ELTP ERM Trainee Manual 2023 PDF

ENTERPRISE RISK MANAGEMENT (ERM) ELTP TRAINEE MANUAL MODULE 1 1.1 Introduction to ERM Enterprise risk management (ERM) is a methodology that looks at risk management strategically from the perspective of t...

ENTERPRISE RISK MANAGEMENT (ERM) ELTP TRAINEE MANUAL MODULE 1 1.1 Introduction to ERM Enterprise risk management (ERM) is a methodology that looks at risk management strategically from the perspective of the entire firm or organisation. It is a top-down strategy that aims to identify, assess, and prepare for potential losses, dangers, hazards, and other potential harm that may interfere with an organisation’s operations and objectives and/or lead to losses. ERM provides a framework for risk management, which typically involves identifying particular events or circumstances relevant to the organization’s objectives (threats and opportunities), assessing them in terms of likelihood and magnitude of impact, determining a response strategy, and monitoring process. By identifying and proactively addressing risks and opportunities, business enterprises protect and create value for their stakeholders, including owners, employees, customers, regulators, and society overall. 1.2 Importance and Advantages of ERM Enterprise risk management is a very relevant and important topic for any organization that wants to achieve its objectives and survive in a complex and uncertain environment. ERM can help an organization to:  Identify and prioritize the key risks that may affect its performance, reputation, or sustainability.  Develop and implement effective strategies to manage, mitigate, or transfer those risks.  Align risk management with the organisation’s vision, mission, values, and goals.  Enhance decision-making, planning, and resource allocation based on a comprehensive understanding of the risk landscape. 1|Page   Improve communication, collaboration, and accountability across the organization and with external stakeholders.  gain a competitive advantage, improve decision-making, increase resilience, agility and foster innovation in a dynamic changing environment.  help an organization to meet the expectations of various stakeholders, such as shareholders, employees, customers, regulators, and society as a whole. By implementing ERM, an organization can create and protect value for its shareholders, employees, customers, regulators, and society as a whole. ERM is not a one-time project or a compliance exercise; it is an ongoing process that requires continuous monitoring, evaluation, and improvement. ERM is also not a one-size-fits-all solution; it should be tailored to the specific needs, culture, and context of each organization. 1.3 Traditional Versus Enterprise Risk Management Traditional risk management (TRM) is an approach to managing risks that focuses on specific areas or departments of an organization. For example, a manufacturing company might have a risk management team focused solely on safety risks on the factory floor. Enterprise risk management does not focus on a specific area but rather it’s on the entire organisation and individual unit or department risk management is a subset of the holistic approach. Key Differences Traditional Risk ERM Scope It is a siloed and fragmented It’s a holistic and integrated approach approach that focuses on specific that considers all types of risks across risks within a particular area or the entire organization department Methodology a reactive and tactical approach a proactive and strategic approach that that deals with risks as they arise aligns risk management with the or after they have occurred organisation’s vision, mission, values, and goals Outcomes a value-creating and performance- is a value-protecting and compliance- enhancing approach that helps the oriented approach that helps the organization to anticipate, organization minimize the impact of manage, and mitigate risks, risks on a specific area or department 2|Page  thereby protecting its reputation, assets, and long-term success, Perspective Seen to be less effective and more It’s considered to be a more effective of a knee-jerk approach that is and efficient approach and creates unsustainable sustainability However, in today’s complex and uncertain business environment, ERM is generally considered to be a more effective and efficient way to manage risk than TRM. ERM can help an organization gain a competitive advantage, improve decision-making, increase resilience, and foster innovation. ERM can also help an organization meet the expectations of various stakeholders, such as shareholders, employees, customers, regulators, and society as a whole. 1.4 Challenges of ERM Implementation Lack of management support and commitment: ERM requires the involvement and buy- in of senior management and board members, who need to provide clear direction, guidance, and resources for ERM activities. Without their support, ERM may not be aligned with the organisation’s vision, mission, values, and goals, and may not receive adequate attention or priority. Different management priorities and perspectives: ERM needs to consider all types of risks across the entire organization, which may involve different functions, departments, units, and stakeholders. However, these groups may have different views and interests on risk management, such as different risk appetites, definitions, assessments, and responses. This may lead to conflicts, inconsistencies, or gaps in ERM processes and outcomes. Reluctance to share sensitive information: ERM requires the sharing of risk-related information among various parties within and outside the organization. However, some parties may be reluctant to disclose such information due to confidentiality, security, or competitive reasons. This may limit the quality and completeness of risk identification, analysis, and reporting. Difficulties in quantifying and measuring risks: ERM needs to assess the likelihood and impact of various risks on the organization’s objectives and performance. However, some risks may be difficult or impossible to quantify or measure due to uncertainty, 3|Page complexity, or lack of data. This may affect the accuracy and reliability of risk evaluation and prioritization. Lack of a common risk language and framework: ERM needs to establish a common risk language and framework that can be understood and applied by all parties involved in ERM activities. However, different parties may use different terms, concepts, models, or standards for risk management, which may cause