Internal Control system: Cost of Risk vs. Risk Management. Case study: Romanian Banking System

The evolution of the global financial systems from the last 8-10 years showed to all involved stakeholders (from Supervisory Authorities to shareholders) that a good market discipline is necessary. This statement is derived from the observation period that considered the global economic growth registered in the years 2005-2008 but also taking into consideration the years preceding the global financial crisis. The scope of the article is to illustrate a brief picture of the internal governance in financial institutions before the financial crisis, as well as the latest developments and guidelines issued in order to enhance the internal governance through its risk management and internal control system. The main objective of the paper is to present and propose a new concept in the internal control system, the three lines of defense model. A case study is made considering a Bank from Top 5 Assets from Romania (Assets higher than EUR 5 bln.) in order to observe the implementation and execution of the new internal control system. For the current exercise the component of the cost of risk represented by administrative costs of the risk management program was taken into account as to show the costs of the implementation and execution of a strong and reliable internal control system. The results of the exercise revealed a cost of approximately EUR 0.8 mio per year coming from the salary expenses and also EUR 0.1 mio represented by the cost and implementation of a software which helps in the daily activities of the Credit Risk Control function. The conclusion of the article underlines the necessity of the financial institutions to strengthen their internal control system considering the regulatory requirements but, also as a driver in order to have a better and solid risk management program which leads to an improved market and credit discipline.