declines by more than the
announced loss amount, this is interpreted as a repu-
tational loss5
• The actuarial approach, which focuses on the loss
distribution. Frequency and loss severity are modelled
separately and then aggregated using either Monte
Carlo or numerical techniques
Whilst quantification is arguably as much an art as it is a
science, we believe quantification is useful even where
there are large uncertainties. It contributes to intelligent
decision making and makes the risks even more tangible.
Naturally, decision makers should continue to give due
consideration to factors that defy quantification and that
are thought to be important.
Management
The ERM Integrated Framework proposed by COSO
defines four risk responses: avoiding, accepting, reducing
and sharing.
Avoiding risks that can cause reputational damage is
far from obvious, since these risks are often embedded
in the core of the business. A classic example, however,
of a risk that can be avoided is the reputation risk linked
to mergers and acquisitions. When making strategic
investment decisions, management should look into the
litigation, regulatory and compliance history of its target.
Targets that engage in wrongful conduct are often better
avoided to prevent reputational damage to the acquirer.
Another example is the risk of mis-selling, a risk that can
be avoided by being less aggressive on sales targets.
Accepting certain reputational risks is a strategy that
must be implemented with great care, as expectations
can, and do, change over time. Take the example of oil
companies in the previous century. During many years,
little attention was paid to environmental issues. Whilst
behaviour such as oil spills was criticised in the media,
52
it was not sanctioned. Consequently, companies in the
oil industry accepted the risk of a spill. Then, suddenly,
a large oil spill in 1969 ignited an environmental move-
ment and stakeholders raised the bar, expecting all
organisations to strengthen their environmental efforts.
Companies that failed to do so and continued to neglect
environmental concerns suffered important reputational
damage.
Reducing reputational risks through preventive and
detective control activities is the most likely and often the
most appropriate response. Control activities should be
designed to minimise the first-order risks (e.g. operational
risks). In the context of reducing reputational risks, the
importance of corporate governance deserves to be high-
lighted. Firms should articulate, disseminate and enforce
an ethical code throughout the business. Employees at
all levels of the organisation should be well aware of the
risks and events that could affect the firm’s reputation.
The objective should be to develop and reinforce a true
risk management culture in which compliance is put at the
top of the agenda.
Sharing risks in the context of reputational risk man-
agement is rare, and not recommendable. By nature,
reputational risk is not something that can be legally
transferred. Therefore, firms must be aware that they can
even suffer reputational damage as a result of actions
taken by others. A good illustration of this is the effect of
the market distress that began in the second half of 2007.
Banking organisations under no contractual obligations
provided voluntary support to ABCP conduits and other
off-balance sheet financing vehicles, including structured
investment vehicles (SIVs), because of concerns about the
potential damage to their reputation and to their future
ability to sell investments in such vehicles if they failed to
provide support during the period of market distress6.
The overall aim of managing reputational risk should be
to close the gap between the stakeholders’ expectations
and the true performance of the organisation. Indeed,
reputation is at risk as soon as expectations exceed reality.
Should an organisation identify an expectations gap, it
needs to either lower expectations (through communica-
tion) or increase performance (through operations).
FSI magazine | #5 April 2009
Preparing for the worst: developing a crisis response 1
“ Reputation and its Risks”, by Robert G. Eccles, Scott C. Newquist,
and Roland Schatz, Harvard Business Review, February 2007
strategy 2
“Risk Management and Other Corporate Issues”, Issues Paper,
Evidently, no matter how well-developed the risk mitiga- CEIOPS, 17 July 2007
tion tools in place (crisis prevention), no firm can fully
3
“Reputation: Risk of Risks”, The Economist Intelligence Unit,
December 2005
avoid being exposed to reputational risk events. This 4
Guidelines on the Application of the Supervisory Review Process
leads us to the importance of crisis management, aimed under Pillar 2 (CP03 Revised), Committee of European Banking
Supervisors , 25 January 2006
at minimising the damage caused by such events. Being 5
“Measuring Reputational Risk: The Market Reaction to
able to respond effectively to crisis events is likely to prove Operational Loss Announcements”, Jason Perry and Patrick De
Fontnouvelle, available at http://papers.ssrn.com/sol3/papers.
to be a much more efficient means of mitigating reputa- cfm?abstract_id=861364&rec=1&srcabs=967313
tional damage than (just) setting aside capital. Therefore, 6
“Observations on Risk Management Practices During the Recent
it is best practice for firms to develop a crisis response Market Turbulence”, Senior Supervisors Group, March 6, 2008,
available at http://www.newyorkfed.org/newsevents/news/bank-
strategy. Such a strategy would typically include at least ing/2008/ssg_risk_mgt_doc_final.pdf
the following elements:
• Identify a crisis response team with everyone's roles
and responsibilities clearly defined
• Prepare draft versions of internal and external com-
munications with all key stakeholders
• Ensure fast access to relevant data that the crisis
response team will need to make its decisions
• Simulate crises in order to test the crisis management
plans
This last point is often overlooked. Having a crisis man-
agement plan is a good first step, but it will only become
useful once it is tested through simulation exercises.
Simulating a crisis enables errors to be identified and
addressed and lessons to be learned. Unfortunately, crises
will rarely happen as envisioned during the simulations.
Therefore, the crisis management plan should be flexible,
and the people in charge of executing the plan must have
the ability to adapt accordingly.
Conclusion
Whilst many organisations are aware of the importance
of reputational risk management, only few have imple-
mented a true reputational risk management framework.
The main challenge is recognising the need for a focused
approach, and giving one person the responsibility to
execute this. If done properly, the benefits will far out-
weigh the costs and the organisation will be assured that
its most important intangible asset is well protected. About the authors
Dr. Frank De Jonghe is Partner at Deloitte ERS,
Belgium. Mathias Christiaens is Manager at Deloitte
ERS, Belgium.
53
 FSI magazine | #5 April 2009