confusion or miscommunication. This may hamper the consistency and effectiveness of ERM practices. Limited access to data and technology: ERM needs to collect, process, store, analyze, and report large amounts of risk-related data from various sources. However, some organizations may not have sufficient access to data or technology that can support ERM functions. For example, they may lack the tools or systems that can integrate data from different sources, perform advanced analytics, generate visualizations, or enable real- time monitoring. Failure to leverage the power of digital technologies: ERM needs to leverage the power of digital technologies that can enhance risk management capabilities and outcomes. For example, artificial intelligence (AI), blockchain, and the Internet of Things (IoT) can help identify and predict emerging risks, automate risk responses, improve risk transparency, or create new opportunities. However, some organizations may not be aware of or prepared for the potential benefits and challenges of these technologies for ERM. Inadequate governance and oversight: ERM needs to have a clear governance structure and oversight mechanism that can ensure the accountability and responsibility of ERM activities. For example, there should be a designated risk committee or function that can oversee the development and implementation of ERM policies and procedures. However, some organizations may not have a well-defined or effective governance model for ERM that can provide guidance or feedback for continuous improvement. 4|Page 1.5 COMPONENTS OF THE ERM 1.5.1 Goals and Objective Setting As a company determines its purpose, it must set objectives that support the mission and goals of a company. These objectives must then be aligned with a company's risk appetite. For example, an ambitious company that has set far-reaching strategic plans must be aware there may be internal risks or external risks associated with these lofty goals. In response, a company can align the measures to be taken with what it wants to accomplish such as hiring additional regulatory staff for expansion areas it is currently unfamiliar with. 1.5.2 Risk/Event Identification Positive events may have a great impact on a company. On the other hand, negative events may have detrimental outcomes on a company's ability to continue to operate. ERM guidance recommends that companies identify important areas of the business and associated events that may have dire outcomes. These high-risk events may pose risks to operations (i.e. natural disasters that force offices to temporarily close) or strategic (i.e. government regulation outlaws the company's primary product line). 1.5.3 Risk Assessment In addition to being aware of what may happen, the ERM framework details the step of assessing risk by understanding the likelihood and financial impact of risks. This includes not only the direct risk (i.e. a natural disaster yields an office unusable) but residual risks 5|Page (i.e. employees may not feel safe returning to the office). Though difficult, the ERM framework encourages companies to consider quantifying risks by assessing the per cent change of occurrence as well as the dollar impact. The process of prioritizing risks based on their significance and urgency is critical. 1.5.4 Risk Response/Treatment A company can respond to risk in the following four ways: a. Risk Avoidance. This results in the company leaving the activity that causes the risk as the company would rather forgo the benefits of the activity than incur the risk. An example of risk avoidance is a company shutting down a product line and discontinuing selling a specific good. b. Risk Reduction. This results in the company staying engaged in the activity but putting forth effort in minimizing the likelihood or magnitude of the risk. An example of risk reduction is a company keeping the product line above open but investing more in quality control or consumer education on how to properly use the product. c. Risk Sharing. This results in the company moving forward as-is with the current risk profile of the activity. However, the company leverages an independent third party to share in the potential loss in exchange for a fee. An example of risk sharing is purchasing an insurance policy. d. Risk Acceptance. This results in the company analyzing the potential outcomes and determining whether it is financially worth pursuing mitigating practices. An example of risk acceptance is the company keeping the product line with no changes to operations and risk sharing. 1.5.5 Risk Monitoring and Reporting This component involves tracking and reviewing the performance and effectiveness of the risk response strategies, as well as the changes in the risk environment. It also includes reporting and communicating the risk information to relevant stakeholders. It involves getting feedback, analysing company data, and informing management of unprotected risks. Additionally, the team need to capture and apply lessons learned towards improving the framework, as well as identifying and addressing the gaps and weaknesses in the ERM framework. 1.6 Integrating ERM into Organizational Strategy 6|Page To integrate ERM into organizational strategy, an organization needs to follow a systematic and iterative process that involves the following steps: 1. Understand the environment: This step involves analysing the internal and external factors that may influence the organization’s strategy, such as its mission, vision, values, stakeholders, resources, capabilities, competitors, customers, regulators, and market trends. This step also involves identifying the potential risks and opportunities that may arise from these factors, as well as their interrelationships and dependencies. 2. Build the plan: This step involves developing the strategic plan that defines the organization’s goals and objectives, as well as the strategies and initiatives to achieve them. This step also involves assessing and prioritizing the risks and opportunities that may affect or be created by the strategic plan, as well as determining the risk appetite and tolerance of the organization. 3. Execute the plan: This step involves implementing the strategic plan and monitoring its progress and outcomes. This step also involves selecting and applying appropriate risk response strategies to manage, mitigate, or transfer the risks, or to exploit or enhance the opportunities. This step also involves allocating resources and responsibilities for risk response actions. 