2022 has been an eventful year, marked by several highs and lows. Macroeconomic and geopolitical turmoil have been dominating the lows – just as the world has come out of the clutches of the pandemic over the past couple of years. Meanwhile, the banking and financial services industry, including its regulatory authorities and key players, has been undergoing a tectonic change in how it operates, what it offers, and how it interacts with customers. This article discusses some of these trends and changes, and their impact on the financial sector in its entirety.
Fine-tuned approach towards credit risk:
While it is not possible to accurately predict whether or not a global financial crisis (GFC) similar to the one that occurred in 2008 could happen in 2023 or at any other time in the future, undeniably, there are strong indicators pointing in the direction. Economic events and financial crises are complex and can be influenced by a variety of factors, including economic policies, market trends, and geopolitical events. However, in the backdrop of widespread fears of a GFC redux, financial institutions and regulators need to avoid falling into the “simplistic thinking trap”.
- The problem that we’re faced with today is not as simple as it was in 2008, which was actually a local credit crisis in its heart, which later spread globally. Today, the world is much more networked and financial institutions much more interconnected than in 2008, thereby implying greater potential for collateral damage. Not just that, the financialization of economies has increased, with more of savings going into financial assets rather than physical assets. Moreover, free money in the West has bloated the balance sheets to unbelievable levels. Increased derivative exposures by all kinds of players have in turn increased vulnerabilities due to excessive leverage.
- The solution to the economic downturn is also not as simple this time. Traditional equations like “crude bearish, equity bullish”, “bullish USD, bearish commodities” are witnessing sea changes, due to changing geopolitics and reworked supply chains in the aftermath of the pandemic. This calls for a much more calibrated approach towards policy making in contrast to 2008 where the (short-term) solution was simple – relentless money printing by central banks!
In this regard, the need of the hour is for financial institutions to keenly monitor their asset books using technology, in a manner that’s contextual to the specific portfolios under consideration. What works for corporate exposure may be completely unsuited to retail exposures, and what works for working capital may be very different from what works for long-term exposures, for instance. Thus, banks have to give up their sledgehammer approach towards credit monitoring and take a more active involvement in fine-grained analysis that goes beyond regulatory reporting. This is possible through modular solutions that take care of differentiated needs of risk managers at different stages of the credit lifecycle, yet enable the bank to have a 360-degree view of their customers by aggregating risks stemming from different sources, such as different products across different departments within the bank.
The impending bust of the cryptocurrency bubble:
It is a well-known fact that central bankers are wary of cryptocurrencies. In India, the RBI has been cautioning the public for quite some time, even recommending a ban on cryptos. After bitcoin lost two-thirds of its value this year, and the FTX debacle, the RBI governor went to the extent of saying that the next financial crisis could come from private cryptos. The RBI’s approach seems well-informed, with the newly launched e-Rupee CBDC in its pilot phase, utilising the technological strengths of digital currency, while simultaneously arguing against private cryptos, due to their speculative and volatile nature. Tight regulation for digital currencies is expected to be announced soon, and the upcoming budget may even pronounce the death of private cryptos in India. The message is clear – digital currency is good as it is cheaper to issue and manage, and can potentially enable centralised monitoring using technology to prevent terror funding and other abuse, but this applies only to Central Bank issued digital currencies and not private cryptos. FinTechs would do well to identify potential use cases around payments using the e-Rupee, which is definitely going to become mainstream very shortly.
Enhanced focus on sustainability and ESG:
Banks and financial institutions need to be frontrunners in driving sustainability initiatives. Investors and regulators will be expecting not only concrete steps to reduce their own carbon footprint but also a quality credit portfolio promoting sustainable investing practices. To this effect, in a first, the Indian Banks’ Association (IBA) has set up a large working group, comprising representatives of about a dozen-and-a-half key banks, solely for handling issues covering the entire spectrum of sustainability and green financing, in light of the growing importance of this segment in the financial sector[1]. Banks and financial institutions need to gear up their efforts to play an important role in promoting sustainability and ESG initiatives. These efforts could be on the lines of enhancing credit appraisal processes to include ESG barometers, and technology enablement to monitor adherence to the same.
Increased role of Board of Directors:
The Board of Directors need to play a critical role in climate risk and sustainable finance by banks and financial institutions. A study conducted by the Sustainable Finance Group (SFG) in the Department of Regulation (DoR), RBI, had shocking findings[2]:
- Board-level engagement on climate risk and sustainable finance was found to be inadequate.
- Only a few banks had included climate risk / sustainability / environmental, social and governance (ESG) related Key Performance Indicators (KPIs) in the performance evaluation of their top management.
- Many of the banks did not have a separate business unit or vertical for sustainability and ESG-related initiatives.
Also, SEBI’s new Business Responsibility and Sustainability Reporting (BRSR) has made it mandatory for the top 1000 listed companies to annually report ESG-related information from the financial year 2022-2023[3]. Hence it becomes imperative for the board or top management to have complete oversight on the initiatives relating to sustainable finance and climate-related risks.
Focus on IT and cybersecurity:
Banks and financial institutions operate in a very competitive and tough environment. Information Technology has become both an enabler as well as a risk for the banks. While on one hand, IT has helped the banks to build better products for the customer, on the other hand it has also led to various IT and cybersecurity threats such as phishing and other malware attacks. Hence, banks must place a larger emphasis on their IT and cybersecurity practices to keep both the institutions and the customers safe. The RBI has recently placed a Draft Master Direction – Information Technology Governance, Risk, Controls and Assurance Practices for comments from stakeholders and public[4]. The IT Governance Framework lays emphasis on the governance structure, the role (including authority) and responsibilities of the Board of Directors (Board) / Board-level Committee and Senior Management to include adequate oversight mechanisms to ensure accountability and mitigation of business risks.
Authors
Swaminathan KS
Associate Vice President – Products, BCT Digital
Swami has 18+ years of experience in the areas of Governance, Risk Management, and Compliance working with Fortune 500 clients across diverse industries such as Banking & financial services, Energy & Utilities, Hi-Tech & Manufacturing clients. He has spearheaded multiple projects focused on Enterprise Risk, Trading Risk, IT Risk, Business Continuity, and Third-Party Risk Management. He is also a PECB Certified ISO 31000 Senior Lead Risk Manager.
Shankar Ravichandran
Presales & Solutioning Consultant, BCT Digital
Shankar’s profound expertise in the field of corporate and retail banking spanning across Credit Risk, Transaction Banking, Service Delivery and Product Management spans over a decade. He is an MBA graduate from Indian Institute of Management, Bangalore.
