The Future of Bank Risk
Management
By Philipp Härle, Andras Havas,
and Hamid Samandari
Banks have made dramatic changes
to risk management in the past decade—and the pace of change shows no signs of
slowing. Here are five initiatives to help them stay ahead.
Risk management in banking has been transformed over the past
decade, largely in response to regulations that emerged from the global
financial crisis. But we believe it could be set to undergo even more sweeping
change in the next decade. Indeed, while risk-operational processes such as
credit administration today account for some 50 percent of the function’s
staff, and analytics just 15 percent, by 2025 those figures could be around 25
percent and 40 percent respectively.
The trends shaping the risk
function come from all directions. While we cannot draw a blueprint of what a
bank’s risk function will look like in 2025—no one can predict all the
disruptions that might lie ahead—we can paint a picture of some important
changes that are relatively certain. We see financial and nonfinancial
regulation continuing to broaden and deepen as public sentiment becomes ever
less tolerant of any appearance of preventable errors and inappropriate
practices, or of bank failures. Simultaneously, customers’ expectations will
rise in line with changing technology. In the battle for customer
relationships, banks will need to offer real-time responses to customer
requests to open an account or take out a loan, for example, which means the
risk function will need to find ways to assess risks automatically, without
human intervention. Risk functions will also have to cope with additional,
emerging risks—from cyberattacks to contagion in global markets and losses made
due to the increasing use of models to make decisions (losses that are not
uncommon but seldom reported).
At the same time, evolving
technology and advanced analytics, such as machine learning, are enabling new
risk-management techniques. Banks are experimenting with self-learning
algorithms in credit underwriting, monitoring, and credit-card fraud detection,
with encouraging results. Advances in behavioral economics will also help risk
managers make better choices as they learn to recognize and eliminate common
biases from their decisions. On the downside, with banking margins under
pressure worldwide, the risk function will probably be expected to deliver
these improvements with substantially reduced operating costs.
Five future-proof initiatives
So how should risk managers
respond to these changes? Our belief is that there are some basic initiatives
that banks can undertake today that will both deliver short-term results and
help them prepare for the future. Here are five that not only have a strong
short-term business case, but also will help build what we see as the essential
components of a high-performing risk function in 2025.
Digitize core processes. By 2025,
the risk function will have minimized manual interventions. Modeling,
simplification, standardization, and automation will take their place, reducing
nonfinancial risk and lowering operating expenses. To that end, the function
should push to digitize core risk processes such as credit application and
underwriting by approaching business lines with suggestions rather than waiting
for the businesses to come to them. Increased efficiency, lower costs, and,
often, a superior customer experience and improved sales will be the short-term
gains.
Experiment with advanced
analytics and machine learning. In the same vein, risk functions should
experiment more with analytics, and particularly machine learning to enhance
the accuracy of their predictive models. Some financial institutions have
already achieved significant model improvements, leading to better credit-risk
decisions.
Enhance risk reporting.
Ever-broader regulation and the need to adjust to market developments require
rapid, fact-based decision making, which means better risk reporting. While
regulatory requirements have already done much to improve the quality of the
data used in risk reports and their timeliness, less attention has been given
to a report’s format or how it could be put to better use when making
decisions. Replacing paper-based reports with an interactive tablet solution
that offers information in real time and enables users to do root-cause
analyses would enable banks to make better decisions, faster, and identify
potential risks more quickly too.
Collaborate for balance-sheet
optimization. Given the many different and new regulatory ratios (such as
capital, funding, leverage, total loss-absorbing capacity, and bank levy, to
name a few), the composition of the balance sheet is arguably more important
than ever to support profitability. The risk function can help optimize the
balance sheet by working with finance and strategy functions to consider
various economic scenarios, strategic choices (how much a bank would be
prepared to increase or shrink a loan portfolio, for example), and likely
regulation. The process, performed with the support of analytical optimization
tools, often suggests ways to improve return on equity by anywhere between 50
and 400 basis points while still fulfilling all regulatory requirements.
Put the enablers in place. It
goes without saying that high-performing risk functions depend on a
high-performing data infrastructure. What perhaps deserves more attention is
the importance of starting to build the right mix of talent and embedding a
risk culture. Data scientists with advanced mathematical and statistical
knowledge will increasingly need also to be able to work as “business
translators,” collaborating across the bank to convert data insights into
business actions. Indeed, risk managers will become trusted counselors to
business areas (though fewer staff will be needed in traditional operational
areas). Attracting talented employees will itself be a challenge, as many
potential candidates could be lured to technology firms unless banks strengthen
their value propositions. A strong risk culture—in which detection, assessment,
and mitigation are part of the daily job of all bank employees—will be central
to the success of the risk function. For despite the push toward automation and
more sophisticated analytical and technical capabilities, only human
intervention will ensure they are applied appropriately and ethically.
Fundamentally changing bank risk-management functions will take years. Now is the time to start the transformation. Our vision for a bank’s risk-management function in 2025 is one where the function is the architect of a seamless system that monitors risk throughout the organization and makes de-biased risk decisions, that has stronger, more collaborative relationships with other parts of the bank, and that is more engaged at a strategic level than it is today. The actions described here are some steps risk functions can take today to move toward this vision and to help the bank excel among its competitors.
Source : http://www.mckinsey.com/business-functions/risk/our-insights/the-future-of-bank-risk-management