4. Review and revise: This step involves evaluating the performance and effectiveness of the strategic plan and the risk response strategies, as well as identifying and addressing any gaps or weaknesses in the ERM framework. This step also involves updating and improving the strategic plan and the ERM framework based on feedback and best practices. By following these steps, an organization can integrate ERM into its organizational strategy and create more value from its risk management activities. ERM can help an organization achieve its strategic objectives while minimizing its exposure to potential threats and maximizing its potential for growth and innovation. 1.7 The Basel Accord The Basel Accord is a set of international banking regulations issued by the Basel Committee on Banking Supervision (BCBS), which consists of representatives from central banks and regulatory authorities from around the world. The first Basel Accord (Basel I) was introduced in 1988 and focused on credit risk. The second Basel Accord (Basel II) was introduced in 2004 and expanded the scope to include market risk and operational risk. The third Basel Accord (Basel III) was introduced in 2010 and revised in 7|Page 2017 to address the lessons from the global financial crisis and enhance the resilience of banks. The Basel Accords were developed over several years beginning in the 1980s. The BCBS was founded in 1974 as a forum for regular cooperation between its member countries on banking supervisory matters. The BCBS describes its original aim as the enhancement of "financial stability by improving supervisory know-how and the quality of banking supervision worldwide." Later, the BCBS turned its attention to monitoring and ensuring the capital adequacy of banks and the banking system. The Basel I Accord was originally organized by central bankers from the G10 countries, who were at that time working toward building new international financial structures to replace the recently collapsed Bretton Woods system. The meetings are named "Basel Accords" since the BCBS is headquartered in the offices of the Bank for International Settlements (BIS) located in Basel, Switzerland. Member countries include Australia, Argentina, Belgium, Canada, Brazil, China, France, Hong Kong, Italy, Germany, Indonesia, India, Korea, the United States, the United Kingdom, Luxembourg, Japan, Mexico, Russia, Saudi Arabia, Switzerland, Sweden, the Netherlands, Singapore, South Africa, Turkey, and Spain. 1.7.1 Basel I The first Basel Accord, known as Basel I, was issued in 1988 and focused on the capital adequacy of financial institutions. The capital adequacy risk (the risk that an unexpected loss would hurt a financial institution), categorizes the assets of financial institutions into five risk categories 0%, 10%, 20%, 50%, and 100%. Under Basel I, banks that operate internationally must maintain capital (Tier 1 and Tier 2) equal to at least 8% of their risk-weighted assets. This ensures banks hold a certain amount of capital to meet obligations. For example, if a bank has risk-weighted assets of $100 million, it is required to maintain capital of at least $8 million. Tier 1 capital is the most liquid and primary funding source of the bank, and tier 2 capital includes less liquid hybrid capital instruments, loan-loss, and revaluation reserves as well as undisclosed reserves. 8|Page 1.7.2 Basel II The second Basel Accord, called the Revised Capital Framework but better known as Basel II, served as an update of the original accord. It focused on three main areas: minimum capital requirements, supervisory review of an institution's capital adequacy and internal assessment process, and the effective use of disclosure as a lever to strengthen market discipline and encourage sound banking practices including supervisory review. Together, these areas of focus are known as the three pillars. Basel II divided the eligible regulatory capital of a bank from two into three tiers. The higher the tier, the less subordinated securities a bank is allowed to include in it. Each tier must be of a certain minimum percentage of the total regulatory capital and is used as a numerator in the calculation of regulatory capital ratios. The new tier 3 capital is defined as tertiary capital, which many banks hold to support their market risk, commodities risk, and foreign currency risk, derived from trading activities. Tier 3 capital includes a greater variety of debt than tier 1 and tier 2 capital but is of a much lower quality than either of the two. Under the Basel III accords, tier 3 capital was subsequently rescinded. 1.7.3 Basel III In the wake of the Lehman Brothers collapse of 2008 and the ensuing financial crisis, the BCBS decided to update and strengthen the Accords. The BCBS considered poor governance and risk management, inappropriate incentive structures, and an overleveraged banking industry as reasons for the collapse. In November 2010, an 9|Page agreement was reached regarding the overall design of the capital and liquidity reform package. This agreement is now known as Basel III. Basel III is a continuation of the three pillars along with additional requirements and safeguards. For example, Basel III requires banks to have a minimum amount of common equity and a minimum liquidity ratio. Basel III also includes additional requirements for what the Accord calls "systemically important banks," or those financial institutions that are considered "too big to fail." In doing so, it got rid of tier 3 capital considerations. The Basel III reforms have now been integrated into the consolidated Basel Framework, which comprises all of the current and forthcoming standards of the Basel Committee on Banking Supervision. Basel III tier 1 has now been implemented and all but one of the 27 Committee member countries participated in the Basel III monitoring exercise held in June 2021. The final Basel III framework includes phase-in provisions for the output floor, which will start at 50% on Jan. 1, 2023, rising in annual steps of 5% and be fully phased-in at the 72.5% level from January 2028. These 2023 onward measures have been referred to as Basel 3.1 or Basel IV. Basel Accord provides a framework for banks to measure and manage their risks, including credit, market, and operational risks, and to maintain adequate capital to cover those risks ERM can help banks comply with the Basel Accord requirements and improve their risk management practices. Basel 1 Basel 2 Basel 3 Risk weights categorized Banks use their introduced more assets into four internal models to standardized and risk categories calculate risk conservative measures for based on risk weights for different credit risk, market risk, weights0%, 20%, types of exposures. and operational risk2. 