As long as banks have a well thought out plan of attack for their compliance risk assessments, adequately document their methodology, assumptions, and conclusions, theyll be okay as far as the examiners are concerned. But this isnt solely an exercise for the examiners sake; assessing risk is an important task to determine where the hot spots are in the bank and to avoid trouble in the future. In this age of rapid regulatory change, its absolutely essential. Pry is a senior director with Washington, sed Treliant Risk Advisors llc. He can be reached at). A defining skillset of any effective project manager is their ability to assess and mitigate risk. Spotting bumps in the road, predicting outcomes and preventing failures are all part of the responsibility of managing a project successfully.
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A focus solely on how a control operates without also examining how it was designed risks overestimating its overall effectiveness. Sometimes called controlled risk or something similar, this is the writing ultimate evaluation of where the institution stands after inherent risk is measured and controls applied. It answers the question where do we stand right now? This is also the critical rating from the examiners perspective, since it shows where the banks gaps are and where resources should be dedicated to further reduce the risk. It should be measured in the same fashion as inherent risk, using the same scale (whatever that might be depending on the bank). A key point here is to ensure that the ultimate rating is supported by documentation, so examiners, auditors, management, or other interested parties can see the assumptions, methodology, and process behind the rating. As an administrative matter, the residual risk rating cannot be higher than the inherent risk, no matter how effective the controls may be designed and/or executed. This makes sense since controls serve to reduce inherent risk, not increase. It is possible that the applied controls dont move the needle on the inherent risk rating at all, but thats a judgment call (and also a call for further action to tighten up the controls). Residual risk ultimately dictates where the compliance officer needs writing to dedicate time and resources. And since resources arent unlimited (especially in the compliance field banks should prioritize their action plans based on the highest residual risk ratings.
This factor must also be evaluated. Execution or operational effectiveness evaluates how well the control performs in practice; does it do what it was designed to do? In our flood example, if an automated control is designed to identify all structure-secured loans (the design is effective) but due to technical deficiencies it doesnt always find all loans in a certain origination system, the controls operation is not very effective. This rating is judged independently of the design effectiveness; poorly-designed controls can operate perfectly and therefore have a favorable execution effectiveness rating. However, the overall rating of the control is a cascade, meaning the controls overall rating cannot be higher than that of its paper design effectiveness. In other words, if a control is not designed properly, it wont matter how well it operates the control will not be effective. So if a bank uses a one-to-five scale to rate its controls and design effectiveness is rated three (meaning its designed moderately well for instance, and its execution effectiveness is rated five (it operates extremely well the controls overall effectiveness rating cannot be higher than. It wasnt designed to detect all issues before theyre allowed to occur; thus its not a highly effective control overall. Both elements are essential to properly evaluate compliance controls.
Evaluating design effectiveness means considering the reliability of the control: will it identify shortage exceptions in every necessary instance? Are all systems and business lines covered by design? Can it easily be resume circumvented (manual processes tend to fall into this category)? These are a few of the factors that contribute to the evaluation of control design effectiveness. Design effectiveness should be evaluated using a scale, just like inherent risk. There is no mandated methodology here either but it is easier to use the same scale as elsewhere. But even a well-designed control serves no purpose if its not put into place to do its job.
They can be automated or manual, but ideally they should be prescriptive, meaning they should perform their function to prevent a violation from taking place. Detective controls, such as identification of past instances of noncompliance, while certainly useful to identify what may continue in the future, only count problems that have already occurred; they dont control the problem from happening in the first place. Many argue these arent controls at all; they are quality control or testing mechanisms instead. An overlooked fact about controls is that there are really two aspects to their evaluation: design effectiveness and execution (or operational) effectiveness. Design effectiveness sounds pretty obvious, but if a control is not designed properly it wont matter how well it operates. For example, consider a control designed to ensure an adequate amount of flood insurance is in place on all structure-secured loans. To be effective, the control must be designed to identify any loan in the institution made that is secured by a structure; ensure the loan has a flood policy in place before closing (assuming the property sits in a flood hazard zone and ensure the. An effectively-designed prescriptive control would prevent loans from closing unless the proper amount of insurance is in place. This could be an automated process, where the closing package would be halted by the system unless proper documentation is present indicating coverage, or it could be a manual check-off procedure.
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So even though you claim to have a scale of three, the waters get muddied quickly and paper you end up with more landing points. So why not set it up that way in the first place? A one-to-five scale (or something even more granular) takes care of this problem by allowing finer degrees of judgment. The grades can still be manager color-coded (blue for two, orange for four, etc.) to present information in a dashboard format, if that is what is desired by management. The only caution here is how to label the categories.
