6 Major Obstacles to Risk Management Banks Face in 2023

Some degree of risk — in this particular context, the potential for adverse outcomes, financial losses, or disruptions in operations — is to be expected when working in the banking industry. Although risk is inescapable, that doesn’t mean that banks must simply accept it — instead, they must take proactive measures to mitigate it.

Risk management is the key to navigating the murky and sometimes dangerous waters of the banking industry, but creating an effective risk management strategy is a challenge that many banks struggle with. 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.

What Is Risk Management in the Banking Industry?

Banks are naturally exposed to risk due to the nature of their business, which involves handling financial assets, investments, and the liabilities that come with them. Banks must also adapt their strategies based on market fluctuations and make sense of economic and regulatory uncertainty. Although these risks come with the territory, banks can take proactive measures to address them and, as a result, lessen their impact.

Risk management refers to the systematic process of identifying, assessing, and mitigating the various risks a bank may face in its day-to-day operations and activities. Though risk management in banking can take many forms, effective risk management strategies typically involve a combination of policies, processes, tools, and governance structures, and may use dedicated resources; in many instances, banks have entire risk management departments dedicated to the sole purpose of monitoring, measuring, and controlling risk. These teams may conduct routine risk assessments and stress tests and analyze different scenarios to ensure that their institution is able to withstand the various risks it may be subject to.

Ultimately, the goal of risk management in banking is to strike the right balance between risk-taking and risk mitigation to achieve sustainable growth and profitability while safeguarding stakeholder interests.

Top Risks for Banks [& How to Mitigate Risk in Banking]

Banks face a significant amount of risk; these are the seven top risks for banks today:

● 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.

Banks can overcome operational risk by implementing robust internal controls, conducting routine risk assessments, providing thorough training (and refresher courses) to staff, and continuously improving upon operational procedures.

● 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 rates.

There are many ways banks can manage market risk — including diversifying their investment portfolios and stress-testing their positions against adverse market scenarios — but one of the most important steps is to stay informed on economic trends and geopolitical developments, both of which could lead to market fluctuations and potential disruption.

● 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.

To combat liquidity risk, banks must strike an appropriate balance between their liquid assets and liabilities, diversify their funding sources, and develop contingency funding plans. By taking these proactive measures, banks can improve their ability to meet short-term financial obligations, even when faced with financial challenges.

● 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.

Mitigating compliance risk requires a multifaceted risk management strategy, one that includes establishing regulatory frameworks, conducting routine internal audits, maintaining close contact with regulatory authorities in order to remain up to date on various requirements, and providing comprehensive compliance training to employees.

● 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.

Managing reputational risk requires a slightly different approach to the other sources of risk in banks presented here, if only because it can be caused by a wide variety of actions or behaviors. For example, reputational risk resulting from poor data privacy practices requires an entirely different solution than reputational risk incurred from a poor customer service interaction.

With that in mind, banks should implement a wide variety of reputational risk mitigation strategies to address the myriad causes, from developing a culture of ethical behavior and transparency to maintaining effective crisis communication strategies.

● 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.

The best way to prevent credit risk is to conduct in-depth credit assessments for all borrowers, set appropriate lending criteria, and implement monitoring systems to gauge the creditworthiness of borrowers over time. In addition to these measures, banks can also look to diversify their loan portfolios for added coverage.

● 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. Banks can offset business risk by maintaining a diverse portfolio of products and services, continuously optimizing operations, and improving upon existing business strategies according to changing market conditions.

Obstacles to Risk Management in Banks

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 they can take steps to avoid the potentially severe consequences of non-compliance.

Compliance risk management in banks essentially boils down to three basic steps:

1. The bank becomes aware of the regulation.

2. The bank works to understand the impact of the regulation on its core business model.

3. 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.

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 to mobile banking apps becoming 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 2021 research report revealed that 77% of financial apps have at least one serious vulnerability that could lead to a data breach.

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 them Erin — recently used their mobile banking app to look up information about interest rates on short-term CDs. Based on that and other information about them, such as their current account balances, Erin’s bank might target them with an ad for other products with attractive rates, such as a money market account, the next time they log into the app. Even if they don’t immediately act on the offer, the bank could retarget Erin with other ads about low-risk, high-yield savings products 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.

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 modern 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 (AI) 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.

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.

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.

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 financial services 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.

By taking a more client-centric approach — one that considers accounts for all channels when designing a new client experience — banks can not only meet, but exceed customer expectations and fend off encroaching competitors.

How Banks Can Manage Risk with AI & Analytics

The most effective way to manage all forms of risk in the banking business is to invest in artificial intelligence and data analytics. These technologies empower risk management teams to analyze both real-time and historical data, identify patterns, create predictive models, and proactively assess anomalies and potential threats. Ultimately, analytics and AI provide risk managers in banks with the tools and knowledge they need to make informed decisions and create effective risk management strategies.

Hitachi Solutions provides banks across all sectors with the tools and technologies they need to effectively manage risk, including data analytics and AI. We leverage our deep technical expertise to help institutions such as yours create a modern data platform capable of turning your business data into actionable insights to drive more informed risk management strategies.

What’s more, 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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