50%, and 100%. Risks focused Expanded the scope principally on to include market Credit risk risk and operational risk 10 | P a g e  Pillars Introduced the Expanded to 3 Maintained the pillars but Pillar 1, Capital pillars: Supervisory deepened the requirement process and requirements disclosure requirements Capital 8% Minimum 8% Minimum 10.5% Minimum capital. requirements Capital capital requirement Introduced the buffer requirement with with 6% in tier 1 conservatory capital of 4% tier 1 capital capital 2.5% and Counter-cyclical buffer of 0-2.5% Leverage Did not address Did not address this introduced a leverage ratio and Liquidity this of 3% and two liquidity Ratios ratios: the liquidity coverage ratio (LCR) and the net stable funding ratio (NSFR) MODULE TWO 2.0. ERM TEAM: ROLES AND RESPONSIBILITIES 2.1. Board Responsibilities The role of the Board in ERM:  Defining the bank’s overall strategic direction and tolerance level for each risk element.  Ensuring that the bank maintains the various risks facing it at prudent levels.  Ensuring that senior management as well as individuals responsible for managing individual risks facing the bank possess sound expertise and knowledge to accomplish the risk management function.  Ensuring that the bank implements sound fundamental principles that facilitate the identification, measurement, monitoring, and control of all risks facing it. 11 | P a g e   Ensuring that appropriate plans and procedures for managing individual risk elements are in place. The Board’s Oversight & Governance:  To secure the independence of the B o a r d Risk Management C o m m i t t e e ( BRMC), the Chairman of theBoard shall not be a member of the committee in line with the Code of Corporate Governance for Banks in Nigeria.  Membership of the BRMC shall include at least two (2) non-executive directors, one of whom should be an independent director. One of the non-executive directors shall serve as Chairman.  The MD/CEO shall be a member of the BRMC to complement his oversight role as the Chief Executive Officer of the bank.  The Board Risk Management Committee (BRMC) should be responsible for ensuring adherence to the bank’s risk management policy and procedures as set out by the board as well as reviewing the bank’s risk strategy for appraisal by the board. 2.2. Management and Responsibilities Management’s role in ERM: Senior management is responsible for the implementation of risk policies and procedures in line with the strategic direction and risk appetite specifiedby the board. For the effective management of risks facing a bank, senior management should at the minimum be responsible for:  The development and implementation of procedures and practices that translate the board's goals, objectives, and risk tolerances into operating standards that are well understood by the bank’s personnel. 12 | P a g e   Establishing lines of authority and responsibility for managing individual risk elements in line with the Board’s overall direction.  Risk identification, measurement, monitoring, and control procedures.  Establishing effective internal controls over each risk management process.  Ensuring that the bank’s risk policies, appetite and tolerance are welldocumented and communicated throughout the bank. Operationalizing ERM within Management: This involves integrating risk management practices into the company's daily operations and decision-making processes. Here are some steps to achieve this:  Establish Key Risk Indicators (KRIs) and Key Performance Indicators (KPIs) to track risk and performance.  Assign accountability to specific individuals or departments and ensure that risk owners are responsible for monitoring and managing their assigned risks.  Conduct training and awareness programs to educate employees about the importance of risk management and their roles in it.  Ensure transparency and clear communication of risk exposure and mitigation progress.  Periodically review and update the ERM framework and processes.  Invest in ERM software and tools to streamline risk data collection, analysis, and reporting. 2.3. Auditors and Responsibilities Auditor’s Role in ERM Assessment:  Risk Assessment: Internal auditors assist in identifying and assessing various types of risks, including credit risk, market risk, operational risk, liquidity risk, and compliance risk. They evaluate the effectiveness of risk assessment methodologies used by the bank. 13 | P a g e   Risk Measurement and Quantification: Internal auditors evaluate the bank's methods for quantifying and measuring risks. They assess whether the bank uses appropriate models and data to estimate potential losses under various risk scenarios.  Risk Reporting: Internal auditors review the bank's risk reporting process to ensure that risk information is accurate, timely, and useful to senior management and the board of directors. They check if reports comply with regulatory requirements.  Risk Management Policies and Procedures: Auditors assess the adequacy of risk management policies and procedures in place. They check whether these policies align with the bank's risk tolerance and regulatory guidelines.  Regulatory Compliance: Internal auditors ensure that the bank complies with relevant regulatory requirements, such as Basel III, Dodd-Frank Act, and Anti- Money Laundering (AML) regulations. They also check for adherence to internal policies and procedures.  Control Testing: Auditors conduct control testing to determine whether the risk mitigation controls are effective in managing identified risks. They assess whether controls are consistently applied and whether there are any control deficiencies.  Fraud Detection: Internal auditors may also be involved in detecting and preventing fraud within the bank. They review transactional data, processes, and systems to identify potentially fraudulent activities.  Continuous Monitoring: Auditors perform ongoing monitoring of risks to ensure that risk profiles are up-to-date and that the bank is responding appropriately to emerging risks. Auditing ERM effectiveness:  Review the bank's risk appetite statement and strategic risk management plan to ensure alignment with business objectives.  Review the bank's risk mitigation strategies and controls to determine their adequacy and effectiveness.  