Certainly terms such as high, high/mod, moderate, low/mod, and low work, but some may try to get creative and use terms such as acceptable or allowable. In compliance there is really no such thing as an acceptable risk, and weve all had conversations with those who claim theyll accept or take on the risk. The risk assessment should not lead examiners (or anyone else) to think that the bank is prepared to allow violations of law or regulations. Compliance risk must be managed and mitigated, not allowed to occur. Dont let terminology get you in trouble. Controls are processes to mitigate, or address and reduce, inherent risks that have been identified.
There are no regulatory requirements that any particular measurement system be used as long as a conclusion is made (in the form of a rating) that is supported by logical rationale. Low-mod-high is used throughout the Interagency bsa/aml examination Manual, so thats what many used when formulating that particular risk assessment, but again thats not the only game in town. There are two interrelated issues with the low-mod-high scale. The first is that many banks like to present risk information using a dashboard format, and low-mod-high corresponds nicely with green-yellow-red. This is great in theory, but in practice many people have a strong negative reaction when they see red, so the tendency is to avoid red at all costs.
This can lead to underestimating risk. High inherent risk is not an indictment of the bank; it just signifies an identified elevated risk level. If inherent risk is underestimated, sufficient controls will likely not be put into place. What results is a tendency to bunch everything in the middle: Well rate yellow to avoid too much red, but on the other hand we dont want to be seen as ignoring risk, so too many things shouldnt be green, either. The dashboard ends up mostly yellow. The related issue is that when looking at this too-yellow dashboard, people will start making distinctions within the moderate/yellow rating. This one is kind of a low-moderate, but this other one is kind of a high-moderate, and so forth.
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What do you mean my risk is high? I just told you all the things to prevent violations. If dashboard-type reports moliere are produced by compliance, people usually dont like the fact that something in their area might show up as red, even though its not a personal affront to the way the business conducts itself. The key is to step back and make sure people understand that youre not judging anyones performance when evaluating inherent risk. Youre merely obtaining a thorough understanding of the products, services, and processes involved in order to evaluate where compliance risk may lie. That takes detailed knowledge of both the regulatory requirements as well as the business processes. Once there, the next step is to pin an objective label on it: apply essay a rating. What scale should be used? There are generally two trains of thought: the low-moderate-high scale and the one-to-five scale.
An approach that aspires to make everyones lives easier, by focusing time and effort on processes that present greater risk, is a much easier sell. This is often the most difficult concept to explain to those in the business units. Inherent risk is the risk of violations if there were absolutely no controls in place. No compliance department, no monitoring, no testing, nothing. It can be a difficult concept simply because inherent risk isnt always explained very well. Heres a typical conversation: Whats the inherent compliance risk for flood insurance in this line of business? Oh, were good the risk is very low. We do many things to ensure everything is done correctly and timely when it comes to flood. Obviously the missed point is that inherent risk means controls and mitigation strategies are not considered, but undoing this damage is sometimes taken thesis as an insult.
requirements? In the end it doesnt matter; we have to evaluate compliance risk regardless. So how best to do it? There is no one right way, but there are some best practices that have developed over many trial and error efforts, and thats what well discuss here. The end game is to effectively evaluate the banks risk of violating laws or regulations and to then adequately mitigate that risk through well-designed and executed controls. To start with, compliance risk belongs to the business units. They own it since the business processes involving the banks products and services and interaction with customers are performed in those units, not in the compliance department or anywhere else. The compliance department exists to assist business units in identifying and developing controls to mitigate the risks but those controls should be performed within the lines. Business units must take ownership of the process. Whatever can be done to achieve that buy-in within the business (and because the regulators say so usually wont do it) will make the process easier and ultimately more effective.
Formulating the bank secrecy Act (bsa anti-money laundering (AML) risk assessment about five years ago was many a compliance officers first experience with putting one together. Fair lending soon followed (initially just for the largest banks; by now, nearly everyone) but now we are at the point where risk assessments are critical to the compliance function overall. Examiners expect banks to know where their compliance risks are and to devote resources to those areas that present the greatest risk to the institution. There is vegetarianism even a growing expectation that banks perform an enterprise-wide compliance risk assessment that is, evaluate any and all compliance risks across the institution, rate them, then prioritize accordingly. That is a daunting task to be sure, especially since many compliance officers werent raised that way. Were used to putting out fires when they crop up, preparing for new regulatory requirements, and generally providing advice; however this new approach is the way of the future. This isnt just a compliance concern increasingly banks are being charged with understanding their operational, credit, market, and reputation risk profiles as well.
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Risk Assessment us epa, jump to main content, risk. Assessment, learn about, risk. Assessment, human health, risk. Assessments, resources for, environmental Professionals. Editor's Note: For an update to the article, read the 2018 taxi article: Today's best practices for compliance risk assessment. Putting together a compliance risk assessment is pretty much standard procedure by now. Although risk assessment methodology in general has been around for quite a while, its prominence in the compliance field is a fairly recent phenomenon.