The Risk Mindset That Covid-19 Demands
The simultaneous supply and demand shock set off by the global pandemic has no precedent in recent memory. In the early months, bank leaders worked hard to make sense of what was happening, what it meant and how to deal with it.
Many of those questions have been answered, but much uncertainty remains. Is the worst over? Can you focus on renewal? What actions should you take now to prevent another firefight in three months?
Traditional Signals Miss the Picture
When the coronavirus hit, firms had fair amounts of capital and liquidity reserves that cushioned the initial blow. But what is the outlook now? Unfortunately, this uncertainty doesn’t diminish when bankers examine the risk signals and metrics they’ve relied on in the past.
For example, early-stage delinquencies are at historic lows; in a normal environment, that indicator would be very benign. But during a time of high unemployment, you have to look at the underlying cause: stimulus checks and other relief passed as part of the CARES Act. How much more stress should your bank expect in consumer and small business sectors after these programs expire?
Consider Nontraditional Signals
If historical performance cannot reliably indicate future performance, you need to turn your attention to other environmental factors. What has changed, what are the likely drivers, and can you start capturing and incorporating their effect?
The impact of Covid-19 has been very regional. What if you looked at the expected hospitalization rate within a zip code? Or observed test positivity rates? Could those tell you something about the financial and economic hardships to expect there?
You, your bank and your customers are relying more on digital channels. Are your cyber risk processes built to address this sudden shift to digital? Do you have good visibility into the infrastructure threats and the mitigations that are in place? What reporting do you get regularly, or do you rely on your chief information security officer?
Yes, this is a lot of new data to analyze, and these new risk indicators don’t have the history and discipline that exists for financial risk management. However, if you want a better understanding and response to a new kind of crisis, you need to assess the impact and put appropriate mitigations in place.
A Strong Operational Risk Program
The pandemic’s imperative to quickly pivot to new ways of working have renewed focus on operational resiliency. How many banks had to deal with a surge in call volume from customers who could not visit branches? How did you deal with the surge when your backup facility was overseas and suddenly offline?
Most firms struggled, but the ones that had contemplated such scenarios – albeit not this extreme – and ran internal simulations and developed contingency plans fared better.
Banks must bring the same rigor and discipline to emerging operational risks that they do to existing risk: identify, measure, mitigate, manage and report. In the past, the focus has been to measure and control; now, you need to focus on predicting and planning for future contingencies.
The wealth of data available from internal and external sources presents an opportunity to advance what’s possible. While it is difficult to make sure you’re getting true signals rather than just noise, banks can employ large amounts of computing power, advanced analytics and artificial intelligence to deliver insights.
Looking Forward With Data, Insights
I understand that it is easier to look at historical relationships when evaluating risk: The causes and effects are clearer, the patterns are familiar, and there is less distressing uncertainty.
However, bankers also need to turn and look forward. You need to know where indicators are headed and, if you don’t have an informed view, model the impact of different scenarios. Look at a range of scenarios, and throw in a few that may seem historically implausible. How might they impact the organization? What contingency plans do you need to have in place?
Sometimes you get lucky and face a situation you’ve encountered before; more often than not, you are confronted with a very different crisis from the last one. Systems and processes that helped you address the last crisis will only take you so far.
If you don’t take risks, you have no returns. Expanding the scope of risk signals that you consider in your decision-making will help you take prudent risks, so your bank will be even stronger when the next crisis hits.