Examine the bank's risk monitoring and reporting processes to ensure timely and accurate reporting to senior management and the board. 14 | P a g e   Evaluate the quality of risk reporting, including the identification of emerging risks.  Ensure that stress testing results are integrated into the bank's decision-making processes.  Evaluate the bank's cybersecurity measures and technology risk management. 2.4. Risk Officers and Responsibilities Chief Risk Officer (CRO): The Chief Risk Officer (CRO) is a senior executive responsible for overseeing all aspects of an organization's risk management efforts within the context of an Enterprise Risk Management (ERM) system. They ensure that risks are identified, assessed, mitigated, and monitored effectively to protect and enhance the organization's value and reputation while ensuring compliance with relevant regulations and standards. Risk Officer’s role:  Risk Identification: The risk officer is responsible for identifying and documenting all potential risks that could affect the organization. This includes both internal and external risks, such as financial risks, operational risks, regulatory risks, market risks, and reputational risks.  Risk Assessment: After identifying risks, the risk officer assesses the potential impact and likelihood of each risk. This involves analyzing data, historical trends, and qualitative information to determine the significance of each risk.  Risk Measurement: The risk officer may use various quantitative and qualitative methods to measure the magnitude of risks. This can include financial modelling, stress testing, scenario analysis, and key risk indicators (KRIs).  Risk Monitoring: Continuous monitoring of risks is crucial. The risk officer tracks and reports on the status of risks, ensuring that any changes or new risks are promptly identified and assessed. This involves maintaining a risk dashboard or reporting system. 15 | P a g e   Risk Reporting: The risk officer communicates risk information to senior management, the board of directors, and other stakeholders. Reports should provide a clear understanding of the organization's risk profile, trends, and potential impacts on the business..2.5. The Three Lines of Defense Model The Three Lines of Defense (3LoD) model is a risk management framework commonly used in Enterprise Risk Management (ERM) to help organizations effectively manage and control risks. Each "line" represents a different level of responsibility and oversight. The 3LOD model helps organizations create a structured approach to risk management, with clear roles and accountabilities at each level. This separation of duties and responsibilities helps enhance the overall effectiveness of risk management and promotes a culture of risk awareness and accountability throughout the organization. Understanding the Model: First Line of Defense: The first line of defence consists of the operational business units, departments, and teams within an organization that directly engage in day-to-day activities and processes. These units are responsible for identifying, assessing, and managing risks as an integral 16 | P a g e part of their operations. Key responsibilities include setting risk tolerances, implementing controls, monitoring, and reporting on risks, and taking immediate corrective actions when risks are identified. Second Line of Defense: The second line of defense is comprised of risk management, compliance, and control functions that provide oversight, guidance, and support to the first line of defense. This includes risk management departments, compliance teams, and financial control functions. Their role is to independently assess and validate the effectiveness of risk management processes, ensure compliance with regulations and internal policies, and provide guidance on risk mitigation strategies. They also monitor risk exposures at a broader organizational level. Third Line of Defense: The third line of defense is represented by the internal audit function, which operates independently from both the first and second lines of defense. Internal auditors provide an objective and unbiased evaluation of the effectiveness of the risk management and control processes. They conduct audits and reviews to assess whether the first and second lines of defense are functioning effectively, adhering to policies and procedures, and achieving their risk management objectives. Their findings and recommendations are reported to senior management and the board of directors. Interaction Between the Lines  The first line of defense is provided by front-line staff and operational management.  The second line of defense is provided by the risk management and compliance functions.  The third line of defense is provided by the internal audit function. 2.6. Strengths & Weaknesses of the Model: While the model has its strengths, it also has some weaknesses: Strengths: 17 | P a g e Clear Accountability: The 3LoD model establishes clear roles and responsibilities for risk management, which helps ensure that everyone in the organization understands their role in managing risk. This clarity can improve accountability and reduce the likelihood of gaps in risk oversight. Effective Risk Governance: It promotes strong governance by clearly defining the roles of various stakeholders, including operational management (1st Line), risk and compliance functions (2nd Line), and internal audit (3rd Line). This separation of duties helps prevent conflicts of interest. Efficient Use of Resources: The model allows organizations to allocate resources efficiently. Operational teams (1st Line) focus on their core activities, while specialized risk and compliance teams (2nd Line) provide expertise and oversight. Internal audit (3rd Line) provides independent assurance. Comprehensive Risk Management: By involving multiple lines, the model encourages a holistic view of risks. It combines risk identification and management at the operational level with independent oversight and audit, ensuring a more comprehensive risk management approach. Alignment with Regulatory Expectations: Many regulatory bodies, including banking and financial authorities, support or require the implementation of the 3LoD model. Adhering to this model can help organizations meet regulatory compliance requirements. Weaknesses: Overlaps and Gaps: In practice, there can be overlaps or gaps in responsibilities between the lines. This can lead to confusion about who is responsible for specific risk management tasks, potentially resulting in inadequate risk management. Complexity: Implementing the 3LoD model can be complex, especially in large organizations. Managing interactions and coordination between the three lines can be challenging, potentially leading to inefficiencies. 