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What Is Risk Management in the Banking Sector?

Roland Alston, Appian
May 22, 2024

2023 was a challenging time for banks worldwide, marked by a banking crisis fueled by everything from global economic instability and market volatility to trade disruptions and geopolitical uncertainties. The resulting credit defaults, liquidity challenges, and operational disruptions put pressure on banks to fortify their risk management practices in a quest for resilient growth. 

For continued success in 2024 and beyond, particularly in preparation for regulations like the digital operational resilience act (DORA), banking leaders need to have a foundational grasp on what risk management is and how to practice it effectively.

Watch: FinextraTV and Guy Mettrick, Industry Vice President - Financial Services, Appian, explore how the technology landscape has changed risk management over the past decade and how technology has become a facilitator for operational resilience.

Definition of risk management in banking.

Risk management in banking refers to the process of identifying, assessing, and mitigating various types of risks that a bank may encounter in its operations. That includes credit risk, market risk, liquidity risk, operational risk, and compliance risk. The primary objectives of risk management in banking are to safeguard the bank's financial health, protect shareholder value, ensure regulatory compliance, and maintain trust and confidence among stakeholders.

In light of the multiple high-profile bank failures in 2023, executives are making modernizing their legacy infrastructure a top priority and widening the scope of risk management beyond credit and operational risk to account for things like cybersecurity risk, third-party vendor risk, ESG and climate risk, and model risk.

Download this resource to learn more about ways to navigate risk management: The Automation Advantage: Navigating the Complexities of Enterprise Risk Management

In fact, risk management will be fundamental to every other banking activity. Sudhir Pai, EVP, Chief Technology & Innovation Officer, Financial Services Global business at Capgemini, wrote for Forbes:

“Risk management will be at the core of every activity at banking and insurance firms—focusing on accountability and responsibility as well as a revamped risk strategy with greater investment in data, infrastructure, reporting capabilities and compliance.”

6 risk management challenges for banks.

Banks commonly face six obstacles when managing risk and compliance:

  1. Siloed data: Information that is not readily accessible to those who need it prolongs onboarding and causes frustration for employees and customers alike.
  2. Inefficient risk assessment: Financial institutions need an efficient way to assess customer information and make informed decisions to avoid unnecessary risks.
  3. Irrelevant information: Financial organizations often find themselves sifting through heaps of unrelated data to get what they need.
  4. Fragmented processes: Activities across systems and data silos take longer than they need to, diverting time and energy from value-driven tasks.
  5. Manual tasks: These make the Know Your Customer (KYC) and customer onboarding process longer than necessary and take time away from other business-building activities, like prospecting and customer service.
  6. Inflexible compliance management systems: Adapting to fast-evolving regulations while abiding by corporate policies requires flexibility, which legacy technology doesn’t always allow.

To address these bank risk management challenges, consider the strategies presented below.

Get expert advice on integrated risk management in financial services. Watch the webinar: Making the Case for Integrated Risk Management Across The Three Lines of Defense.

5 ways to strengthen your risk management strategy.

Prioritize CLM and KYC pain points

Compliance is a core tenet of a financial services organization’s day-to-day operations, and KYC and customer lifecycle management (CLM) activities are intertwined with risk management. Embed risk management practices throughout the customer journey to assess, mitigate, and monitor the risks associated with customer onboarding, credit, compliance, fraud, and more.

Leverage artificial intelligence.

Technology plays a pivotal role in managing risk, and modern banks have been embracing advanced analytics, artificial intelligence (AI), and machine learning to analyze vast amounts of customer data, identify patterns, and assess risks with accuracy and efficiency.

"The role technology plays in gaining a real-time understanding of an organization's inner workings cannot be overstated,” says Guy Mettrick, Industry VP, Financial Services, at Appian. “Traditional batch processes are no longer sufficient in today’s fast-paced financial landscape. Organizations must embrace real-time monitoring and analysis to effectively manage factors like liquidity and balance.”

Develop a data management strategy that supports risk management.

According to Deloitte’s global risk management survey, 12th edition, data is top of mind for organizations when it comes to risk management. They report: “Sixty-nine percent of respondents said that enhancing the quality, availability, and timeliness of risk data will be an extremely or very high priority for their institution over the next two years. Only about one quarter of respondents believed their institutions are extremely or very effective at managing data quality (26%).” 

Invest in data management technologies and solutions that allow your bank to gain insights in real time and take immediate action when risk is detected. “By harnessing advanced technology like data fabric, AI, and process automation, decision-makers gain comprehensive visibility and the ability to quickly respond to emerging challenges,” says Mettrick.

Banks may be able to use these tools on top of legacy systems by working with a process automation platform where these tools are built-in capabilities.

“It's about gaining insights in real time and taking immediate action. The key is leveraging technology to stay agile and responsive, ensuring your organization can navigate complex environments successfully,” Mettrick added.

Don’t forget about social media’s impact on risk.

Social media platforms have magnified the dissemination of misinformation and rumors, particularly when it comes to the banking industry and depositor sentiments. In the current digital landscape, a single post in the morning can swiftly trigger a chain reaction, culminating in a run on deposits within a matter of hours. This phenomenon demands heightened awareness from banks.

“Banks often engage in what is known as maturity transformation,” says Mettrick. “They commonly borrow funds on a short-term basis and channel these resources into long-term lending endeavors. This fundamental practice carries inherent risks,” he says, ”particularly when exacerbated by the rapid dissemination of rumors facilitated by social media, which may have contributed to the 2023 crisis.”

Moving forward, Mettrick says, financial institutions must bolster their capabilities for monitoring social media and implement robust protocols to manage risk and identify and address emerging concerns in this new era of digital connectivity. Indeed, social media exposure and incident management must be considered part of modern enterprise risk management.

Promote a risk management culture.

While technology is great at augmenting human labor, people are also an important part of any risk management strategy. Skilled risk management professionals possess the expertise to assess risks, design mitigation strategies, and monitor risk exposures. Banks need to promote a risk-aware culture throughout the organization and make continuous training in risk management part of the process.

Importance of risk management for banks.

By prioritizing strategies to strengthen credit risk management, manage liquidity risk, mitigate operational risk, and address regulatory and compliance risks and by leveraging technology, nurturing skilled risk management professionals, and fostering collaboration, banks can create a solid foundation for sustainable success in an ever-changing banking landscape.

“A well-executed, end-to-end risk-function transformation can decrease costs by up to 20 percent while improving transparency, accountability, and employee and customer experience.”

–McKinsey, Transforming Risk Efficiency and Effectiveness

Process automation is ideally suited to enable organizations to embed their risk controls directly into their processes. For example, see how the Options Clearing Corporation (OCC), a Systemically Important Financial Market Utility (SIFMU), optimized its risk management process. 

As a SIFMU, the OCC was required by the US government to have complete control and visibility over its end-to-end processes. OCC implemented a process automation platform across its legal department for regulatory filing processes, corporate actions, and new product development. Before this, the OCC processes were based on spreadsheets and email, and teams lacked complete visibility into processes. Moving forward on the platform, the OCC was able to provide clear documentation to auditors for process decisions and actions. The OCC now has end-to-end tracking of processes, has achieved digital agility to quickly adapt processes to new regulations, and is applying automation in key processes to drive greater process efficiency.

Listen to the OCC share their experience live at Appian World 2023 in this session.