Risk Management & Analytics: 5 overlooked risks to watch in financial services

5 overlooked risks to watch in financial services

Yes, we all know cyber security is the top risk facing banks and companies across all industries. However, as financial industry leaders scramble to address cyber risk and security, other banking risk could easily fall under the radar. When assessing business risk in the coming quarter and heading into 2019, keep these sneaky culprits in mind:

1. REGULATORY UNCERTAINTY (MOST NOTABLY CECL) 

We know … the Financial Standards Accounting Board’s (FASB) new Current Expected Credit Loss (CECL) is already at top of mind for most financial institutions so it is not necessarily an “overlooked” risk. But to be fair, CECL is a risk that could be severely underestimated, which is why we put it at the top of the list. How might an institution underestimate CECL risk? Where should we begin? The FASB has asked that financial institutions estimate loss beyond historical and current losses and factor in expected (forecast) credit loss. This may not be such a big deal for some, but the reality is that to comply, many financial institutions will require a great deal more data, more sophisticated modeling and cross-functional alignment. Additionally, your institution could under- or overestimate losses, especially if you are trying to force certain portfolios into the same estimation methodology. Not to mention, FASB does not prescribe a specific approach for CECL modeling, leaving many financial institutions downloading every CECL white paper in sight. If you are one of those, it might just help to talk to an expert.

2. INTEREST RATE RISK (IRR)

Interest rates are rising, albeit at a moderate rate, which is leading some financial institutions to take it with a grain of salt. However, the moderate pace of increases the Fed has laid out may still catch some institutions off guard, and the flattening yield curve is compressing margins for financial institutions. Neglecting the impact of interest rate risk on assets, portfolios, financial models and business decisions may leave a financial institution in a reactive state. If your financial institution has not completed an IRR analysis or validated your financial models using multiple interest rate and economic scenarios, it is probably time to take that step. Reach out to Situs’ analytics firm, MountainView, and see how interest rates could affect your assets and liabilities.

3. FALLING BEHIND

With all of the threats facing organizations, the risk of falling behind is not always the first to come to mind. However, for many institutions, innovation has suffered over the last several years due, in part, to regulatory change. Margins have tightened due to the onslaught of new compliance requirements, making it difficult for financial institutions to invest in the tools, technology and resources needed to compete. In addition, fintech firms and non-traditional entrants emerged right as many institutions were focusing on keeping up with compliance. Since non-traditional firms aren’t bound by the same regulations, they were able to quickly embrace digital tools, crowdfunding, P2P lending, online and mobile banking, and automation. If your institution has fallen behind on innovation, take the time to analyze the competition and identify practical solutions that will keep you in front of the customer.

4. OPERATIONAL RISK

As the saying goes, “what goes up must come down”; if Newton were in financial services today, he might point out that the US economy has been going up for quite some time. Some experts are saying that a recession may be around the corner, pointing to a flattening yield curve as evidence. Whether a recession occurs is beyond the control of financial institutions and their customers. What financial institutions can control is how prepared their organization is to analyze, measure, monitor and manage risk. As many organizations have learned from the last recession, centralized decision-making without checks and balances (one decision-maker) can result in a waterfall of bad decisions. Fragmented and de-centralized risk operations can result in incomplete and inaccurate analyses, which feed those decisions. Organizations should check their risk processes to identify interrelated and idiosyncratic risks across all functions, ensure that analyses are stress-tested, monitored and sent to executive leaders on the board responsible for assessing risk. Doing so will help a committee or board make more risk-informed decisions.

5. LIQUIDITY RISK

Today, money moves more freely than it ever has in history. Technological innovations such as mobile, apps, online banking and the internet have created a highly competitive environment by making it easy for a customer to quickly research and compare product pricing and change institutions with a click of a button. That said, as short-term rates rise and long-term rates stay steady, banks margins will compress due to the cost of funds going up. Banks competing for deposits would be wise to monitor deposit behavior closely. If your depositors are jumping ship, your institution can quickly become subject to a liquidity crunch.


Regulatory reform hasn’t translated into relaxed enforcement

Banks may have secured some regulatory relief, but they still have to worry about enforcement actions.

Lawmakers and regulators have eased up in several areas, including [on] qualified mortgages, exam schedules, call reports and reciprocal deposits. The threshold for becoming a systemically important financial institution was raised, and pending legislation would reduce the reporting burden for suspicious activity reports.

Though welcome news for bankers, the reality is that regulators will remain diligent in their oversight of areas such as fair lending, money laundering compliance and the Community Reinvestment Act, industry experts said.

Many hot-button issues remain for regulators to enforce, said Pam Perdue, chief regulatory officer at Continuity, a consulting firm. “My advice to bankers: Don’t take your eye off the ball when it comes to regulations you know are already there.”

Read more: American Banker


CME to launch Libor-substitute contract linked to Bank of England rate meetings

CME Group has said it will launch a ground-breaking futures contract linked to Bank of England interest rate meetings as part of global efforts to scrap use of the Libor benchmark that banks sought to manipulate.

The Bank of England wants the market to substitute Libor in financial contracts such as interest rate futures with its own “risk-free” interest rate known as Sonia or Sterling Overnight Index Average.

Banks were fined billions of dollars for trying to manipulate Libor, which measures borrowing costs between lenders. Risk-free rates are seen as harder to rig.

The CME’s “monetary policy committee” Sonia futures contract will have critical dates that align with when the BoE’s rate setting panel meets, the Chicago-headquartered bourse said.

Read more: Reuters


Past performance doesn’t guarantee future results

A bank’s investment manager is constantly performing a juggling act, trying to strike the right balance between earnings, liquidity and interest rate risk — all while considering the impact on capital when making investment decisions. With so many moving parts, assessing the performance of the individuals responsible for managing the investment portfolio can be a difficult task.

There is no one-size-fits-all method to assessing the performance of a bank’s investment management team. Rather, a combination of methods should be used, including:

  • Arranging for an independent review of the investment portfolio by a professional independent investment adviser on a periodic basis.
  • Assessing the relative performance of the investment portfolio compared to option-adjusted spread (OAS) and price sensitivity targets.
  • Comparing results to a benchmark portfolio.
  • Comparing results to peer group results. (This analysis usually leads to more questions than answers, as the peer groups’ policy limits, risk tolerances, portfolio structural needs, interest rate risk position, liquidity risk position and interest rate view are all unknown.)

Read more: American Bankers Association Banking Journal


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