18 | P a g e Silos: The model may inadvertently create silos, where each line focuses primarily on its specific responsibilities and lacks a holistic view of risks. This can hinder effective risk identification and management. Resource Constraints: Smaller organizations may struggle to implement the 3LoD model effectively due to resource limitations. They may find it challenging to maintain distinct lines of defense and hire specialized risk and compliance staff. Resistance to Change: Some employees and managers may resist the changes associated with implementing the model, viewing it as bureaucratic and adding unnecessary layers of oversight. Dependency on Culture: The effectiveness of the 3LoD model depends on the organization's culture. If the organization does not have a strong culture of risk management and accountability, the model may not function as intended. In summary, the Three Lines of Defense model provides a structured approach to risk management with clear roles and responsibilities. However, its successful implementation requires careful planning, strong communication, and a risk-aware organizational culture to address potential weaknesses and ensure its effectiveness. Organizations should adapt the model to fit their specific needs and challenges while addressing any potential shortcomings. 19 | P a g e  MODULE THREE 3.0 THE COSO CONCEPT COSO Enterprise Risk Management - Integrated Framework (COSO ERM Framework): The Committee of Sponsoring Organizations of the Treadway Commission (COSO) is a joint initiative to combat corporate fraud. 20 | P a g e  It was established to guide executive management and governance entities on relevant aspects of organizational governance, business ethics, internal control, enterprise risk management, fraud, and financial reporting. COSO has established a common internal control model against which companies and organizations may assess their control systems. The COSO ERM Framework consists of eight components: Governance and Culture, Strategy and Objective-Setting, Performance, Review and Revision, Information, Communication, Reporting, and Monitoring. It helps organizations integrate risk management into their strategic planning and decision-making processes. 3.1 Integrated Framework The COSO framework is designed to view Enterprise Risk Management as an initiative that covers:  Eight (8) Components of the Organization  Across all relevant levels of an organization: Enterprise/Entity Level, Division and Subsidiary Level, and Strategic Business Unit (component Product or Service) Levels.  AND to ensure the achievement of the entity’s objectives: Strategic, Operations, Reporting and Compliance. 3.1.1 The ERM Framework depicts the following three sides: SIDE 1: Entity’s objectives 1. Strategic Objectives – High-level goals. 2. Operations Objectives- Efficient management of the entity’s resources. 3. Reporting Objectives- Reliable reports/feedback process 21 | P a g e  4. Compliance Objectives- Applicable laws and policies. SIDE 2: The Eight Components: The above objectives should cover the following components to ensure effective Enterprise Risk Management. 1. Internal Environment- The tone and risk culture of the entity 2. Objective setting – Management must set realistic objectives 3. Event Identification- Internal and external events 4. Risk Assessment – Entity’s ability to analyze risks 5. Risk Response- avoiding, accepting, reducing or sharing risks 6. Control Activities- Policies and procedures in place 7. Information and Communication- Get all relevant info. 8. Monitoring – Ensure effective monitoring of the entity risks. SIDE 3: The different units of the entity that should be covered under the ERM framework are: 1. Subsidiaries 2. Business Units 3. Divisions 4. Entity Level 3.2 The 8 Components of the Framework. The COSO principles integrate its 8 components with an entity's objectives across the different units by ensuring that the components are aligned with the objectives and that they work together to achieve the objectives. 1. The internal environment 22 | P a g e   Sets the tone for the organization and creates a culture that is conducive to effective risk management.  The tone at the top is set by the organization's leaders, and it should be communicated throughout the organization.  The organization's culture should emphasize the importance of risk management and the need to take responsibility for managing risks. 2. Objective setting  Ensures that the organization has clear and achievable objectives.  The objectives should be aligned with the organization's mission and strategic goals.  The organization should regularly review its objectives to ensure that they are still relevant and achievable.  Is applied when management considers risk strategy in the setting of objectives. 3. Event identification component involves:  Identifying events that may have a positive impact represents natural offsets (opportunities), which management channels back to the strategy setting. Identifying the potential events that could negatively impact the organization's ability to achieve its objectives (risks).  These events can be internal or external, and they can be positive or negative.  The organization should use a variety of methods to identify potential events, such as brainstorming, interviews, and risk assessments. 4. Risk assessment involves.  Assessing the likelihood and impact of each potential event.  The likelihood refers to the probability that the event will occur. The impact refers to the consequences of the event if it does occur. 23 | P a g e   The organization should use a variety of methods to assess the likelihood and impact of potential events, such as quantitative analysis and qualitative analysis. 5. The risk response component involves.  Developing and implementing strategies to manage the risks identified. The strategies can include avoiding the risk, transferring the risk, reducing the likelihood of the risk, or reducing the impact of the risk.  Identifies and evaluates possible responses to risk, and then selects and executes response based on evaluation of the portfolio of risks and responses.  