T
he Solvency II framework consists of These expected benefits make SII an increasingly impor-
three pillars, each covering a different tant issue for insurers. Not surprisingly, solvency has
aspect of the economic risks facing evolved into an academic discipline of its own and much

Solvency II:
insurers (see figure 1). This three-pillar
approach aims to align risk measure-
ment and risk management. The first
pillar relates to the quantitative requirement for insur-
of its literature is aimed at the quantitative requirements.
Yet, despite the progress made in SII, the next section
indicates that insurers will also encounter a number of dif-
ficulties and challenges in operational risk before they can

Dealing with operational risk

Historically, insurers have focused on understanding and managing
ers to understand the nature of their risk exposure. As
such, insurers need to hold sufficient regulatory capital
to ensure that (with a 99.5% probability over a one-year
period) they are protected against adverse events. The
second pillar deals with the qualitative aspects and sets
out requirements for the governance and risk manage-
ment of insurers. The third pillar focuses on disclosure
and transparency requirements by seeking to harmonise
utilise these expected benefits.
The importance of operational risk in Solvency II
Over the past few decades many insurers have capitalised
on the market and have developed new business services
for their clients. On the other hand, the operational risk
that these insurers face have become more complex,
more potentially devastating and more difficult to antici-

investment and underwriting risk. However, recent developments

reporting and provide insight into insurers’ risk and return pate. Although operational risk is possibly the largest
profiles. threat to the solvency of insurers, it is a relatively new risk

in operational risk management, guidelines by the rating agencies Solvency II (SII) is the updated set of regulatory require-
category for them. It has been identified as a separate risk
category in Solvency II. Operational risk is defined as the
and the forthcoming Solvency II regime increase insurers’ focus ments for insurance companies operating in the European capital charge for ‘the risk of loss arising from inadequate

on operational risk. Insurers consequently have to decide on their

Union. It revises the existing capital adequacy regime and or failed internal processes, people, systems or external
is expected to come into force in 2012. It has a number events’. This definition is based on the underlying causes

approach to managing operational risk. of expected benefits, both for insurers and consumers.
Although the most obvious benefit seems to be prevent-
of such risks and seeks to identify why an operational
risk loss happened, see figure 2. It also indicates that
ing catastrophic losses, other less obvious benefits which operational risk losses result from complex and non-linear
are considered to be important are summarised in table 1. interactions between risk and business processes.
By Jürgen van Grinsven
and Remco Bloemkolk
Table 1: Solvency II expected benefits Figure 2: Dimensions of operational risk

Insurer Consumer Processes

Figure 1: Solvency II framework
Reduced losses suffered by Reduced risk of failure or
Solvency II policyholders default by an insurer
Enables internal risk and Reduced costs of insur- People
capital assessment models ance and investment
contracts Event Loss
Underwriting Risk Pillar 1 Pillar 2 Pillar 3
Reduced costs and Broader range of Systems
Minimum Standards Supervisor Review Market Discipline increased flexibility products
Investment Risk
Increased confidence in Better match between
(Quantitative (Quantitative (Disclosure & the financial stability of the products and individual External events
Credit Risk requirements) requirements) Transparency insurer requirements
requirements)
Provides supervisors with
Liquidity Risk Several studies in different countries have attributed insur-
early warning so that they
can intervene promptly ance company failure to under-reserving, under-pricing,
Operational Risk Implementation Contol Disclosure if capital falls below the under-supervised delegating of underwriting authority,
required level rapid expansion into unfamiliar markets, reckless

