Value Through Scenario Analysis
POWERFUL INSIGHTS
Issue
Based on the recent large financial institution failures
triggered by the subprime crisis, it is evident that, among
other issues, the concepts, methodologies and discipline
developed by operational risk management to anticipate
and address extreme events were not adopted or followed
by many institutions.
In the days that followed the Paulson and Bernanke meeting
on Capitol Hill, there was much anger in the public and
turmoil in the marketplace. What is shocking is not just the
cost of the bailout program (some estimates indicate the
total cost of the crisis may hit $8.5 trillion2), but the industry’s under-preparedness for such an extreme risk event.
The markets declined with unprecedented volatility as
investors became even more anxious about the uncertainty
and risks that lie ahead. So-called “nightmare scenarios”
became real in a matter of days.
Challenges and Opportunities
For most organizations, scenario analyses pave the way
to designing such a process. To impact firm strategy,
scenario analyses should be rooted in an institution’s
culture and in the strategic thinking of top management.
Too often, the use of scenario analysis is ill-defined in
operational risk management policies and, when defined,
poorly executed.
Understanding the value of scenario analysis provides a
way for all organizations – not just financial institutions –
to be proactive in identifying their top operational risks,
identifying processes where there may be the greatest risk,
and prioritizing risk and compliance initiatives. In fact, the
benefits of critical thinking to which scenario analysis lends
itself often are the basis for identifying strategies to gain
competitive advantage.
Our Point of View
Decisions are based on a person’s predictive judgments as
to what might happen (scenarios).
Decision
Feedback
On the evening of September 18, 2008, Federal Reserve
Chairman Ben Bernanke and U.S. Treasury Secretary Henry
Paulson held an urgent and unusual session on Capitol
Hill. Congressional leaders listened in stunned silence as
Paulson told them, “… we’re literally maybe days away from
a complete meltdown of our financial system, with all the
implications here at home and globally.” Within a few days,
Paulson proposed a $700 billion bailout package.1
Predictive Judgments
Many firms (large, small, old and new) found themselves
embroiled in a situation for which they could have been better
prepared. They could have at least partially reduced the overall impact if they had effectively embedded in their business
processes and culture a cost-effective, repeatable process
called scenario analysis. Instead, they faced a crisis similar
to what a senator on the Banking Committee described as
“flying a $700 billion plane by the seat of our pants.” Another
senator added, “Shouldn’t we have the process designed
before we have to do a $700 billion experiment?”3
Our view is that organizations should prepare to make the
best possible predictive judgments by utilizing a repeatable
scenario analysis methodology. The quantification of the
1 “Summary of the Emergency Economic Stabilization Act of 2008,”
3 “Paulson Under Pressure to Toughen Bail-out Plan,” Guardian News
United States Senate Committee on Banking, Housing and Urban Affairs.
2 Jim Puzzanghera. “Economic rescue could cost $8.5 trillion,”
Los Angeles Times, November 30, 2008.
Information
and Media, September 23, 2008.
top operational risks resulting from this methodology can
be used not only to calculate capital, but also to pinpoint
the most critical areas needing control investments, and to
revisit current risk management strategies being deployed
or that may be over-controlled.
Taken solely in isolation, scenario analysis will not prevent
the type of systemic risk seen in the marketplace today.
Employed effectively and in a disciplined manner, scenario
analysis can serve to identify potential “trouble spots”
earlier than competitors and allow the organization to take
action to protect or even enhance stakeholder value.
PROVEN DELIVERY
How We Help Companies Succeed
We work together with our clients to develop reasonable,
insightful and challenging scenarios. Using our proprietary
scenario methodology, we guide executive leaders to debate
and agree to their top operational risks, and help organizations quickly gather the most appropriate information that
can be used to build scenarios scaled to their organization.
Our expertise in decision-making, including social psychology and organizational behavior, allows us to mitigate the
negative implications of decision-making biases and keep
leaders focused on generating predictive judgments and
choices. Additionally, our deep experience in risk quantitative methods allows for rapid development of mathematical
models and interpretation in everyday terms.
Example
One of the 10 largest U.S. financial institutions sought to
identify its top five operational risks. Workshop sessions
were held with senior executives from all aspects of the bank,
leading the executives through a scenario analysis methodology. Protiviti professionals worked with the client’s corporate
operational risk team to gather the appropriate supporting
information, including internal losses, external consortium
data, risk and control self-assessments, Sarbanes-Oxley data
and compliance findings.
Our professionals helped the client generate potential incidents and five scenarios for event risk categories that could
have severe impacts and used them during the workshops
to guide conversation and critical thinking. We worked with
the executives to build severity distributions. These values
provided estimates of the likelihood and size of loss events
occurring in each business line, as well as the maximum
loss a business could incur from a single loss event.
Feedback on the executives’ confidence in their decision
outcomes and – equally as important – satisfaction with
the scenario process was rated “high value add to the
organization.” Our client’s business leaders had never
worked together across business and functional boundaries
in such a repeatable fashion to identify the top risks for
the organization. As a result of this effort:
• Capital modeling was improved through the influence of
information obtained in scenario analysis.
• Risk initiatives and investments were prioritized more
effectively.
• Management’s confidence in anticipating and managing
risks increased substantially.
• Communication across business lines and functions was
enhanced significantly, improving risk discussions and
transparency.
Contacts
Cory Gunderson
+1.212.708.6313
cory.gunderson@protiviti.com
Jim Ryan, Ph.D.
+1.312.931.8710
jim.ryan@protiviti.com
Shaheen Dil
+1.212.603.8378
shaheen.dil@protiviti.com
About Protiviti
Protiviti (www.protiviti.com) is a global consulting firm that helps companies solve problems in finance, technology, operations,
governance, risk and internal audit. Through our network of more than 70 offices in over 20 countries, we have served more than
35 percent of FORTUNE® 1000 and Global 500 companies. We also work with smaller, growing companies, including those looking
to go public, as well as with government agencies.
Protiviti is a wholly owned subsidiary of Robert Half International Inc. (NYSE: RHI). Founded in 1948, Robert Half International is a
member of the S&P 500 index.
© 2012 Protiviti Inc. An Equal Opportunity Employer. PRO-0212-107026
Protiviti is not licensed or registered as a public accounting firm and does
not issue opinions on financial statements or offer attestation services.