Navigating with 'what if'

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In today’s world, planning a holiday route from the airport to your vacation destination in an unfamiliar location is no longer a case of working out the directions via paper map and requesting directional updates from a nervous partner. Rather, with a few clicks on your mobile device, you can get an optimized route with real-time traffic updates, as well as modified, alternative directions as traffic and events change. If only risk and finance offered such planning capabilities, real-time updates, alternative scenarios and stress tests to give you confidence around the plans!

But perhaps this vision isn’t too far to reach after all. Increasingly, business drivers and risk-finance navigators feel more confident about jointly mapping a financial route to a chosen business destination and monitoring the road to get there.

Hidden Insights: Navigating with 'what if'

Navigating with 'what if'

Risk and finance in the same sandbox

Risk and finance teams know more about each other’s worlds than at any time since risk emerged from finance and got its own C-level executive. To play in the same sandbox, risk and finance leaders have evolved the language of risk, bringing it back to finance (and vice versa) to successfully deliver key regulatory and finance reporting projects.

Especially in the banking industry, all this investment mainly focuses on delivering the latest ECL reporting requirements. But with a few years’ experience of risk and finance teams playing well together, it’s time to shift the emphasis from reviewing “what is” happening today to the “what-ifs” of tomorrow. This shift from what is to what if introduces a more forward-looking assessment of both the expected and unexpected future.

Historical performance no longer enough

For many banks around the world, satisfying multiple regulatory requirements using historical performance (Pillar 1) alone is no longer enough. Regulators are asking them to demonstrate that they can satisfy performance requirements and expectations for their financial KPIs and KRIs today and in the future.

For example, a theme common to the latest regulatory changes is the demand for more transparency and granularity across the various forward-looking regulatory calculations. When forecasting their financial KPIs and KRIs, banks will need to perform more calculations and produce more reports with greater frequency. And all while following more analytical approaches and less expert-judgment based forecasting.

At the same time, the strategic business tools for determining and making decisions around a bank’s strategy, future plans and activities are covered by budgeting, financial (capital) planning and ALM. Both the business and regulatory-driven, forward-looking processes aim to forecast the bank’s future balance sheet, P&L and the respective KPIs and KRIs under a macroeconomic and/or business scenario. Senior executives at banks use the information gathered from these processes for strategic decisioning. They also use this information to steer the bank in the direction most likely to achieve performance goals.

Business forecasting processes focus more on the expected financial KPIs and are typically driven by finance. ALM and regulatory-driven initiatives, on the other hand, focus on a broader picture. They cover both the expected and the unexpected future and are often owned by risk. Changes introduced through IFRS 9 and CECL, impacting the credit risk provisions (or impairments), affect bank performance along three dimensions: balance sheet, profit and loss, and balance sheet and IRB shortfall.

Banks must look ahead

These types of new regulatory initiatives and market developments, as well as digital trends, are all demanding more forward-looking perspectives on a bank’s performance, covering both the expected and the unexpected. Banks need to adapt in order to be able to proactively and quickly respond to sudden market developments. They also need to understand the impact of their decisions before making them and provide more forecasted information to external and internal stakeholders.

At the same time, regulators are becoming less sceptical of AI and talking more about its potential benefits. But banks need to support AI with modern data and application architecture. This will ensure robust model governance and controls around the new – and often very complex – risk models. In short, there is little value in AI if the right infrastructure, end-to-end processes and governance are not in place.

Risk and finance have to address the need to create and govern forward-looking plans that a bank’s leadership team can use and feel confident about. To accomplish this, they need to align and automate their forecasting activities, bridge the gaps between various finance and risk processes, and consolidate their underlying systems.

Transformation trends

The Boston Consulting Group and SAS paper Seven Trends That Will Transform Banking and How Technology and Analytics Can Help discusses the trends that are likely to define how the financial services industry will most probably evolve over the coming years. It is important to implement a standardized and integrated risk and finance platform. This platform should allow for interaction between the different stakeholders across the business and risk/finance. The delivery of a risk and finance platform that includes advanced analytics and big data will enable smarter, forward-looking decisions and more efficient processes, from credit to compliance and risk management. The aim should be to apply analytics more widely. With analytics, banks can turn internal and external data into real-time insights and decisions and better customer experiences.

Unsurprisingly, as with planning and then driving a route outlined by your Satnav system, there are many factors across Risk and Finance that can impact the final choice of the directions you follow. That’s why it’s best to have a Risk & Finance platform that identifies these factors across the business (and includes new factors as they arise), assesses their impact on your alternative future directions, and then picks and navigates to the most appropriate route for your firm.

A neverending process

Risk and finance planning and scenario analysis is a recurring process (like updating the Satnav application and mapping data). But banks should also consider it a continuous, ever-updating, neverending process shared across the business, rather than an annual finance or risk team exercise. Those that succeed in introducing a more agile and forward-looking approach will be able to foresee the obstacles in their path, proactively take impact-aware actions, and successfully steer their bank in today’s challenging and unstable geopolitical and economic highways.

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About Author

Peter Plochan

Peter Plochan, FRM is Senior Risk Management Consultant at SAS assisting financial institutions in dealing with their risk management challenges around risk regulations, ERM, risk governance and risk analysis and modelling. Peter has a finance background (Master’s degree in Banking) and is certified Financial Risk Manager (FRM) with 10 years of experience in risk management in financial sector. He has assisted various banking and insurance institutions with large-scale risk management implementations (Basel II, Solvency II,…), worked internally and also externally as a risk management advisor (PwC). In his free time Peter enjoys reading books (fantasy / sci-fi) and plays Capoeira.

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