Banks have made dramatic changes to risk management in the past decade—and the pace of change shows no signs of slowing. It is estimated that by 2025, risk functions in banks will likely need to be fundamentally different than they are today and unless banks start to act now and prepare for these longer-term changes, they may be overwhelmed by the new requirements and demands they will face.

The future of bank risk management

The structural trends that are driving many of these substantial shifts stem from multiple sources. Regulation will continue to broaden and deepen as public sentiment becomes less and less tolerant of any appearance of preventable errors and inappropriate business practices. Simultaneously, customers’ expectations of banking services will rise and change as technology and new business models emerge and evolve. Risk functions will also have to cope with the evolution of newer types of risk —all of which require new skills and tools. Fortunately, evolving technology and advanced analytics are enabling new products, services, and risk-management techniques, while de-biasing approaches that improve decision making will help risk managers make better choices about risks. However, the risk function of the future will probably be expected to deliver against all these requirements and deal with these trends at a lower cost, because banks will in all likelihood have to reduce their operating costs substantially.

So what will the risk function look like in 2025? It is likely to have broader responsibilities, to be very engaged at a strategic level, and to have stronger, collaborative relationships with other parts of the bank. At the same time, its talent pool will probably have experienced a massive shift in expertise toward better analytics and greater collaboration, and away from operating processes. Most of the latter can reasonably be expected to be automated, real-time, and paperless by then. IT and data will likely be much more sophisticated, often employing big data and complex algorithms. As a result, the risk function may be able to make better risk decisions at lower operating costs while creating superior customer experiences.

If banks want their risk functions to thrive during this period of fundamental transformation, they need to start now with a portfolio of initiatives that balance a strong short-term business case with enabling the long-term achievement of the target vision. Here are six trends that are shaping the role of the risk function of the future.

1. Regulation will continue to broaden and deepen.

Increasingly, banks are being required to assist in crackdowns on illegal and unethical financial transactions by detecting signs of money laundering, sanctions busting, fraud, and the financing of terrorism, and to facilitate the collection of taxes. Governments are also demanding that their banks comply with national regulatory standards wherever they operate in the world. Banks operating abroad must already adhere to US regulations concerning bribery, fraud, and tax collection, for example. Regulations relating to employment practices, environmental standards, and financial inclusion could eventually be applied in the same way.

2. Customer expectations are rising in line with changing technology

Technological innovation has ushered in a new set of competitors: financial-technology companies, or fintechs. They do not want to be banks, but they do want to take over the direct customer relationship and tap into the most lucrative part of the value chain—origination and sales. In 2014, these activities accounted for almost 60 PERCENT OF BANK'S PROFITS. They also earned banks an attractive 22 PERCENT RETURN ON EQUITY, much higher than the gains they received from the provision of balance sheet and fulfillment, which generated a 6 percent return on equity.

Ready to use fintech to improve your bank's risk assessment of commercial loans? Schedule a call with us here and we will walk you through what we can do to jumpstart growth.

3. Technology and advanced analytics are evolving

Technological innovations continuously emerge, enabling new risk-management techniques and helping the risk function make better risk decisions at lower cost. Machine learning, such as the financial condition analysis service that CreditBPO employs, improves the accuracy of risk models by identifying complex, nonlinear patterns in large data sets. Every bit of new information is used to increase the predictive power of the model. A number of banks that have used models enhanced in this way have achieved promising early results and, combined with big data, AI, and crowdsourcing - can have a potential huge impact on risk function assessment.

Do you want to find out how to leverage fintech to improve your bank's risk assessment of commercial loans? Schedule a call with us here.

4. New risks are emerging

Inevitably, the risk function will have to detect and manage new and unfamiliar risks over the next decade. Model risk, cybersecurity risk, and contagion risk are examples that have emerged. To prepare for new risks, the risk-management function will need to build a perspective for senior management on risks that might emerge, the bank’s appetite for assuming them, and how to detect and mitigate them. And it will need the flexibility to adapt its operating models to fulfill any new risk activities.

5. The risk function can help banks remove biases

Behavioral economics has made great strides in understanding how people make decisions guided by conscious or unconscious biases. It has shown, for example, that people are typically overconfident—in a few well-known experiments, for example, enormous majorities of respondents rated their driving skills as “above average.” Business, too, is prone to bias. Business cases are almost always inflated, and if the first person to speak in a discussion argues in favor of an idea, the likelihood is high that most present, if not all, will agree.

Find out how you can use fintech to temper inherent biases in your credit risk analysis. Let's talk.

6. The pressure for cost savings will continue

The banking system has suffered from slow but constant margin decline in most geographies and product categories. The downward pressure on margins will likely continue, not least because of the emergence of low-cost business models used by digital attackers. As a result, the operating costs of banks will probably need to be substantially lower than they are today. After exhausting traditional cost-cutting approaches such as zero-based budgeting and outsourcing, banks will find that the most effective remaining measures left are simplification, standardization, and digitization.

Do you need fintech to generate cost savings for your bank? Schedule a call here.

These six trends suggest a vision for a high-performing risk function in the next several years. It will need to be a core part of banks’ strategic planning, collaborate closely with businesses, and act as a center of excellence in analytics and de-biased decision making. Its ability to manage multiple risk types while complying with existing regulation and preparing for new rules will make it more valuable still, while its role in fulfilling customer expectations will probably render it a key contributor to the bottom line.

In the next installment, we will tackle how initiatives based on these trends can be implemented that will bring short-term business gains while helping build the essential components of a high-performing risk function for banks.

Source: McKinsey.com

Ready to implement a transformational change in your risk management process? Schedule a call with us here and we will walk you through how to leverage and make use of what today’s technology offers through CreditBPO.