By Andrew Bisset.
2 November 2020 (2 days ago)
Banking has undergone declining credit quality and daily volatile market conditions, indicating unparalleled dire times for Chief Risk Officers (CRO), risk functions and the business. There are three main areas that should be prioritised and by taking suitable actions, risk leaders can assist their organisations support the immediate crisis management, operational and financial disruption and stabilising for how it will embark on the post-COVID “new reality”.
Our first focus is credit risk. The credit impacts differ significantly by sector and business. From the standpoint of credit, banks have to identify the most affected sectors such as tourism, airlines, oil and gas and healthcare and figure out how they can support. This might include an acceleration of credit review and approval processes for immediate liquidity and subsidised loans— deterioration of credit quality may contribute to an increased number of default cases, increased demand for forbearance measures and rising credit risk provisions. To counter this risk, banks should start exploring the use of D&A based methodology and digitalisation, as well as normalised decision tress to improve efficiency. In the long run, banks should establish a strategy on how to deal with recalibrations of rating models and consider COVID-19 scenario analysis on credit portfolio. Lastly, banks must regularly and thoroughly check all regulatory and governmental relief measures for their applicability.
The second risk we should evaluate is liquidity and treasury risk. Banks need to have solid liquidity management to support serious drawdowns of facilities and changing customer borrowing needs.During March, banks operated under their crisis governance with contingency funding plans being activated by many institutions. As the spread of pandemic slackened, central banks and governments have proposed measures to support banks with liquidity. Besides that, banks may need to revise the blueprints used for liquidity management. Liquidity stress models that were recognised based on experiences from the 2008 financial crisis might not provide significant insight on current liquidity development, thus banks need to back test and review certain models.
Last but not least, we have to assess the current market risk. There has been an increased noise in market data, dispersion of spreads and high market volatility across all asset classes since March. This has led to limit breaches, back-testing outliers and increased risk measures, which in turn increasing market risk capital requirements. In response, banks have to focus on day-to-day market risk operations and closely monitor capital requirement implications and respective mitigating supervisory measures. However, an increase in regulatory prudent valuation figures impacts bank’s regulatory capital ratios.
While supervisory measures to mitigate prudent valuation impacts are anticipated, a re-design of the framework in the light of overly cyclical methodologies is recommended.