Banks have been making sure that economies work well for a long time. But the credit crisis, the global recession, and the Covid-19 pandemic were all big setbacks for the banking industry. By 2025, risk functions in banks are expected to become less predictable. If banks don’t act right away and get ready for these longer-term changes, they will be overwhelmed by new restrictions and needs.
Risk management is becoming the focus of intense regulatory scrutiny and a key component of senior management strategy development and decision-making. Risk management in banks is going through many changes, and the core of these changes is the integration of risk management processes. Integrated risk management is a broad approach to taking risks that includes strong risk identification, dynamic risk assessments, strong control evaluation, key metric definition and monitoring, loss reporting, issue management, and comprehensive risk reporting. It involves making sure the bank’s board is happy with bigger business plans, management skills, capital strength, and a general willingness to take risks.
Banking’s Operational Risk Management
Operational risk is losing money because of mistakes, infringements, disruptions, or damage caused by internal processes, people, outside events, or systems, whether they were made by accident or on purpose. Damages from operational risks can be very bad, not just in terms of money but also in terms of how they affect the bank’s business, which could threaten its ability to stay in business. In the past few years, banks worldwide have been involved in scandals that made headlines because they couldn’t control operational risk.
Even though it’s hard, banks need to do everything they can to control Operational Risks. Operational risks are harder to limit and manage than financial risks because they are more complicated.
Several banks don’t understand, measure, or take care of the interconnected administrative processes, IT systems, and human behaviour that adds to operational risk. They have a hard time putting the cultural, management, and administrative structures needed to keep these risks in check.
Top Banking Operational Risks
Here is a list of some operational risks that are well known in the banking industry:
Losses from fraud in a bank can come from misuse of assets, forgery, bribes, theft, and not paying taxes.
Fraud is done by someone else, like theft, check fraud, breaking system security, stealing data, or hacking.
Banks are becoming increasingly dependent on vendors, which means that they need to find, evaluate, and control vendor risks throughout their relationships with those firms. But banks must also be aware of and evaluate the risks that come with the vendors’ suppliers and contractors.
System failure and business interruption
Software or hardware problems, problems with communications, and power outages can all affect how a bank does business and cause it to lose money.
Even though banks are doing more to protect their IT, cyber threats like phishing and ransomware happen and pose a huge risk to them.
Managing Operational Risk
A robust approach to ORM takes into account four main areas:
Since the worldwide financial crisis, the number of rules that banks have to follow has gone up. Banks that work in more than one territory may have to deal with regulatory systems that conflict or overlap. Errors can be expensive and upsetting, leading to lost customers and punishments from the government. It can be hard to keep up with how quickly and much rules change. When banks keep costs down, they have to put money into people, systems, and processes that help them stay compliant.
Even today, employees and the customers they talk to can do a lot of damage when they don’t do their jobs right, whether on purpose or by accident. Trouble can also be caused by breaking the rules on purpose and illegally, not doing things well, not having enough training or knowledge, or having unclear procedures.
Structure of the company and important processes
Banks can encourage and overlook risky behaviour by giving employees high sales goals and praising them when they reach them. When these kinds of actions are found out, they can lead to losses for shareholders, fines from regulators, and management changes. Also, processes and practices that work well can lead to operational failure.
Systems can be broken into, and information can be changed or taken. Even third-party IT providers face the same risks as banks. Because of this, many banks use cloud-based storage today. Systems can go down, making it impossible for customers to use ATMs. Even the speed at which technology changes is an operational risk. Since the cyber ecosystem is changing so quickly, it could be hard for banks to keep up with new threats.
Methods for banks to handle risk
There are four important steps in how banks handle risks:
Risk identification helps banks figure out where they stand in understanding and controlling operational risks.
This process tries to find, evaluate, and control the operational risks or dangers that a bank faces. It also tells the bank if something bad could hurt their business.
At each stage of risk development, banks must make sure there are good controls in place. The risk journey will work better to find and deal with risks if the controls are put in place as soon as possible.
Regular checks and improvements
Much of how well operational risk management gets better depends on how willing senior management is to be proactive and quick while also addressing operational risk managers’ concerns in the right way.
Key New Trends in Managing Operational Risk
Usually, it’s hard to figure out how to measure operational risk. Simple statistical models have had trouble because they didn’t have enough data. But several banks and other financial institutions have noticed the following important trends:
Operations that are digitized:
The entry of digital fintech companies into the banking industry has changed how traditional banks work because customers prefer to do business easily. Once these risks are known, steps can be taken to make them less likely. There’s no doubt that digitalization can make risks worse for community banks that change. Better risk management for digital banking is the answer to this problem.
How technology has changed the way risk management is done:
Technology is the most important force changing the banking industry. As monolithic players give way to the platform economy, the market becomes more interdependent and linked. This generates opportunities for incumbents, new market entrants, and consumers but raises problems about regulation and responsibility as customer data becomes more valuable.
Regulatory changes affect risk management policies:
For banks to keep their businesses safe from changing rules, their GRC program must stay flexible. They must be able to make changes to their program as new rules come out. They must use broad-spectrum threat intelligence from inside and outside the company to keep the risk management processes on high alert.
Getting rid of a “silos” approach:
Companies are being forced to take a structured approach to GRC because of how hard regulators and the market look at their businesses. The goal is to define, manage, and keep an eye on the business environment. Technology is a key part of ensuring that this GRC process is consistent, long-lasting, transparent, and efficient.
AI and ML innovate business:
Now, both internal and external networks can be examined in more depth. This mostly solves the problem with data that plagues traditional models. But it creates a whole new problem because this data isn’t organized in the usual way. It can be in charts, texts, voice files, images, and other formats. Because of this, businesses need a new set of powerful analytical tools. This is one of the major reasons all banks and financial institutions need to use AI in their risk and compliance processes. AI and ML play a substantial role in operational risk management today.