Fortifying the banks: Effective risk management strategies
Risk is inherent in banking operations. Given the impact of banking on governments and the economy, poor risk management can prove detrimental to all stakeholders of the banking sector.
Due to rapid digitalisation, rising inflation, a volatile geopolitical climate, and strict regulatory laws, traditional risk models are no longer enough. Today, banks need a robust risk-management solution that combines predictive capabilities, real-time risk monitoring, and an agile response system.
While it is impossible to eliminate risk, a comprehensive risk-management strategy for banks can help in the following:
- Mitigating loss
- Enabling a quick response and recovery if disaster strikes
- Protecting stakeholders’ interests
- Safeguarding the bank’s reputation
- Maintaining high credit ratings
All aspects of a banking risk management strategy
Rising delinquencies, bankruptcies, and complex cybercrimes in the wake of the pandemic are making it increasingly difficult for banks to anticipate the nature and magnitude of potential risks. An effective risk management strategy for banks must account for six types of risk, as follows:
Credit risk is among the biggest risks to banks, stemming from the potential non-repayment of loans.Since banks depend mainly on interest rates for their revenue, borrowers defaulting on personal or business loans, credit card payments, or mortgages can cause significant losses. Risk management for banks must necessarily include credit scoring to establish the borrower’s creditworthiness and sound underwriting standards.
Market or systematic risk results from volatile market conditions, such as recessions and exchange rate fluctuations. To manage market risks, banks need hedging strategies like derivatives, variable interest rates, and flexible pricing.
A bank incurs liquidity risk when it cannot meet its financial obligations. An effective risk management strategy for banks includes asset-liability management to guard against illiquidity.
This risk occurs from failed or sub-optimal operations, such as service interruptions, data breaches, or employee inefficiencies. Operational risk management requires continuous monitoring of internal processes and relevant initiatives, including employee training, equipment maintenance, and software updates.
Negative publicity or bad organisational behaviour may harm a bank’s reputation. Banks must comply with regulatory norms and uphold their integrity at all times to avoid reputational damage.
Cyber risks stem from technology gaps, security breaches, data breaches, or fraud. Cyber risk management in banks is a continuous and comprehensive process, including strong access controls, data security practices, and fraud management practices.
Developing a risk management plan for banks
Banks need a standardised risk-management plan that addresses all risk types and facilitates a quick response when issues arise. Here is a six-step plan that banks can follow in designing an enterprise-wide risk-management programme:
Quantify and analyse
The first step in managing banking risk is to develop a comprehensive and enterprise-wide risk-identification programme. This includes identifying newer risks, such as cybercrime and compliance risks, and factoring them into the existing risk framework.Use a root-cause approach to determine the risk source and obtain better control over the risk management function.
Develop a process to quantify risk exposure with relevant tools and technologies such as BETA, simulation-based methods, or loss data analysis. Build analytical models to obtain a better understanding of risk outcomes and probabilities.Quantifying and analysing risk help in establishing the likelihood of disaster and developing remediation procedures.
Establish robust mechanisms for mitigating all risk types. This includes credit scoring, meticulous underwriting, data access controls, fraud detection tools, and SOPs for risk reporting. Automate core operations and surveillance for better security.
Develop separate modules for managing different types of risk and apply them organisation-wide.
A crucial part of risk mitigation is training employees to identify and report risks and implement preset risk management practices.
Proactively and continuously monitor risk to obtain greater visibility into systemic issues that may impact revenue and operations. Risk monitoring includes testing systems, processes, and risk initiatives, collecting performance metrics, and resolving incidents.
Correlate risk factors, business units, and risk mitigation procedures to get a comprehensive picture of risk exposure. This helps to identify key dependencies and bridge gaps in risk assessment. It also enables the bank’s risk management teams to design centralised controls for strategy implementation.
Conduct audits to acquire a granular understanding of the bank’s risk profile and regularly report on the progress of various risk management initiatives. Besides providing a comprehensive picture of the effectiveness of the risk management programme, reports are crucial in getting buy-in from all stakeholders.
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How can Infosys BPM help?
Infosys BPM offers specialised services to help banks automate and streamline their business processes and enhance their operating models. Our digital offerings include multiple risk management tools and services, such as application processing, credit review, underwriting, loss mitigation, and fraud detection.
Know more about how Infosys BPM can augment your organisation’s risk management capabilities, with bpm in banking industry.