54 55
 FSI magazine | #5 April 2009

Operational risk may

represent the greatest
threat to insurers

management, abuse of reinsurance, shortcomings in inter- Table 2: O

 perational risk categories and insurer Risk self-assessment (scenario analysis) can be an Table 3: Difficulties and challenges concerning operational risk at insurers
nal controls and a lack of segregation of duties. See the exposure extremely useful way to overcome the problems of inter-
examples below. Unbundling operational risk from other nal and external loss data. It can be used in situations in Loss data Risk self-assessment Techniques, tools,
risk types in risk management and risk measurement can Operational risk category Example of insurer which it is impossible to construct a probability distribu- governance
help prevent future failures. This holds true for smaller and exposure tion, whether for reasons of cost or because of technical Lack of internal loss data Risk self-assessment process Biases of interviewees
larger losses. Often, larger losses are the cumulative effect Internal fraud Employee theft, claim difficulties, internal and external data issues, regulatory is labour-intensive are not understood
of a number of smaller losses. In other words, the result fabrication requirements or the uniqueness of a situation. It also
Quality of internal loss data Static view of risk self- Chasing changing loss
of the bad practices that flourish in excellent economic External fraud Claim fraud, falsifying enables insurers to capture risks that relate, for example,
assessments data
circumstances, when the main focus is on managing the application information to new technology and products, as these risks are not
business rather than operational risks. likely to be captured by historical loss data. However, cur- Applicability of internal loss Inconsistent use of risk self- Techniques and tools
Employment practices and Repetitive stress, data assessments are not shared in the
workplace safety discrimination rent scenario analysis methods are often too complex,
insurance firm
Examples of insurance company failure not used consistently throughout a group and do not take
Clients, products and busi- Client privacy, bad faith, Aggregation of internal loss Quality of results Techniques have a bad
Insurance company failures in which operational risk ness practices redlining adequate account of the insurer’s strategic direction, busi-
data fit with tools
played a significant role include: ness environment and appetite for risk.
Damage to physical assets Physical damage to own Reliability of external loss Subjectivity of results Coordination of large
• The near-collapse of Equitable Life Insurance Society
office, own automobile data data volumes
in the UK, which resulted from of a culture of manipu- fleets The techniques and tools that insurers use to support risk
lation and concealment, where the insurer failed to self-assessments are often ineffective, inefficient and not Consistency of external loss Assessments are only Linkage between quali-
Business disruption and sys- Processing centre
communicate details of its finances to policyholders or tem failures downtime, system successfully implemented. Research indicates that 19.5% data refreshed annually tative approaches and
regulators. interruptions of current practices are often not shared within the group, scenario analysis used
• The failure of HIH Insurance, which resulted from while 22% of respondents are dissatisfied and 11% very Applicability of external loss Approaches tend to focus on Governance of risk
the dissemination of false information, money being dissatisfied with the quality of their information technol- data expected losses department versus actu-
obtained by false or misleading statements and inten- Difficulties and challenges in insurers’ operational risk ogy support services. Another question that can be raised arial department
tional dishonesty. management is the governance of risk management. How, for example, Aggregation of external loss Low-frequency, high-impact Key risk indicators do
• American International Group (AIG) and Marsh, Insurers have not historically gathered operational risk are the risk and actuarial departments aligned? data assessments can be arbitrary, not link back to causal
resulting in significant over factors identified
where the CEOs were forced from office following data across their range of activities. As a result, the major
or understatement of sol-
allegations of bid rigging. Bid rigging, which involves difficulties and challenges that insurers face are closely Conclusions vency and economic capital
two or more competitors arranging non-competitive related to the identification and estimation of the level of In this article we discussed operational risk in the context requirements.
bids, is illegal in most countries. exposure to operational risk. A distinction can be made of Solvency II. Operational risk is possibly the largest
• Delta Lloyd, Fortis ASR and Nationale Nederlanden between internal and external loss data, risk self-assess- threat to insurers. This is because operational risk losses
(the Netherlands) agreed to compensate holders of ment, supporting techniques, tools and governance. See result from complex and non-linear interactions between
unit-linked insurance policies for the lack of transpar- table 3 for an overview. risk and business processes. Unbundling operational risk
ency in the product cost structures. from the other types of risk in risk management and risk
Loss data form the basis for measuring operational risk. measurement can help prevent future failures for insurers.
The above examples illustrate that such losses are not iso- Although internal loss data are considered the most SII is on track to put greater emphasis on the link between
lated incidents in the insurance industry, but instead occur important source of information, they are generally insuf- risk management and risk measurement of operational
with some regularity. The large loss events mentioned ficient because of a lack and the often poor quality of risk. We have addressed the most important difficulties About the authors
above can be drilled down into operational risk catego- such data. Insurers can overcome these problems by sup- and challenges in operational risk management: loss data, Dr. ing. Jürgen H.M. van Grinsven is director at
ries. Table 2 presents several examples of operational risk plementing their internal loss data with external loss data risk management, tools, techniques and governance. Deloitte Enterprise Risk Services and author of the
categories and insurer exposure. from consortia such as ORX and ORIC. However, using Those insurers able to ensure an effective response to books Improving Operational Risk Management and
external loss data raises a number of methodological these major difficulties and challenges are expected to Risk Management in Financial Institutions.
Given the high-profile events, insurers need to be increas- issues, including the problems of reliability, consistency achieve a significant competitive advantage. Drs. Remco Bloemkolk works at ING corporate risk
ingly aware of the commercial significance of operational and aggregation. Insurers consequently need to develop management. Prior to joining ING he worked at Swiss
risk. The forthcoming Solvency II regime will present a documentation and improve the quality of their data and Re and Ernst & Young. Remco Bloemkolk has written
number of difficulties and challenges for the operational data-gathering techniques. this article in a personal capacity.
risk management activities of insurers.