The organization should select the risk response strategies that are most appropriate for each risk. 6. The control activities component involves the policies and procedures that are put in place to ensure that the risk responses are effective. The control activities can be preventive, detective, or corrective. The organization should design and implement control activities that are appropriate for the risks that it faces. 7. The information and communication component involves ensuring that the organization has the right information to identify, assess, and manage risks. The information should be timely, accurate, and accessible to the people who need it. The organization should establish communication channels to ensure that information is shared effectively. 8. The monitoring component involves ongoing monitoring of the organization's risk management processes to ensure that they are effective. The monitoring can be done through self-assessment, internal audits, or external audits. The organization should regularly review its risk management processes to identify any areas that need improvement. By integrating its 8 components with an entity's objectives, the COSO principles help organizations to identify, assess, and manage risks to achieve their objectives. All these must occur throughout the organization, at all levels and in all functions. 24 | P a g e 3.3. Internal Control & Risk Management Internal control – a system or process that an organization uses to achieve its operational goals, internal and external financial reporting goals, or legal and regulatory compliance goals. Limitations of COSO The COSO (Committee of Sponsoring Organizations of the Treadway Commission) principles for Enterprise Risk Management (ERM) are widely recognized and utilized, but like any framework, they have their limitations and challenges. Here are some of the limitations associated with the COSO ERM framework:  The framework is not prescriptive. The COSO framework provides a set of principles and concepts, but it does not provide specific instructions on how to implement them. This can make it difficult for organizations to know where to start and how to ensure that they are implementing the framework effectively.  The framework is not a silver bullet. The COSO framework is not a guarantee that an organization will be able to avoid all risks. It is a tool that can help organizations identify, assess, and manage risks, but it is not a substitute for good judgment and common sense.  The framework can be complex and time-consuming to implement. The COSO framework is comprehensive, and it can be complex and time-consuming to implement. This can be a barrier for some organizations, especially those that are small or do not have a lot of resources.  The framework is not always adaptable to different industries and organizations. The COSO framework is designed to be adaptable to different industries and organizations, but it may not be possible to adapt it to all organizations. This is because the risks that different organizations face can vary widely.  The framework can be difficult to monitor and evaluate. The COSO framework is designed to be monitored and evaluated on an ongoing basis, but this can be 25 | P a g e  difficult for some organizations. This is because it requires organizations to have a good understanding of the framework and how to measure its effectiveness. Despite these limitations, the COSO framework is a valuable tool that can help organizations identify, assess, and manage risks. However, it is important to be aware of the limitations of the framework and to take steps to mitigate them. Here are some tips for mitigating the limitations of the COSO framework:  Customize the framework to the specific needs of your organization. The COSO framework is designed to be adaptable, so you should customize it to the specific needs of your organization. This will help you to ensure that the framework is effective and that it is not too complex or time-consuming to implement.  Get buy-in from top management. The success of the COSO framework depends on the support of top management. Make sure that top management is aware of the benefits of the framework and that they are committed to implementing it effectively.  Provide training to employees. Employees need to understand the COSO framework and how to implement it. Provide training to employees so that they can understand their role in the risk management process.  Monitor and evaluate the framework on an ongoing basis. The effectiveness of the COSO framework should be monitored and evaluated on an ongoing basis. This will help you to identify any areas that need improvement and to make sure that the framework is still effective. 26 | P a g e MODULE 4 This Photo by Unknown Author is licensed under CC BY-SA Introduction and Origin of the Equator Principles Introduction This session is on the Equator Principles. This framework is of significant importance in the banking sector, especially for those involved in project financing. We will delve into what the Equator Principles are, their origins, and why they matter in banking. Origin of the Equator Principles The Equator Principles are a set of environmental and social guidelines for financial institutions. They were first introduced in 2003 as a response to the growing need for sustainable project financing. Ten major international banks initially adopted these principles during the International Finance Corporation (IFC) annual meetings in Washington D.C. The impetus for the Equator Principles came from a recognition of the role that financial institutions play in shaping sustainable development. Banks are responsible for ensuring that projects they fund adhere to certain environmental and social standards, thereby mitigating potential risks and promoting sustainable practices. Purpose of the Equator Principles 27 | P a g e The Equator Principles serve several key purposes:  Risk Mitigation: They provide a framework to identify, assess, and manage environmental and social risks associated with project financing. This is crucial in protecting the interests of both the financial institutions and their stakeholders.  Promoting Sustainable Development: By adhering to the Equator Principles, financial institutions contribute to the development of projects that are not only financially viable but also environmentally and socially responsible. This ensures the long-term sustainability of the projects and the communities they impact.  Alignment with Global Standards: The Equator Principles align with other global standards and guidelines, such as the International Finance Corporation's Performance Standards and the World Bank's Environmental, Health, and Safety Guidelines. This fosters consistency and coherence in sustainable financing practices worldwide.  