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Bank Risk Management: Top Challenges and Their Solutions

Roland Alston, Appian
October 20, 2023

In today's dynamic financial landscape, threats are not only escalating but also rapidly evolving. At the same time, regulators impose stricter transparency and compliance requirements on financial institutions. So, how can decision-makers navigate this challenging environment, with relentless cyber threats coming at them from one side and rising regulatory demands from the other?

The journey begins with identifying, assessing, and prioritizing a wide range of threats—from credit and market to operational and compliance. Addressing these threats requires a multifaceted approach that combines rigorous compliance, astute risk management, and strategic decision-making. Read on for some pragmatic tips, tactics, and strategies to grow and thrive amid the shifting landscape of risk and regulatory mandates.

[ Download the executive brief: The Automation Advantage: Navigating the Complexities of Enterprise Risk Management. ]

Top challenges in bank risk management.

Cybersecurity threats.

In the age of AI, cybersecurity is more essential than ever. Automating security controls could make it easier to stop attackers using established tactics. However, automated threat testing is still not widespread in the industry, exposing banks to potential breaches and substantial financial and reputational losses. Hackers are consistently evolving their methods, and companies could lose $10.5 trillion to cyberattacks by 2025. However, a proactive approach to cybersecurity can neutralize threats before they inflict harm.

Credit risk.

During the 2023 banking crisis, larger financial services organizations weathered the storm relatively well. In stark contrast, smaller, regional Tier 2 banks—subjected previously to lighter regulation—felt the brunt of surging interest rates. As interest rates soar alongside borrowing costs, credit risk becomes an increasingly vital indicator of stress on bank balance sheets. This underlines the importance of thorough credit assessment and vigilant monitoring.

"It's evident that the light-touch regulatory approach previously applied to regional and tier-two banks is poised for substantial tightening by regulators," says Guy Mettrick, Industry VP of Financial Services at Appian. "These banks will likely face heightened scrutiny and be compelled to undergo more rigorous evaluations, like stress testing. It's also probable that regional banks will need to maintain higher levels of tier-one capital to assuage concerns about adapting to rapid changes in their deposit accounts."

Solutions to the challenges.

Harnessing AI and automation: pioneering a new era in cybersecurity.

In an era where cyber threats are evolving in sophistication and frequency, relying solely on traditional security measures can be insufficient. Enter the integration of artificial intelligence (AI) and automation—a game-changing strategy that elevates cybersecurity defenses.

Automation, especially when enhanced with AI capabilities, streamlines continuous threat monitoring. This reduces the dependence on human vigilance alone, which can be error-prone. Furthermore, AI not only predicts and detects emerging threats but also delves deep into patterns and behaviors with machine learning, pinpointing vulnerabilities that might elude manual inspections.

Given the high stakes of cyberattacks and data breaches, an integrated approach to security is imperative. By merging AI and automation with human oversight, banks can erect a robust shield against cyber threats.

Staying informed on regulations: the key to compliance.

Regulations are continuously adapting to socio-economic changes, technological innovations, and global economic patterns. Navigating this fluid regulatory environment mandates that banks not only remain compliant but also anticipate impending shifts. Central to this proactive stance is fostering an organizational culture that prioritizes continuous learning and professional growth. Employees, particularly those in compliance and risk management roles, are on the front lines of this challenge. Equipping them with up-to-date knowledge and skills is not merely advantageous—it's essential.

Robust credit risk management.

Credit risk management has emerged as a cornerstone of resilience and sustained success for banking institutions. Effective credit risk management hinges on a detailed and diversified strategy.

To begin with, banks should employ rigorous credit appraisal systems. This involves:

●     Comprehensive evaluation of a borrower's creditworthiness.

●     Taking into account factors like their credit history.

●     Analyzing their current financial standing.

●     Projecting potential future income streams.

Such meticulous evaluations ensure that loans are granted only to those who genuinely have the capacity to repay, minimizing the risk of defaults that can impact a bank's financial health. Furthermore, with the aid of AI and advanced analytical tools, banks can navigate extensive data to identify patterns and insights pertinent to credit risk.

Leveraging technology to address contemporary risks.

In the age of AI, technology—including AI, blockchain, and data analytics—is central to pioneering risk management strategies. They enable proactive risk identification and optimize the assessment and risk mitigation processes. In fact, integrating AI and machine learning within regulatory compliance is proving to be indispensable. It allows organizations to efficiently plow through massive data sets, identify potential anomalies, and improve the accuracy of compliance reporting.

"While technology undoubtedly serves as a linchpin in aiding organizations to adjust to emergent risks, it's essential that it's the right fit," notes Mettrick. "The ideal technology aligns with current needs while retaining the flexibility to adapt to future challenges. It should empower organizations to refine their strategies based on distinct risk profiles and the fluid regulatory environment. The focus shouldn't solely be on embracing technology, but on selecting adaptable solutions that align with an organization's strategic objectives and regulatory duties."

Regular audits and assessments: anchoring sound banking.

Compliance isn't solely about setting protocols. It's also about consistently examining and honing them, which underscores the critical role of regular audits and assessments. Internal and external audits, while distinct, are synergistic. Internal audits delve into the bank's own processes, procedures, and controls, offering a reflective look. In contrast, external audits provide an external benchmark, juxtaposing the bank's practices against industry norms.

The remarkable evolution of the financial sector also means that regulatory standards are in constant flux. Audits don't just help banks adapt but positions them to lead the way in aligning with evolving standards. Even though audits might be scheduled events, their influence is lasting. They foster a culture of accountability, vigilance, and perpetual refinement—traits essential for any bank to stand out in the competitive financial arena.

What it all comes down to is this: Mastering bank risk management transcends theory. It's an urgent imperative, a lesson underscored by the bank crises of 2023. The forthcoming decade in risk management may witness even more upheaval, propelled by forces such as the AI boom and the explosion of data. That's why elite institutions are weaving tech solutions into their foundational goals and regulatory commitments to reduce operational expenses and sharpen decision-making, all to navigate the ever-evolving challenges of risk management.

[ Learn more about integrated risk management in financial services. Watch the webinar: Making the Case for Integrated Risk Management Across The Three Lines of Defense. ]