56 57

The Netherlands and
the United Kingdom
are leading the way in
introducing the Tax
Control Framework
Financial institutions seeking greater efficiency and insight in tax function
Towards a more
transparent tax position
By Caroline Zegers and
Robbert Hoyng
Driven by stakeholder demands for transparent risk
management, financial institutions are increasingly
having to work with a balanced Tax Control
Framework. The benefits of such a framework
are obvious: risks are identified promptly and
opportunities are made use of more rapidly, while
the tax function also becomes more effectively
rooted in the organisation.
58
O
ver the past few years, financial
institutions across the world have
become increasingly interested
in the issues of correct reporting
and proper risk management. The
attention devoted to corporate
governance, which has been prompted by developments
such as the Sarbanes-Oxley Act and the introduction of
IFRS, has resulted in European company directors wanting
and having to establish a more in-depth understanding of
the money flowing through their organisations. And this
also means ensuring a proper understanding of tax pay-
ments, both in terms of the risks and the opportunities
they create.
Horizontal monitoring
This trend of gaining a greater understanding of cash
flows is reflected in the changing attitudes of stakeholders
such as shareholders, tax authorities and CFOs. They, too,
are increasingly focusing on financial institutions’ internal
risk management and control processes. A good example
of what this can result in is the Dutch Tax and Customs
Administration’s decision a few years ago to introduce
'horizontal monitoring'. The traditional approach, where
inspectors focused primarily on tax information in the
returns, is now firmly in the past, with the tax authorities
switching from control based on an absence of trust to
monitoring through trust. The term “horizontalisation”
illustrates that the government, and therefore also the
Tax and Customs Administration, is no longer seeking to
position itself above citizens and businesses, but instead
alongside them. And this trust demands a proper Tax
Control Framework (TCF) so that businesses can demon-
strate that they are 'in control' of their tax affairs.
In other European countries, too, we have seen tax
authorities moving in this direction. The Netherlands and
United Kingdom are leading the way in introducing the
TCF, while other European tax authorities are currently
working on such frameworks or similar ones. The various
countries’ tax authorities get together every two years to
discuss tax risk management in the OECD Forum on Tax
Administration. The most recent meeting, held in January
2008 in Cape Town, culminated in the forty participants
issuing a communiqué emphasising the crucial importance
FSI magazine | #5 April 2009
of risk management processes, of senior and executive
management taking a greater interest in their companies’
tax strategies and of the need to extend regulations link-
ing tax strategy and good corporate governance.
Risks create opportunities
However, it is not only external stakeholders who are
pushing for more transparent risk management. Indeed,
we have seen a gradual change in attitudes to tax risk
management within the financial institutions themselves
since around the turn of the century. Previously, financial
institutions thought of tax risks in terms of the risk of
paying too much tax, or the risk of fines as a result of
non-compliance. Now, however, they are increasingly
aware that tax risk management actually means using,
optimising and planning tax-related opportunities. The
issue of social responsibility is also important. In the
United Kingdom, for example, it is now perfectly normal
to publish information on which sectors pay most tax
(three-quarters of total UK corporate tax revenues are
attributable to financial institutions and the oil industry).
Given the importance of proper management of tax risks
and the extensive range of risks (see box 1) to which
financial institutions may be exposed, it is recommended
classifying these risks in a risk portfolio. One way of doing
this is to use a transparent tool such as the tax decision
web (see figure 1), which helps financial institutions to
visualise their risks and the extent to which they are and
wish to be exposed.
Each TCF is tailor-made
What do these developments mean for financial institu-
tions’ management? Managers need to monitor risks
continually and to confirm in an 'in control statement'
that they are managing the processes within their
organisations properly, including those relating to tax.
Implementing an Internal Control Framework (ICF) to
describe how all the business processes are managed is
very important in this respect. And one vital element of
this is the Tax Control Framework, which focuses on inter-
nal control of tax processes. The form of such a TCF will
depend on the financial institution’s size and complexity.
Each TCF is tailor-made and based on the need to provide
organisations and, therefore, their stakeholders with an
59

