Banks increasingly face challenges that put pressure on the bottom line. In this post, I’ll focus on the threats that affect the risk departments of banks. In my view, there are three critical areas.
The 3 core challenges
1. Regulatory and accounting demands
The first is increased regulatory and accounting demands. Over the last few years, and particularly since the financial crisis, regulators have placed more and more demands on banks and other financial institutions. Some of these demands come from central banks, such as the European Central Bank’s TRIM exercise. Others come from banking authorities, such as the requirement for stress testing from the European Banking Authority or its new default definition guidelines. Banks also have to comply with accounting standards, such as IFRS 9 on measuring and accounting for Expected Credit Losses. And Basel IV recommendations are now looming over the horizon.
2. Increased competition
The second area is increased competition from new players in the market. Much of the pressure in this area is not directly from competitors themselves, but from customers because of the activity of new entrants. New players tend to be more agile and customer-focused. Their new products and services, therefore, lead to increasing demands from customers on traditional banks.
These customers want banks to react faster and deliver attractive user interfaces. This, in turn, means that banks need to innovate to keep a competitive edge. However, innovation is not without its challenges, and risk departments need to ensure that they can support swift onboarding processes and customer (creditworthiness) qualification.
3. Emerging risks
There are also several emerging risks that require attention. These include model risk and cyberrisk. The numbers of models in banks are rising steeply, so it is becoming increasingly important that banks accurately assess and manage the risk of these models. Risk departments have their work cut out to keep track. At the same time, the move online and pressures to open bank infrastructure (e.g., European PSD2 directive) have also meant increasing challenges managing cyberrisk and ensuring security.
Increasing challenges, increasing demands
These challenges demand more and more resources from risk and compliance departments in banks. These departments are therefore increasing in size. For example, Danske Bank mentioned in a recent press release that its financial crime department has quadrupled over the last few years. I recently performed a brief and unscientific market survey through conversations with risk resources in Nordic banks and found that the number employed has at least doubled since the financial crisis. Over the same period, risk departments have evolved from being primarily a mandatory cost function. They are now represented in the management group and taken seriously in discussions about the bank’s strategic direction.
The bottom line is that risk departments need to be more efficient. These departments are costly because of the sheer number of employees. At the same time, people with the required skills are getting harder to find and recruit. No bank wants its expensive risk analysts spending 80% of their time cleansing data. Instead, banks want these valuable assets to focus on their core tasks: assessing and managing risk.No bank wants its expensive risk analysts spending 80% of their time cleansing data. Instead, banks want these valuable assets to focus on their core tasks: assessing and managing risk. #riskmanagement #banking Click To Tweet
Increasing risk management efficiency
To increase the efficiency of risk management, banks must ensure:
- The data foundation for risk management is common across all risk disciplines, and data aligns to the principles of BCBS 239.
- Risk calculations and risk management, in general, use a platform aligned across risk disciplines and the chronological flow (covering all points from data at one end to results at the other).
- The processes around risk are controlled by workflows that tie tasks together and ensure that everybody knows what their tasks are at any point in time – and of course, that decisions and tasks are audited and tracked for future reference or replay.
By doing this, banks will ensure coverage, transparency, flexibility and agility in the face of an ever-changing risk landscape.
To find out more, I recommend this report from McKinsey & Company about The future of bank risk management.