Bank Risk Management’s Super Stress Tests

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The tenth annual Ernst & Young/ Institute for International Finance global bank risk management survey, polling 95 institutions in over 40 countries, praised financial strength the past five years in meeting regulatory capital and liquidity ratios while underscoring future gaps from unrelated geopolitical, cyber and other challenges. Since the crisis a decade ago banks have slashed short-term funding, deleveraged balance sheets and divested non-core assets. Accounting changes promoted higher disclosure and “countercyclical” buffer building. Executives increasingly focus on anti-crime and money laundering compliance in prudential norms as they prepare for tougher economic times ahead, with a view also to charting digital and artificial intelligence strategies for new products and customer protection. Climate change is already an overarching theme that affects business lines and physical operations, and will likely usher in additional human and natural resource complications. As line officers try to create a multi-dimensional framework for non-financial risks, boards traditionally focused on audit and governance must in turn develop better understanding and tools or plans will be partial and incapable of execution, the report warns. Trade and military conflicts encompass all regions, as Europe copes with the aftermath of sovereign debt crisis and Brexit. Basel standards apply universally, but are implemented at different levels and timetables, and across a broad automation and technology range.

Unlike 2008, the world is now “de-globalized” with political populism and investment and immigration restrictions, as interest rates dipped further into unprecedented negative readings. Analysts no longer believe standard output, unemployment and sentiment indicators can forecast trouble as they experiment with real-time data collection and machine modeling. Privacy has become an overriding issue with big computer hacks, and Europe’s strict access and sharing guidelines could soon be adopted elsewhere. Cyber-security has become an industry-wide task where preserving critical information and infrastructure also presumes public sector collaboration. The review argues that banks are still “catching up” to severe attack potential and may be misreading defensive performance. Data transitions from in-house and vendor servers and platforms to the cloud are “inevitable,” but backups should also be determined. A consensus holds that political power globally is shifting from West to East and that domestic uncertainty is rising with new parties and foreign influence techniques, and monitoring is not just a policy but a profit and loss responsibility.

 Environmental sustainability looms as a credit, client and societal concern leading to the recent promulgation of UN banking principles, as regulators form their own “green” disclosure and conduct approaches. The IMF’s Financial Stability Board has a task force for this purpose, and central banks have forged separate formal and informal networks. In the next five years products and services likely will move from sale/own to subscription/rent models, replicating the pattern in other industries including retail and entertainment. Half the respondents came from emerging market geographies where economic slowdown and trade war dangers have abated the past month, sparking an MSCI equity rally with both the main and frontier tiers up 7%. China and Russia with 30% gains top the pack, even as their banking links with Western counterparts are at commercial and diplomatic odds for another layer of supercharged risk.