Figure 1: The tax risk decision web
ongoing and up-to-date view of the tax position. The
Dutch Tax and Customs Administration does not stipulate
any specific model for the TCF, but does provide guide-
lines. These are designed to ensure proper insight into the
structure chosen for the TCF so that the Tax and Customs
Administration can determine whether the framework is
equal to the task of providing the required degree of reli-
able information. This results in greater efficiency as the
Tax and Customs Administration no longer has to check
all the information provided. All it has to do is analyse and
evaluate the TCF. This means the financial institution’s tax
position can be established quickly and accurately, which
in turn avoids unpleasant surprises for other stakeholders.
TCF building blocks
These developments mean that major changes in financial
institutions’ tax function are inevitable. Institutions will,
for example, be under increasing pressure to establish
a TCF. And this framework will have to meet certain
general requirements. The first building block involves
establishing the tax strategy, which will be based on the
business strategy. In other words, what the organisation
is seeking to achieve. This in turn should result in a series
of objectives being set for the chosen tax strategy. These
objectives will vary from business to business. They do not
only involve hard parameters such as cash flows or profits,
but also issues such as integrity and the degree of socially
responsible entrepreneurship as, since the start of the
credit crisis, the corporate reputations of financial institu-
tions have become more crucial than ever.
60
A second building block in each TCF is 'Tax Operations
& Risk'. In other words, understanding all the business
processes that interface with the tax function and then
defining the roles, authorisations and responsibilities
within these processes. This also involves analysing all the
organisation’s possible tax risks and opportunities. The
methods that Deloitte uses in this respect include scenario
planning and a tool that supports decision-making proc-
esses, while also providing insight into risks and making
them quantifiable.
The third TCF element is 'Tax Accounting & Reporting'. In
other words, recording the tax position in the organisa-
tion’s administration and correctly accounting for it in
quarterly and annual reports.
The fourth and final building block is 'Tax Compliance',
which involves detailing how and where the financial
institution obtains its tax information. Financial institu-
tions can support these compliance activities via an
electronic platform that transfers information from their
annual financial statements to their tax returns. This in
turn significantly reduces their margin of error.
Internal integration of tax function
In view of these developments, tax risk management
should be high on financial institutions’ management
priorities. A comprehensive understanding of risks and
opportunities is essential if institutions are to avoid
unpleasant surprises and be 'in control'. And until now
that has at best been only in part. Although there is
certainly a growing awareness of the importance of man-
aging tax risks, many financial institutions’ energies are
still being consumed by day-to-day concerns. They either
fail to involve their tax directors or involve them too lit-
tle in relevant business processes. All too often, the tax
department is still seen as a separate department focusing
primarily on completing tax returns and reducing the tax
burden. Stakeholders, however, want financial institutions
also to be 'in control' of their tax position and expect tax
departments to be involved in relevant business proc-
esses. And indeed this is also the basis of good tax risk
management: making sure that tax management is inte-
grated, wherever possible, into the other functions and
processes within the organisation. Just as tax departments
Major changes in
financial institutions’
tax function are
inevitable
these days also have to be closely involved in developing
and launching new financial products, given the possible
tax consequences that these products may have.
Create involvement and insight
Proper tax risk management generally demands a far
more pro-active approach from financial institutions’ CFOs
and tax directors, and that is obviously not always easy
to achieve. Where do you start? The first step is to get
together around a table to create greater involvement and
understanding of the tax function. All parties involved
need to analyse the business processes and activities (such
as investments and projects) in which tax aspects play a
role. These activities may range, for example, from imple-
menting an SAP system to HR’s reimbursing of expenses.
There are often far more aspects involved than might be
expected, certainly in financial institutions. Just think of
the major write-downs that are being seen on so many
financial instruments. Once the processes have been ana-
lysed, it is time to prepare an action plan outlining how
to improve the way the tax function is integrated into the
business and business processes.
These are the first steps in the process of establishing
an informative and customised TCF constituting part of
a solid tax risk management system. The benefits are
obvious: satisfied stakeholders (tax authorities, sharehold-
ers, CFOs) and greater efficiency in and understanding
of the tax function. And then there is the issue of cost.
Establishing a TCF will certainly take a considerable
amount of time. The question that each financial institu-
tion has to answer for itself is whether and, if so, to what
extent tax expertise should be brought in from outside.
The long-term benefits of a TCF are evident: risks are iden-
tified promptly and opportunities are made use of more
rapidly, while the tax function also becomes more effec-
tively rooted in the organisation.
About the authors
Caroline Zegers is Lead Partner FSI Tax and Robbert
Hoyng is an expert on tax strategy and Tax Control
Framework for Deloitte Netherlands.
FSI magazine | #5 April 2009
Box 1: Risks for financial institutions
Key risk areas
• Operational tax planning, strategic tax planning
• Compliance: process and positions
• Legislation: governance and budgets
• Deals: corporate events and major transactions
• Corporate structure: international tax presence
• Operations: day-to-day processes and manage-
ment decisions
Specific risks include:
• Upside/downside of external financing arrange-
ments or use of financing instruments impacting
on tax or interfering with group tax planning
• Tax exposure and missed opportunities result-
ing from insufficient interdepartmental
communication
• Incorrectly implemented tax planning
• Unexpected tax costs or missed opportunities
resulting from inconsistencies between commer-
cial divisions’ and tax department’s goals
• Environmental changes threatening tax rate
sustainability
• Tax inefficiencies resulting from low appetite for
risk or inadequate resources
• Lack of involvement or late involvement of tax in
product development
• Local tax issues overseas
• WHT errors or deemed royalties arising from intel-
lectual property rights in contracts
• Complexity of group structure having adverse
impact on tax management
• Inadvertent creation of CFCs or subpart foreign
income; failure to meet CFC exemptions
• Uncertainty and resource implications arising
from accounting and regulatory changes
• Incorrect tax calculations attributable to spread-
sheet errors
• Failure to perform compliance process on time
(reflected, for example, in late returns)
• Tax law and environmental changes impacting on
group tax profile
61

