Financial Services Scenario Guidebook
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Risk is inescapable, meaning banks must do everything in their power to mitigate it. Risk management is a challenge that many banks struggle to rise to. Meeting this challenge demands a clear understanding of the different types of bank risk to look for and the technologies that will help you overcome them.
Common Types of Bank Risk
Banks face a significant amount of risk; these are the seven most common types:
- Operational Risk: This refers to any risk incurred as a result of failure in people, internal processes and policies, and systems. Common examples of operational risk in banks include service interruptions and security breaches.
- Market Risk: Also known as systematic risk, market risk refers to any losses resulting from changes in the global financial market. Sources of market loss include economic recessions, natural disasters, political unrest, and changes in interest.
- Liquidity Risk: This refers to a bank’s inability to meet its obligations, thereby jeopardizing its financial standing or even its very existence. Liquidity risks effectively prevent a bank from being able to convert its assets into cash without sacrificing capital due to insufficient interest.
- Compliance Risk: Any risk incurred as a result of failure to comply with federal laws or industry regulations. Compliance risk can lead to financial forfeiture, reputational damage, and legal penalties.
- Reputational Risk: As its name implies, reputational risk refers to any potential damage to a bank’s brand or reputation. Banks can incur reputational risk for any number of reasons, from the actions of a single employee to the actions of the entire institution.
- Credit Risk: Retail banks take a credit risk any time they lend money to a borrower without a guarantee that the borrower will be able to repay their loan. The risk itself is that the bank might incur debt as a result of such an agreement.
- Business Risk: This refers to any risk that stems from a bank’s long-term business strategy and affects the bank’s profitability. Common sources of business risk to banks include closures and acquisitions, loss of market share, and inability to keep up with competitors.
Obstacles to Risk Management in Banks
1. Regulatory Changes
The financial services regulatory landscape is in a constant state of flux, with new regulations or amendments to existing regulations being handed down every month in response to political turmoil, public sentiment, emerging technology, and more. It can be challenging for banks to comply with the ever-changing rules, but comply they must, lest they expose themselves to compliance risk and the potentially severe consequences that accompany it.
Compliance risk management in banks essentially boils down to three basic steps:
- The bank becomes aware of the regulation.
- The bank works to understand the impact of the regulation on its core business model.
- The bank implements the necessary changes in order to ensure compliance.
Although it might seem simple on its face, this process requires banks to expend a significant amount of resources, financially and otherwise. Therefore, the best way to conserve resources and achieve compliance that much faster is to automate compliance risk management. Newer cloud-based developer tools and highly automated DevOps technologies reduce the adverse impact of applying frequent regulatory changes to operational systems. Comprehensive cloud-based test systems can be spun up as needed for full-scale regression tests of complex financial systems and then scaled back down to eliminate the carrying cost of idle test systems.
2. Rising Customer Expectations
Today’s customer is adept at using their personal device for tasks they would otherwise perform manually, including banking. This has led mobile banking apps to become ubiquitous — in fact, you’d be hard pressed to find a financial institution that doesn’t have a mobile app. That said, these apps are often treated as a supplement to a bank’s brick-and-mortar offerings rather than a one-stop shop. Even for more tech-savvy institutions, their mobile app often pales in comparison to that of their online banking platform. This is especially frustrating for younger customers, who are accustomed to using their phones for just about everything and expect their bank’s mobile solution to be just as functional as its online platform or branch operations.
The desire for such a solution presents certain challenges: Mobile devices offer limited screen real estate, which can make it difficult to design a user interface that’s both aesthetically pleasing and easy to use. There’s also the matter of security to consider; a 2017 research report revealed that mobile apps belonging to 50 of the world’s 100 largest banks were vulnerable to hacking attacks.
That said, the benefits are substantial: A truly full-service mobile banking app not only has the power to increase customer loyalty, it also encourages more spontaneous interactions (and transactions) and enables banks to monitor customer activity. This last item is especially significant because it empowers banks to market more dynamically to individual customers based on their interests. For example, let’s say that a customer — we’ll call him Jim — recently used his mobile banking app to look up information about home loans. Based on that and other information about him, such as that he has a high credit, score, Jim’s bank might target him with an ad for a home loan with a low APR rate the next time he logs into the app. Even if he doesn’t express an immediate interest in the offer, the bank could retarget Jim with other ads about home loans or related products and services via the app.
