As we deal with the near- and long-term effects of the pandemic, banks will need to re-evaluate their resiliency across all aspects of risk.
Our observations during COVID-19
- The increased capital and liquidity buffers that banks hold due to regulatory requirements in the wake of the global financial crisis stood them in good stead – even if, inevitably, liquidity and market risk management were highly challenging during the peak of COVID-19 related volatility. Many corporate clients drew heavily on their existing revolving credit facilities to bolster their cash and liquidity positions as the crisis began.
- On the credit risk side, banks needed to take immediate action to manage their balance sheet risks in an extremely dynamic and fluid situation. This meant reducing the size of the ‘credit box’ by ceasing certain types of lending – loans against home owner equity for example – and rapidly assessing portfolio risks. In most jurisdictions, banks also moved quickly to introduce forbearance measures for customers. In countries where banks were involved, there was also a significant operational task in administering government-backed loans.
- Risk functions came under extreme pressure from the reporting requirements both internally to boards and externally to regulators, a situation exacerbated by models which simply could not compute the extreme and unprecedented unknowns and variables caused by COVID-19.
Predictions of the new reality for banks:
1. Banks’ risk models will need to continue to be reviewed and recalibrated, while credit portfolios will need to be dynamically managed
The effects of COVID-19 were so rapid, wide ranging and interconnected that banks’ liquidity, market and credit risk models could not adequately reflect them. Unemployment, for example, shot up massively almost overnight in many countries and jurisdictions when in a ‘normal’ recessionary period it climbs slowly over a longer period. Assumptions behind models therefore had to be rapidly reviewed. In many cases, banks had to make ‘free style’ assessments of their credit portfolios and apply qualitative judgments alongside their model outputs – and this will need to continue while fixes are built from the learnings of the crisis. Credit portfolios, which had to be reweighted away from challenged sectors such as airlines, leisure and corporate real estate, will continue to dynamically evolve in the aftermath of the pandemic. Lending criteria in personal markets are likely to become more stringent. However, opportunities could also arise as changes to consumer behavior create new types of credit demand.
2. Data availability and quality will need to be improved across the risk function and with related functions such as finance
Many risk functions across banks struggled to access sufficiently up to date and granular data in order to report ‘in the moment’ to the board and regulators. Significant amounts of data are still held in disparate databases, and information is not always consistent or comparable. Enhanced efforts will be needed to improve data availability and accessibility across the enterprise. Reporting must also become more sophisticated, moving away from static slide decks or spreadsheets to enable real-time sharing, discussion and feedback.
3. Advanced data & analytics and AI will hold the keys to value
Advanced data analytical capabilities will be critical, including cloud-based AI and predictive modeling techniques combining internal with external data to give a truly robust view. One of the key learnings from COVID-19 is that internal data alone is not sufficient. To provide real value, data must connect to inputs from outside the bank.
4. Aspects of operational risk will remain under the microscope, and robust cyber security will be critical
Banks successfully maintained operations through the height of the COVID-19 pandemic, but some fault lines appeared. The template for offshore service center usage will come under review. Some IT systems struggled to handle a huge increase in traffic as operations (and customer transactions) moved to digital, and will need to be upgraded if a truly end-to-end environment is to be a reality. More systems may be moved to the cloud, while use of ‘low code’ systems that can easily and quickly be built on top of existing infrastructure will also proliferate. In a more digital environment, maintaining and continually updating cyber defenses will be a pre-requisite. Banks will also need to ensure that they have robust mechanisms in place for monitoring compliance and adapt their internal control mechanisms for a significant portion of their workforce working remotely. This remote environment is particularly challenging for trading environments and trader surveillance.
5. In a tough economic, trading and lending environment, growth and acquisition opportunities may present themselves to those banks with the strongest risk management regimes
With the world entering a likely recessionary period, levels of credit default are sure to continue to rise at the same time as bank profitability will be challenged. Some banks can be expected to be hit by loan losses and markdowns, reducing their market capitalizations. This may present acquisition opportunities for those banks with strong risk management who preserve capital and liquidity for strategic plays.
Take action now:
Invest in technology and data
Better data availability and quality, enhanced analytical capabilities informed by AI and machine learning, and faster reporting – these must be the hallmarks of a risk function of the future.
Credit risk management must be at the forefront
In a potentially worsening economic environment, credit portfolios must be actively managed on a disaggregated basis. Banks must be able to understand where not only business sectors but individual corporate clients and personal customers are in their own post-COVID-19 journeys, what their cash flow and recovery projections are, and the risks they represent. Risk functions must be integrally connected with the operational and sales sides of the bank.
New models for operational risk and resiliency to cope with the unexpected
Banks proved their resiliency through the height of COVID-19 – and must be able to cope with whatever the future brings. With further lockdowns - on a local or even national level - very much a possibility, operations must be able to flex between physical and virtual footprints or a hybrid of the two. In a more digital world, cyber security and the protection of customer data will become more important than ever – key issues on which a bank’s reputation could depend.
Keep attuned to opportunities for growth, not just risk mitigation
Dynamic, predictive models to better understand customers and the associated risks could also drive opportunities to create competitive advantage and growth. Corporately, strategic acquisition opportunities could also arise as the fallout from COVID-19 unfolds.
Explore how these trends are unfolding in your country using the interactive map below.