Commerzbank reclassi-
fied €44 billion of bonds
from AFS to L&R, while
Deutsche Bank trans-
ferred €12.8 billion of
trading assets and €12.1
billion of AFS assets to
L&R
O
n 13 October 2008, the
International Accounting Standards
Board (IASB) published amend-
ments to ‘IAS 39 Financial
Instruments: Recognition and
Measurement’ and ‘IFRS 7 Financial
Instruments: Disclosures’. These were followed on 24
October by some clarifying guidance on the effective
date of the amendments and transitional provisions. This
guidance was subsequently incorporated in an additional
amendment dated 27 November 2008.
These amendments were a response to calls from constit-
uents, particularly within the European Union, to create
a level playing field with US GAAP regarding the ability
to reclassify financial assets, primarily out of categories
where fair value is applicable. In the general context of
the current financial crisis, the IASB acted with unprec-
edented swiftness, and for the first time an amendment
to a standard was issued without due process (but with
the consent of the IASCF trustees).
Amendments to IAS 39 and IFRS 7 – Reclassification of financial assets
The changes to IAS 39 allow an entity to reclassify non-
Unprecedented action
derivative financial assets out of the fair value through
profit or loss (FVTPL) and available for sale (AFS) catego-
ries in certain limited circumstances. Such reclassifications
require extensive additional disclosures under IFRS 7 to
by IASB
permit users to understand the financial statements had
the entity not reclassified.
As the amendments are effective as of 1 July 2008, sev-
eral financial institutions in Europe started applying them
from the third quarter of 2008.
By Carl Verhofstede Impact of classification on measurement
For a better understanding of the significance of these
amendments, it has to be appreciated how important the
classification of a financial asset (investments in loans,
Never before has the IASB moved so swiftly to issue an bank deposits, bonds, equity shares and the like) is for its
amendment to a standard as it did last October. However, measurement in the financial statements (balance sheet
and income statement). Financial assets can be classified
although the amendments announced will certainly have in four basic categories:
• At fair value through profit or loss (FVTPL)
a material impact on financial statements, the debate on • Loans and Receivables (L&R)
presenting financial instruments is still far from over. • Held to Maturity (HTM)
• Available for Sale (AFS).
62
FSI magazine | #5 April 2009
The rules for attributing a financial asset to any of these
categories at initial recognition are quite complex, being
partially based on:
• intent (for example, assets used in trading activi-
ties are Held for Trading (HFT) and fall under FVTPL
classification);
• specific characteristics of the assets (equity shares, for
example, can never be classified as L&R or HTM);
• a deliberate classification choice made by the entity
when the asset is first recognised in the balance
sheet (examples include the Fair Value Option, where
voluntary classification as FVTPL is possible if certain
conditions are met, or classification as AFS, which
is available for every type of non-derivative financial
asset that is not held for trading purposes, even if
classification in another category would be allowed).
Loans and Receivables (L&R) are financial assets with fixed
(for example, fixed interest) or determinable (for example,
floating rate interest) payments that are not quoted in an
active market, do not qualify as “trading” assets and have
not been designated as FVTPL or AFS. Typical examples
would be a term deposit with a bank, a trade receivable
or an investment in a non-quoted corporate bond.
Held to Maturity (HTM) investments are financial assets
with fixed or determinable payments and fixed maturities,
other than L&R, for which there is a positive intention
and ability to hold to maturity and which have not been
designated as FVTPL or AFS. An investment in a quoted
bond would typically be barred from classification as L&R,
but could be classified as HTM if the entity demonstrates
a positive intent and ability to hold the investment until it
matures.
Before the amendment, a financial asset classified as
FVTPL at first recognition in the balance sheet could never
be reclassified out of that category. This applied even if
there was no longer an active market for the asset, and so
trading the asset had de facto become impossible.
Similarly, initial classification in the AFS category could
not be changed at a later date, with only a very specific
and limited exception for certain assets that are held to
maturity (HTM).
63

