Revamping risk management to manage the ‘new normal’

There is a popular adage which states that “any kind of crisis is good – it wakes you up.” The 2008 global financial crisis shook the financial sector and woke up the regulators to put in place multiple measures to ensure resiliency of the financial sector.

The current economic crisis driven by the COVID-19 pandemic has shocked the financial sector in a different way. The current crisis has altered the business landscape, and organizations are learning firsthand whether the risk management strategies they put in place are working or not.

To date, the banking sector has deployed traditional risk management strategies that are more passive in nature, and are not proactive or forward-looking. The onslaught from the pandemic has turned the focus to revamping traditional risk management strategies, which will require more than few changes to achieve the desired objectives.

Listed below are some of the key practices that organizations will need to implement in their risk strategies  to contain and manage the risks in the “new normal.”

• Proactive risk management: Organizations will need to formulate a proactive approach to risk management, one that is driven by strong board leadership, has active threat surveillance, dynamic response mechanism and continuity plans.

• Non-financial risk: Non-financial risk is a mixed bag of risks that fall outside the purview of financial risk managers, so firms will need to adopt a comprehensive perspective to handle such risks. The global pandemic is bringing back focus on an array of non-financial risks, such as cybersecurity, vendor risk, conduct risk, etc. Although firms have managed these risks in a limited capacity for some time, the ongoing pandemic now necessitates a more integrated and focused response.

• Enterprise risk management: Traditional risk management is departmentalized and tends to not provide a holistic view toward managing risk and decision-making. An enterprise-wide risk management approach extends traditional risk management practices and works in an integrated manner by providing a holistic view aiding in strategic decision-making. An effective ERM will help an organization create agile responses toward pandemics like COVID-19, and it will also enable that organization to formulate timely strategies and seize business opportunities that otherwise may be missed. COVID-19 has put the focus on ERM, but the business benefits of this approach extend far beyond the current crisis.

• Climate risk management: The pandemic has necessitated more focus toward actively managing climate risk. The focus on climate risk emerged during the 2015 Paris agreement, but since then, the business involvement in advocating for preparedness against climate risk has been very limited. In the ongoing COVID-19 scenario, many scientists are also talking about ancient viruses that can be activated through melting glaciers and can put us in greater peril than what we are witnessing today. Thus, climate risk is gaining more prominence and organizations will have to jointly work towards transitioning to a low carbon economy and actively managing climate risk.

• Robust risk modeling: The current pandemic requires recalibration of existing risk models for better estimation of risk parameters. Credit models, for instance, are currently buckling under the strain of COVID-19, and thus are losing their predictive capabilities given the unique nature of crisis and the added difficulty in quantifying the losses. The New Normal will require a combined effort from all banks and regulatory bodies to come up with a more robust methodology and approach for combating such scenarios in the future.

• Stress test strengthening: From a longer-term perspective, banks will need to further strengthen their existing stress test scenarios and also tweak their credit models by including impacts of pandemic risks like COVID – 19 so they are well-positioned to absorb losses arising out of pandemic, along with continuing their regular business activities.

As the complexity and uncertainty increases, so too does the associated risk and the difficulties in risk identification and management. In these trying times, organizations across the globe will need to adopt dynamic risk management strategies with the aid of agile and intelligent technologies that will act as potent tools and enable them to gain access to required insights for strategic and informed decision-making during any challenging scenario.

Ajay Katara is a consultant in banking risk management at Tata Consultancy Services.