Enhancing Reputation and Brand Value: Banks that adopt the Equator Principles demonstrate a commitment to responsible banking. This can enhance their reputation and appeal to stakeholders who prioritize sustainability in their investment decisions. Summary of the Equator Principles The Equator Principles are based on ten key principles: i. Review and Categorization: Financial institutions commit to categorizing projects based on their potential environmental and social impacts. ii. Environmental and Social Assessment: Rigorous assessments are conducted for high-risk projects to identify potential impacts and develop mitigation measures. iii. Applicable Environmental and Social Standards: Projects must comply with the host country's environmental and social laws and regulations, as well as international standards. iv. Environmental and Social Management System: Borrowers are required to implement a management system to address environmental and social risks throughout the project lifecycle. v. Consultation and Disclosure: Meaningful stakeholder engagement and transparent disclosure of project information are crucial components of responsible project development. 28 | P a g e  vi. Grievance Mechanism: Effective mechanisms must be in place for addressing and resolving grievances from affected communities and stakeholders. vii. Independent Review: High-risk projects undergo independent review to ensure compliance with Equator Principles. viii. Covenants: Financial institutions include covenants in loan agreements to ensure ongoing compliance with the Equator Principles. ix. Independent Monitoring and Reporting: Ongoing monitoring and reporting on project performance about environmental and social risks. x. Climate Change: Recognizing the significance of climate change, the Equator Principles include specific provisions related to greenhouse gas emissions and climate risk assessment. In conclusion, the Equator Principles provide a comprehensive framework for financial institutions to ensure that projects they finance are developed and managed in an environmentally and socially responsible manner. By adhering to these principles, banks contribute to sustainable development and uphold their role as responsible corporate citizens. NIGERIAN SUSTAINABLE BANKING PRINCIPLES The principles are: 1. Environmental and Social Risk Management 2. Environmental and Social Footprint 3. Human Rights 4. Women's Economic Empowerment 5. Financial Inclusion 6. Environmental and Social Governance 7. Capacity Building 29 | P a g e 8. Collaborative Partnerships 9. Reporting : Introduction The Nigerian Sustainable Banking Principles are a set of guidelines that form the bedrock of sustainable banking practices in Nigeria. These principles aim to align banking operations with social and environmental considerations, contributing to a more sustainable and inclusive financial sector. Let's dive into each principle. 1. Environmental and Social Risk Management This principle centers on the identification, assessment, and management of environmental and social risks in banking operations. It encourages banks to incorporate robust risk assessment frameworks that factor in potential impacts on the environment and society. This ensures that projects funded by the bank are both financially viable and environmentally and socially responsible. 2. Environmental and Social Footprint This principle emphasizes the measurement and reduction of a bank's environmental and social footprint. It entails tracking and reporting on the bank's resource consumption, emissions, and other impacts. By doing so, banks can take proactive steps to minimize their negative footprint and contribute positively to sustainable development. The first two Principles are regarded as the Umbrella Principles. 3. Human Rights Respecting and upholding human rights is a cornerstone of sustainable banking. This principle calls for banks to ensure that their operations do not infringe upon the rights of individuals, communities, or stakeholders affected by their activities. This includes respecting cultural heritage, and land rights, and ensuring fair labour practices. 4. Women's Economic Empowerment This principle promotes gender equality and women's economic empowerment within the banking sector. Banks are encouraged to implement policies and initiatives that support women's access to financial services, entrepreneurship, and leadership roles within the organization. 5. Financial Inclusion Financial inclusion is a key driver of sustainable development. This principle urges banks to proactively work towards providing access to financial services for underserved and marginalized populations. By doing so, banks play a crucial role in reducing poverty and promoting economic stability. 30 | P a g e 6. Environmental and Social Governance This principle emphasizes the importance of strong governance structures within banks to ensure the effective implementation of sustainable banking practices. It calls for the integration of environmental and social considerations into the bank's governance framework, including board oversight and decision- making processes. 7. Capacity Building Capacity building is vital for enabling sustainable practices within the banking sector. This principle encourages banks to invest in the training and development of their staff, ensuring that they have the necessary skills and knowledge to implement sustainable banking practices effectively. 8. Collaborative Partnerships Sustainable banking cannot be achieved in isolation. This principle advocates for collaboration between banks, regulators, civil society, and other stakeholders. By working together, these entities can pool resources and expertise to address complex sustainability challenges. 9. Reporting Transparency and accountability are fundamental to sustainable banking. This principle underscores the importance of regular and transparent reporting on a bank's performance about the Nigerian Sustainable Banking Principles. It allows stakeholders to assess the bank's progress and hold it accountable for its sustainability commitments. In conclusion, the nine Nigerian Sustainable Banking Principles provide a comprehensive framework for banks to integrate sustainability into their operations. By adhering to these principles, banks contribute to a more inclusive, environmentally responsible, and socially conscious financial sector. 31 | P a g e