Financial Institutions

7 Crucial Issues Facing the Finance Sector

Reputational and Credit Risks are keen in banking, but those are not the only risks bedeviling the sector.
By: | June 22, 2018

From a reputational perspective, the financial sector may have risk management needs that are more pressing than those in any other sector. At Wells Fargo, employee incentives and actions appear to have been diametrically opposed to the best interests of customers. That bank has paid millions in fines and settlement agreements with customers. For a populace still smarting from the financial crisis of 2008, the actions of Wells Fargo aren’t helping the reputations of banks.

Banks must also contend with political volatility that could lead to dire consequences for lenders. Political turmoil in Italy, the European Union’s largest debtor nation, has already sent shock waves through markets and could end up doing much worse. Italy, the third largest economy in Europe, has $2.5 trillion in debt outstanding, according to the Economist. These credit and reputation risks take a prominent place in our list of 7 crucial issues that are facing the financial services sector.

1) Failure to Engage Customers

Investors who put money into a CD or a savings account expect a return in the form of accrued interest.

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But it’s been a long time since money market accounts and certificates of deposit offered anywhere near the return that they did prior to 2008. As the Fed continues to raise interest rates, thoughtful investors have to be asking themselves why their bank isn’t offering them a better rate of return. This raises the risk that investors will increasingly choose other investment options, including online banking, over depositing in brick-and-mortar savings and loan institutions.

2) The Human Element of Cyber Risk

Efforts are underway to do more to make bank employees a more vital part of bank cyber defenses. Breaking down silos between human resources, the chief information security officer, the CFO and operations management will be key to create a more coordinated effort to better train bank employees in detecting phishing and spear-phishing scams.

Optimists say banking employees are naturally compliance-oriented and will do well at this sort of training. Others worry that cyber criminals continue to find new ways to innovate and will always stay one step ahead of the corporate sector.

3) Operational Risk

Operational risk is the risk that can turn into a reputational risk for a financial institution in the span of one news cycle.

Any breakdown in internal processes, whether it be compliance, risk management’s oversight of trades and investing, or the failure of a bank’s investment models falls under this umbrella. In recent months there has been a consistent message emanating from the banking industry that it cannot find enough risk management talent. Some news stories say the shortage is so severe that banks are running a rising risk of compliance failures.

4) Technology Risk

As we see in the commercial insurance business, mergers and acquisitions can result in the combination or inheritance of outdated information technology systems.

The cost of getting legacy technology systems from different organizations to function together can be prohibitive. A lack of coordinated information technology systems can create a host of worries, including the fact that a cyber attack could go undetected for months due to poor management visibility into information technology functions.

5) Reputational Risk

Hundreds of thousands of false accounts created for customers, selling people unnecessary car insurance and on and on. Skeptics and critics wondered whether executives at Wells Fargo should not simply lose their jobs and their bonuses but also be sent to jail instead. Banking has a bad case of the reputational-risk flu and continued outsized salaries and bonuses for bank executives, coupled with meager interest rates being offered to depositors don’t promise an effective or timely cure.

 

6) Credit and Investment Risk

Yes, it’s an interconnected global economy and 2008 taught us how a risk management failure in one part of the economy (in that case, poor decision-making around investing in collateralized debt obligations) can lead to global economic turmoil.

History does repeat itself, but there are indications that the next trigger that results in credit losses may come from political instability. It could be political developments in Italy, the largest debtor nation in Europe, or it could be conflict in the Middle East.

Either way, whether banks have sufficiently girded themselves against these risks won’t be known until the waters of turmoil recede.

7) Regulatory Pressure Forces Talent Out

“Traditional” banking is subject to so much regulation that the pressure to comply with it may force financial services talent out of an established institution toward, for example, a fintech start-up.

Take this risk in conjunction with the above risk that banks are failing to engage customers and it doesn’t take too much effort to imagine droves of customers and employees deserting banks in coming years. &

Sources include The Economist, Willis Towers Watson and CFC Underwriters.

Dan Reynolds is editor-in-chief of Risk & Insurance. He can be reached at [email protected]

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The R&I Editorial Team can be reached at [email protected]