The measurement of a financial asset depends on its
classification:
• Financial assets at Fair Value Through Profit or Loss
(FVTPL) are measured, as the designation implies, at
their fair value on each closing date, and all changes
in fair value are immediately recognised in profit or
loss.
• Loans and Receivables (L&R) and Held to Maturity
(HTM) investments are measured at amortised cost
(that is, basically at cost, but recognising interest
income on the basis of the effective interest method,
which can lead to the difference between the ini-
tial cost and maturity amount being amortised by a
regular adjustment to the carrying value of the asset).
Any impairment loss (discussed below) is recognised
immediately in profit or loss.
• Available for Sale (AFS) financial assets are measured
at fair value in the balance sheet at each clos-
ing date (as for FVTPL assets), but changes in fair
value are temporarily recognised in equity (Other
Comprehensive Income – OCI) and recycled to profit
or loss only when the asset is realised (i.e. sold or
repaid). Nevertheless, effective interest income is
always recognised directly in profit or loss on interest-
bearing debt instruments. Any impairment loss
(discussed below) on debt or equity instruments is
also recognised immediately in profit or loss.
All financial assets have to be assessed for impairment.
Under IFRS, this is a two-step process. The first step
consists of establishing whether an impairment loss has
occurred: the entity has to assess whether there is any
objective evidence that the financial asset is impaired. This
requires identification of any 'loss event' that will have an
impact on the estimated future cash flows of the asset
that can be reliably measured (indicating that the original
investment will not be fully recovered). If such a loss event
is identified, the second step is to determine the precise
amount of the impairment loss.
The calculation of an impairment loss varies, depending
on the categories of financial assets:
• F VTPL assets do not require separate recognition of
an impairment loss as this loss will already be included
in the fair value. But fair value also includes other ele-
64
ments, such as the impact of any intervening changes
in interest rates and changes in market expectations
of future losses (reflected in market credit spreads and
liquidity premiums).
• For L&R and HTM investments (carried at amortised
cost), the impairment loss will be based on a calcula-
tion of the present value of the estimated future cash
flows – excluding future credit losses that have not
been incurred – discounted at the asset’s original
effective interest rate. This means that the calculation
is not impacted by changes in market interest rates,
including credit spreads and other market factors,
occurring since the asset was first acquired.
• For AFS assets (carried at fair value in the balance
sheet), the full amount of unrealised losses based on
the current fair value should be recognised in profit
or loss immediately. That is, all amounts previously
recognised in OCI should be transferred to profit or
loss. All subsequent decreases in fair value are consid-
ered to be impairments and will impact on profit or
loss (and not equity only) for the full amount. Under
certain conditions, impairments on AFS debt instru-
ments, such as bonds, can be reversed through the
income statement, while impairments on AFS equity
instruments (investments in shares) cannot.
The application of different impairment models means
that, for AFS debt instruments, income is recognised in
profit or loss on the basis of (historical) amortised cost, in
line with L&R and HTM assets. Once, however, the value
of the asset becomes impaired, impairment losses are rec-
ognised using a method that reflects not only the impact
of the cash flows estimated to be lost – as in the case
of L&R and HTM assets – but also the effect of changed
market factors on the present value of the cash flows still
expected to be received – as in the case of FVTPL assets.
In other words, reclassifications out of the FVTPL and
AFS categories, as the modified text allows, will have an
impact on day-to-day income recognition of non-prob-
lematic financial assets (for all transfers out of FVTPL), as
well as on the precise amount of loss taken at the report-
ing date for financial assets where an entity does not
expect to fully recover its original investment (for transfers
out of FVTPL or AFS into L&R or HTM).
FSI magazine | #5 April 2009
Transfers out of FVTPL and AFS categories allowed by
IAS 39 amendments
As stated above, transfers out of the FVTPL category were
prohibited before these amendments, while transfers out
of the AFS category were allowed only in certain specific
circumstances and for certain assets, providing the very
strict conditions for classifying them into the HTM cat-
egory were met. No other transfers were permitted.
Transfers out of the FVTPL category are still not allowed
for derivatives (such as forward contracts, swaps and
options) and financial assets that were voluntarily clas-
sified as FVTPL when first recognised (applying the 'Fair
Value Option'). This leaves only non-derivative financial
assets Held for Trading (HFT) as potential candidates for
transfer out of the FVTPL category.
Financial assets can only be reclassified out of FVTPL
or AFS if they meet specific criteria. These criteria vary
depending on whether the asset would have met the
definition of L&R had it not been classified as FVTPL or
AFS at initial recognition.
Sir David Tweedie, chair-
A debt instrument classified as HFT at initial recogni- man of the International
tion may be reclassified out of FVTPL if the asset is not Accounting Standards
intended to be sold in the near term, providing it meets Board (IASB).
the definition of L&R and the entity has the intention and
ability to hold the asset for the foreseeable future or until
maturity.
A debt instrument designated as AFS at initial recognition
may be reclassified to L&R if it meets the definition of L&R
and the entity has the intention and ability to hold the
financial asset for the foreseeable future or until maturity.
Any other debt instrument, or any equity instrument,
may be reclassified from FVTPL to AFS or, in the case of
debt instruments, from FVTPL to HTM if the financial
asset is no longer held for the purposes of sale in the near
term, but only in “rare” circumstances. In its press release
accompanying the amendments the IASB acknowledged
that market conditions in the third quarter of 2008 were a
possible example of a 'rare' circumstance.
65

