The world is facing a banking crisis – two major US banks and one in Europe caved in fast. Credit Suisse is also one of the thirty banks that is designated as Systemically Important Banks (G-SIBs) with an asset book of $1.4 trillion. While the 2008 GFC did result in the strengthening of risk management practices and systems over the years, the fact is, today, financial institutions are faced with newer risks which were “out of syllabus” in the past. Besides credit risk, higher interest, and an unnatural supply of free money from the Fed since the GFC, its subsequent abrupt end, and rapid rate hikes are also to blame.
While risks have expanded, there has also been an increased impact of such risks on institutions far away from the source of the crisis (across the Atlantic), due to the enhanced interconnectedness of the financial system that add layers of complexity.
The Indian Finance Minister’s directive to public sector banks is relevant in this context. The directive tightens risk management and cuts across multiple areas including large exposure monitoring, liquidity management, concentration risk monitoring and market risk management.
Approaches to monitor potential risks, and how technology can be leveraged.
Short business cycles and online and social media platforms make news instantly accessible. Financial institutions now need real-time risk management systems that monitor and control newer risks by processing more data in terms of quantity as well as velocity.
What is likely to work is a combination of the following.
- A bottom-up approach., For example, monitoring of individual large customer accounts – one of the finance minister’s directives and
- A top-down approach wherein overall portfolio risks are mitigated through initiatives such as hedging forex risk, limits for financial counterparties, limiting portfolio concentration through restricting lending to sectors and segments beyond a policy-determined threshold.
Monitoring and reporting of risk, especially market risk and credit risk, must move beyond compliance/regulatory reporting and move towards real-time control for financial institutions’ own benefit. Asset liability matching is a challenging task today, with wild fluctuations in bond yields on one end, and easy deposit flight facilitated by online channels on the other.
Technology is essential in achieving the above. AI/ML algorithms provided by FinTechs enable financial institutions to perform the challenging task of risk management by managing high data volumes which are now beyond human comprehension. Hidden patterns and certain consequences of policy actions cannot be fathomed by the human mind and technology is here to help. Take, for instance, the kamikaze act of the EU during the Ukraine crisis. The EU, which is dependent on Russia for its energy needs, sanctioned Russia, which simply resulted in the EU energy bills skyrocketing due to roundabout supply chains which fed it energy at higher costs. On the contrary, Russia’s currency is the strongest it has been in decades, thanks to the robust demand for its fuel supplies from the EU, which is rerouted through countries like India! The economic turmoil in Europe from the war is vastly understated, and it is not just Credit Suisse that posted its biggest ever loss this quarter, but also the Central Bank of Switzerland, SNB itself, which had invested heavily in financial assets across the globe. Vast Mark to market fluctuations is usually associated with trading desks of risk-taking banks, but today, even central banks face the challenge of risk due to the increased financialization of global economies wherein institutions are investing in each other with a high level of interconnectedness and thereby susceptible to concentration risk.
Way forward for risk management and the role of players like BCT Digital
There was a time when a customer had multiple deposit and loan accounts with the same bank, in different branches. This has changed with systems aggregating accounts under a common Customer ID, mapping every account to the customer. For the first time, this is providing a 360-degree view of the customer to the bankers, which is enabling them to monitor their customers more effectively and increasing their share of the customers’ wallet.
Now, this scenario is playing out in the macro-world, wherein different risks pertaining to the book of the bank, across departments and geographies, must be aggregated, so that the bank and regulators have a 360-degree view of all risks held by the bank, along with granular insights into specific data points such as high-risk portfolios, and time buckets of Asset-Liability mismatch.
Generic IT platforms that are repurposed for financial risk management requirements have had their run. Financial institutions, today, are looking for lightweight solutions which solve their specific pain points such as monitoring top exposures for specific warning signs in a manner that is easy to implement and replace existing legacy systems in a cost-effective way.
Our focus at BCT Digital is also the same.
Reference link https://bit.ly/43CnakB
Author
Ms. Jaya Vaidhyanathan
President — BFSI & Strategic Initiatives and CEO, BCT Digital
Dr. Jaya Vaidhyanathan is an independent Director on several Boards and is focused on bringing in the best global corporate governance principles to India. Her work has found coverage in top news websites like The Hindu and The Times of India. Recently, she pioneered award-winning Early Warning Systems for Indian banks, which have found acclaim in the industry and among counterparts.
