6 minute read 10 Feb 2020
Man on canyoning adventure on waterfall

How banks can strengthen resilience to boost returns

Authors
Jan Bellens

EY Global Banking & Capital Markets Sector Leader

Passionate leader on innovation in financial services, especially in emerging markets. Global citizen. Keen traveler.

Karl Meekings

EY Global Banking & Capital Markets Lead Analyst – EY Knowledge

Believer in a progressive and purpose-led banking sector. Interested in the future of banking. Germanophile. Medievalist.

6 minute read 10 Feb 2020

Banks that better manage risks can boost returns amid profit pressures. Four areas of focus can help CROs build resilience.

This article is part of our Banking in the new decade series.

High achievers are those with a clear core competence, according to an EY analysis of outperforming banks. But while resetting strategy or redefining value propositions takes time, there are faster ways to create advantage, including mitigating risks to strengthen resilience and allow banks to invest in wider transformation. In turbulent times, when many banks are undergoing reorganization and change that is putting the organization under strain, a strong controls infrastructure is critical.

In the 2020 operating environment, Chief Risk Officers (CROs) balance a multitude of risks, with geopolitical and credit risk among the biggest, according to a recent Bank of England survey1. With all signs pointing to a challenging 2020 for banks, the focus for CROs will be tactical risk management, including enhancing underwriting standards in structurally weak markets and building additional data metrics to assess customers in high-growth areas.

They must also manage a range of other risks, including third-party risk management, customer data privacy at partner institutions, and cyberattacks, which are difficult to control and prepare for, but can cause serious reputational damage. Helping the banks avoid one-off expenses – which may impact banks’ ability to invest in those initiatives most likely to boost long-term profitability – will be a critical aspect of CROs’ roles.

CRO's top risk priorities over the next 12 months

With this in mind, CROs must ensure their approach to risk mitigation is best positioned to boost returns. Four key areas of focus can help: 

1. Better risk modeling and balance sheet management

The recent EY/IIF survey found that credit is the second most significant risk for CROs. With this in mind, prudent provisioning will be central to banks’ ability to invest in the wider transformation agenda.

Many banks are already taking action, reducing future provisions by employing prudential credit risk management, tightening prudential calculation rules, de-risking loan portfolios and focusing on customer due diligence. Other tactics to improve credit quality include divesting high-risk businesses and reallocating capital to high-return business segments.

We see some organizations seeking to improve asset quality by selling non-core equity holdings, reducing risk-weighted assets and shrinking the balance sheet to improve capital strength. Enhancing capital efficiency by implementing minimum profitability thresholds and faster asset rotation will also be a key pillar of balance sheet management.

Analytics can also improve fraud detection and credit quality insight while anticipating problems among customer segments and within business lines. 

2. Harnessing technology and data innovation

Big data, analytics, machine learning and cognitive computing can be powerful tools that help banks digitalize risk management operations and introduce new approaches to risk modeling that together reduce costs and strengthen balance sheets.

For example, analytics-based risk assessment can optimize asset and liability composition, allowing banks to better structure their balance sheets to support profitability. Analytics can also improve fraud detection and credit quality insight while anticipating problems among customer segments and within business lines. They can also enhance the analysis of credit risk by giving insights into which products and services should be offered to different client segments, limiting banks’ credit exposure in a downturn and preventing capital dilution in a recession.

Analytics can also be used to support the development of downturn scenario models, including loan portfolio contraction and expansion, evaluation and monitoring of default rates, and risk appetite modeling. In partnership with machine learning, analytics are also used by high performers to better assess money laundering risks. And many banks are broadening their use of biometrics and natural language processing to verify identities and using cognitive computing to improve transaction monitoring and investigation.

3. Partnering to reduce risks and costs

But in many cases, the application of new technologies is in parts of the business that are critical and yet non-differentiating – for example, in know-your-customer (KYC) or financial crime detection. Partnering with a managed services provider in these areas, as well as tax, financial and legal services, can be a more cost-effective option that enables banks to realize the radical cost reduction required to hit return-on-equity (ROE) targets.

Managed services providers with the right mix of technology investment, and the talent and processes to deploy them, can typically generate a greater return on investment than a bank trying to invest across all its non-core functions. And, critically, banks can free up their own resources to focus on creating the strategic opportunities that will add value and grow revenue. 

4. Being alert to new risks, especially reputational threats

While the transition to automation and digitalization creates opportunities to mitigate many forms of risk, it also introduces new ones. Many of these emerging risks are likely to be subject to increased regulatory action, but CROs should act now to secure banks against potential reputational risks:

  • Third-party risk could rise as use of managed services and utilities increases. Banks must rationalize their vendor list, introduce robust vendor management and enable the ability to identify third-party risk and satisfy regulators of their operational resilience.
  • Data risk is a growing threat as open banking sees customer data handled by more parties as it is transferred between banks, their competitors and non-banks. This highlights the requirement for banks to facilitate the transparent and ethical use of customer data or risk reputational damage.
  • Systemic risk is increasing as more banks adopt cloud services as they decentralize technology stacks. Many banks are dependent on the same few providers, with more than two-thirds of the market share going to the top four entities. Additionally, those providers are typically based outside banks’ headquartered jurisdictions.

Cloud dominance

65%

of market share goes to the top four cloud providers.

Source: Bank of England, The Bank’s response to the van Steenis review on the Future of Finance

  • Talent risk as banks face a shortage of skills needed to deploy new technologies across the organization. Attracting talent is less of a challenge than in the immediate aftermath of the crisis, but banks must still seek to mitigate this risk through upskilling existing staff; for example, through partnerships with universities and other third-party training organizations.
  • Responsible banking principles are moving center stage, as investors look for reassurance that organizations are doing the right thing by their clients and the planet. Financial inclusion is one area of focus, as is climate change, with a significant proportion of banks’ lending books exposed to climate-related risk through their clients. The EY/IIF survey found that four in five (79%) banks have incorporated climate change into their risk management approach. A successful approach for banks will focus less on the ultimate exposure and more on initiatives that have helped clients go green and create sustainable business models.

Resilience lays the groundwork for radical transformation

In many ways, the story of banking over the last decade has been dominated by the misjudgement of risk, whether in the drag of non-performing loans in some European markets to the huge fines for conduct breaches that have destroyed profits. The focus of CROs in 2020 must be on strengthening the approach to current risks in the near term, but also preparing to get ahead of emerging threats, particularly those that may lead to reputational damage or financial penalties in the longer term.

With many banks preparing for radical transformation in coming years, effective governance models will ensure organizations build resilience while controlling costs and positioning for future success. 

Summary

High-performing banks know that success comes from a position of strength. CROs that reassess their approach to mitigating current risks – and prepare for future threats – can help build the foundations for revenue growth, even in uncertain times. 

About this article

Authors
Jan Bellens

EY Global Banking & Capital Markets Sector Leader

Passionate leader on innovation in financial services, especially in emerging markets. Global citizen. Keen traveler.

Karl Meekings

EY Global Banking & Capital Markets Lead Analyst – EY Knowledge

Believer in a progressive and purpose-led banking sector. Interested in the future of banking. Germanophile. Medievalist.