After the storm: a new era for risk management in financial services is an Economist Intelligence Unit report that explores the way in which risk management is changing at the world’s financial institutions in response to the global financial and economic crisis.
Almost two years since the financial crisis first emerged from the sub-prime mortgage business in the US, the repercussions continue to be felt. Despite unprecedented efforts by governments, central banks and regulators, the cost to the global economy of the failure of the financial system will be huge, and felt over an extremely long period. According to the latest Financial Stability Report from the International Monetary Fund, global bank losses are likely to exceed US$4.1 trillion. In their efforts to bail out the banking system and deal with wider economic pain, public debt for the G20 countries will mushroom to more than 100% of GDP in 2014.
The way in which financial institutions identify, assess and manage risks continues to fall under intense scrutiny. The crisis has exposed the shortcomings of a whole host of risk techniques, and major soul-searching is now underway to ensure that the risk and controls functions in financial institutions will be more robust, authoritative and accountable in future. Regulators, too, are eyeing the risk capabilities of the industry carefully, and considering the systemic implications of certain approaches to manage risk more thoroughly.
In March 2009, the Economist Intelligence Unit conducted a global survey on behalf of SAS to assess how risk management is changing in the world’s financial institutions. The survey attracted 334 participants from across the financial services industry. The report that follows presents the highlights of those survey findings along with related additional insights drawn from industry experts and commentators. Key findings from this research include the following:
We are seeing an erosion of confidence and a retreat from risk. The survey reveals an industry that appears shell-shocked by the events of the past 18 months. There is limited confidence in the ability of financial institutions to increase revenues or profitability over the next year, while less than one-third of respondents say that they are seeing confidence returning to their business. This erosion of confidence is having a dramatic impact on the kind of business that financial Institutions are willing to carry out, with a significant retreat to familiar, domestic business. More than two-thirds say that they expect a greater focus on domestic business over the next year, while less than one-third are increasing their focus on overseas developed markets, and just over one-third on emerging markets.
Transparency is a common theme to proposed reforms. Asked about the initiatives that they thought would be most beneficial to the financial services industry, respondents pointed to greater disclosure of off-balance-sheet vehicles, stronger regulation of credit rating agencies, and the central clearing for over-the-counter derivatives as being three among the top four that have the greatest potential benefit. Although these are wide-ranging initiatives, there seems to be a common theme across all of them – namely, the requirement for greater transparency and disclosure to facilitate the more effective management of systemic risk issues.
Reforms to risk management within institutions will be far-reaching and comprehensive. Just one-third of respondents think that the principles of risk management in financial services remain sound. In response to this, more than half of respondents say that they have conducted, or plan to conduct, a thorough overhaul of their risk management. Key areas of focus, according to respondents, are likely to be improvements to data quality and availability, the strengthening of risk governance, a move towards a firm-wide approach to risk, and the deeper integration of risk within the lines of business. Respondents say that the need for reform is being driven, in particular, by executive management, but regulators are also starting to apply the pressure.
Culture, expertise and data are the weak points in companies’ risk management. Asked about the barriers to improving risk management in their organisation, respondents point to poor data quality, lack of expertise and a lack of risk culture among the broader business as being the most significant. This theme of a lack of understanding between the risk function and the business certainly seems to be significant. Asked about the areas where communication most needs improvement, respondents point to the channels between the risk function and lines of business as requiring most attention. Elsewhere, just 40% of respondents say that the importance of risk management is widely understood throughout the company, suggesting that more needs to be done to embed risk culture and risk thinking more deeply in the institution.
Respondents lack confidence in the ability of supervisors to formulate the right response to the crisis. Just three in ten respondents are confident that policy-makers can formulate an effective response to the crisis. Regulators, in particular, are singled out as being a potential weak spot, with less than one-third rating their handling of the financial crisis as good or excellent (a lower proportion than for either central banks or governments). In terms of specific regulatory interventions, respondents are most confident in the ability of regulators to maintain overall stability of the financial system, with 53% expressing confidence here. Far lower proportions are confident in their ability to monitor credit ratings and prevent conflicts of interest (18%); secure the implementation of compensation policies that support long-term shareholder value (24%); or co-ordinate the work of regulators across borders (25%).