In this
issue
News & Research 4
All reclassifications must be made at the fair value of the
financial asset at the date of reclassification. Previously
Balancing state aid and competition
recognised gains or losses cannot6 be reversed. The fair
Interview with Irmfried Schwimann,value
Director Financial
at the date of reclassification becomes the new cost
Services, DG Competition of the European Commission
or amortised cost of the financial asset, as applicable.
Will bank branches survive? The existing requirements in12 IAS 39 for measuring
financial assets at cost or amortised cost apply from the
Gains of the credit crisis reclassification date. 17
Column by Harry Smorenberg
For reclassifications out of AFS, IAS 39 requires the
UCITS risk management under construction
amounts previously recognised 18 in other comprehensive
income (OCI) to be reclassified to profit or loss either
Only strong and trusted brands will survive
through 22rate (if the instrument has
the effective interest
a maturity date) or on disposal (if the instrument has no
Foreign retail banking opportunities in China
maturity 24 Amounts deferred in
date, i.e. it is perpetual).
OCI may also need to be reclassified to profit or loss in the
Polish banking leaders caught inevent
the lens
of impairment. 30
‘Banking is the love of my life’ When do reclassifications 34 take effect?
Portrait of Józef Wancer, CEO of Bank BPH
Reclassifications made before 1 November 2008 could
take effect at any time between 1 July 2008 and 31
Financial crisis changes the regulatory
Octoberand 38
2008, providing documentation was in place by
supervisory landscape that date. An entity with a 31 October year-end could,
for example, have chosen 1 August as the reclassification
The cost of cash date in order to align with its43quarterly reporting. Equally,
an entity’s intent to hold assets for trading purposes may
Managing reputational risk have changed part-way through 48 a period for different
loans, say 5 September and 25 September, as a result of
Solvency II: Dealing with operational 54 An entity could reclassify
riskevents on those dates.
specific
at various dates, providing the criteria are met and evi-
Towards a more transparent tax dence is available regarding 58
position the change of intent.
Reclassifications made on or after 1 November 2008,
Unprecedented action by the IASB however, are effective from 62 the date of reclassification.
In other words, on a real-time basis, with no backdating
allowed.
What happens in practice?
What does this mean for those trying to understand the
financial statements of an entity applying the amend-
ments? Several financial institutions in Europe applied
the IAS 39 amendment in the third quarter of 2008.
Commerzbank, for example, reclassified €44 billion of
bonds from AFS to L&R, while Deutsche Bank transferred
€12.8 billion of trading assets and €12.1 billion of AFS
66
assets to L&R. More reclassifications will follow in the
fourth quarter of 2008, and probably additional transfers
later still. Deutsche Bank disclosed that, ‘If the reclassifi-
cation had not been made, the Group’s income statement
for the third quarter of 2008 would have included unre-
alised fair value losses on the reclassified trading assets
of €726 million and additional impairment of €119 million
on the reclassified financial assets available for sale which
were impaired. For the third quarter of 2008 sharehold- 24
ers’ equity (position net gains (losses) not recognised in
the income statement) would have included €649 million
of unrealised fair value losses on the reclassified financial
assets available for sale which were not impaired.’
These amendments will clearly have a material impact on
reported realised losses and on the equity of some enti-
ties. Nevertheless, readers of financial statements should
be able, on the basis of the disclosures, to adjust the
statements to what they would have been if the assets
had not been reclassified. Time will tell whether this is
good or bad.
34
In the meantime, the European Commission has asked
the IASB to consider allowing the reclassification of
financial assets classified as FVTPL under the Fair Value
Option on the same conditions as HFT assets, and also
to consider adjustments to the impairment rules for AFS
assets. In other words, to allow reversals of impairments
on AFS equity instruments through profit or loss, as in
the case of debt instruments, and to limit the impairment
in the income statement to credit losses only (as for L&R
assets), while keeping the remaining changes in fair value
in equity. So the debate will continue for some time to
come, and we can consider whether even a radical revi-
sion of the standards will in the near future be able to
38
resolve the question of what is the proper way to present
financial instruments in the balance sheet, income state-
ment and notes to the financial statements.
About the author
Carl Verhofstede is a Director of Deloitte Enterprise
Risk Services, Belgium
48
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