The key idea here is to run ads that enrich the customer experience rather than detract from it by marketing directly to their interests. By investing in a full-service mobile application, banks are able to deliver the level of technology and personalization that customers desire, thereby ensuring their ability to remain competitive and avoid business risk.
3. Cybersecurity Breaches
As the financial services industry has become increasingly tech-based, cybersecurity has become part of the cost of doing business. Cybersecurity threats such as malware, phishing, and Denial of Service attacks grow more sophisticated with each passing day, to the point where legacy systems implemented prior to the rise of Big Data analytics are incapable of fending them off. As a result, banks’ cybersecurity administrators often find themselves overwhelmed by false positives and spend a significant amount of time investigating things that aren’t actual problems.
The good news is that although cyberattacks have become more sophisticated, so, too, has the technology used to combat them. Banks can now use artificial intelligence to perform rapid pattern recognition analytics across millions of questionable activities and filter out much of the noise. This technology can also be used to automate essential cybersecurity tasks, which is a major win given the ever-growing amount of banking data that lives in the cloud and that the existing pool of cybersecurity professionals is struggling to keep up with demand. Security Information and Event Management software (SIEM) can also help security administrators stay on top of cybersecurity risk by helping them rapidly identify and resolve problems through the power of machine learning and analytics.
4. Fraud & Identity Theft
Similar to cybersecurity, banks’ security admins are often overwhelmed by the number of false positives for fraud and identity theft. In fact, the only real difference between this bank risk and the last is that fraud and identity theft false positives are visible to customers and can interfere with customers’ ability to complete transactions — and, in some cases, cost them money. For this reason, false positives are a significant detriment to bank operations and detract from the overall customer experience.
Just as AI helps prevent cybersecurity breaches and false positives, it can also help with fraud and identity theft. Using AI, banks have the ability to detect potential incidents of fraud and identity theft to a far more refined degree than ever before. This has the dual benefit of preventing customers from experiencing the nightmare that is identity theft, as well as eliminating false positives. Again, this process can be automated, which streamlines security efforts and comes at a huge cost savings to banks. Similarly, AI and automation can be used in conjunction to quickly detect and shut down instances of fraud, thereby protecting banks from financial exposure and reputational risk.
5. Inefficient Internal Processes
Every year, banks need to look for ways to offset the increasing cost of operations in order to prevent liquidity risk or business risk. Automation and stringent practices for underwriting, servicing, and monitoring go a long way not only toward reducing costs, but also toward preventing operational risk, credit risk, and compliance risk. Automation, in particular, makes it easier for banks to achieve regulatory compliance — for example, with custom automation functions configured to meet requirements outlined in such regulations as the Beneficial Ownership Rule.
Another key way banks can save money is by utilizing cloud technology. Cloud computing can introduce efficiencies that lead to substantial cost savings, such as leveraging powerful analytics to cut costs on marketing and time to market for new products.
6. Increasing Competition
In today’s world, traditional banks face increasing competition from internet banks hungry to take market share and tech companies such as Apple, Amazon, and Google that are breaking into the finserv industry. This is especially problematic for local and regional banks, which don’t have the ability to make up for lost customers by simply expanding their geography.
In order to counter this encroachment, traditional banks need to learn to interact with their customers in the same way that their non-traditional competitors do — a shift that often requires them to rethink their customer engagement strategy from the ground up. The most efficient way to get started is for banks to refresh their existing offerings and rejuvenate their portals in order to meet rising customer expectations. From there, it’s in a bank’s best interest to partner with a consulting firm and systems integrator that can introduce new technologies that will enable it to meet different challenges and evolve its business.
Hitachi Solutions is one such firm. We specialize in helping businesses the world over realize the power of the Microsoft platform, from Dynamics 365 to the Azure cloud suite. We have extensive experience helping banks and other institutions within the financial services industry develop comprehensive risk management strategies, optimize business-critical operations, adapt to an increasingly competitive market, and achieve true digital transformation. We even have our own industry IP, built on the Microsoft platform with banks in mind. To find out what Hitachi Solutions can do for you, contact us today.
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