When running a financial institution, or any other kind of business, proper risk management is essential for your success. Any action you take, or decline to take, involves some element of inherent risk.
With the internet, the cloud, increasing regulation, and increasingly clever hackers to fend off along with the traditional interest rate risk and lending risk, it’s far riskier operating a bank or credit union today than ever before.
With this increased risk, financial institution executives must be more diligent than ever with their risk management, yet many are still relying on old, outdated (and risky) techniques.
To ensure that your risk management tools and strategy meet the needs of today’s risk management environment, ask yourself these seven questions:
Many financial institutions don’t have good risk measurement tools, so they are likely underestimating the risk in their portfolios. Such was the case with many banks fined for Bank Secrecy Act and Office of Foreign Asset Control regulations. They didn’t intend to violate the regulations, but they didn’t have the right enterprise risk management (ERM) tools or strategies in place to keep them in compliance.
Risk, if engaged in prudently, provides opportunities for financial institutions. A strong risk management system provides insights into what new products and services can offer good profits with a prudent amount of risk, and which ones come with too much risk and shouldn’t be pursued.
Strategic goals need to be considered when designing management incentives. For example, a bank might want to drive more credit card business. But simply providing bonuses for growing credit card accounts doesn’t take into consideration the additional risk such accounts might bring. A better incentive might be a bonus for opening a certain level of new credit card accounts for customers with FICO scores exceeding 675 or some other level.
A good risk management system will objectively indicate where to invest your risk management dollars. The potential loss of private customer data due to an insecure server is much greater than the risk of lost business due to a marketing cutback.
The earlier you can detect risk, the more likely you are to minimize any negative impacts. Risk may originate in one business line before moving into others. The sooner you can identify it, the sooner you can contain it.
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Decentralized risk management systems result in wasted time and money from duplicated efforts. Additionally, a decentralized system may not recognize related risks (e.g., increasing loan losses and credit card delinquencies) that could indicate a larger issue. A strong, centralized, risk management system eliminates silos so departments can build on and leverage each other’s work.
The Federal Reserve Bank of St. Louis found that the community banks that thrived during the Great Recession were the ones with high CAMELS ratings that “practiced forward-looking risk management with an eye toward long-term bank performance.” Those that neglected ERM missed out on good long-term opportunities.
By properly measuring risk, you can properly devote risk management resources to where they will be the most effective and can confidently move forward with prudent business opportunities for your financial institutions.
For more insights into understanding and managing risk, check out CEO Michael Berman’s latest book, The Upside of Risk: Turning Complex Burdens into Strategic Advantages for Financial Institutions.