The future of risk in Financial Services  

Rethinking the Three-Line Defence

As financial institutions seek strategies to reduce risk management costs without impairing effectiveness, those that embrace the next generation of technology and analytics will be able to not only automate existing risk management activities but also build in controls and monitoring in a new structure optimised around data and analytics.

In the years since the financial crisis,financial institutions have faced a tsunami of regulatory requirements. New regulations have driven up compliance costs, while increased capital and liquidity requirements have reduced returns. These additional regulations have come in a period of varying economic growth, historically low interest rates, and uneven revenue opportunities, which have further reduced returns on equity and led institutions to seek to reduce operating costs including risk management costs.

Today, risk management is at a crossroads. Financial institutions need to decide if they will continue with business as usual or instead fundamentally rethink their approach to risk management. To date, most institutions have responded piecemeal to new regulatory requirements, resulting in a disjointed and inefficient structure. Activities often take place in silos, making it difficult or impossible to gain a comprehensive view of risk management across the organisation, while increasing cost and complexity. 

The future of risk in financial services

As institutions consider how to enhance their ability to manage risk, they will benefit by considering the following six imperatives:

  1. Increase focus on strategic risks like geopolitical, FinTech and other non-traditional competitors; and improve identification and management of these risks.
  2. Rethink the three lines of defense by enhancing business unit responsibility for managing risks and clarifying second line of defense activities.
  3. Leverage emergent technologies to increase efficiency and effectiveness of risk management. 
  4. Establish a formal conduct and culture program to build customer trust and gain a clear strategic advantage.
  5. Enhance risk management capabilities to build a more nimble infrastructure able to address newer nonfinancial risks as well as the challenges of regulatory fragmentation.
  6. Manage capital and liquidity strategically by enhancing governance structures and decision-making processes.

Increase focus on strategic risk

Institutions are entering a period of substantially greater strategic risk from a number of sources.

  • Geopolitical risk has increased with the Brexit vote in the United Kingdom, the potential that populist parties in other EU countries may gain power and seek to withdraw from the European Union, and uncertainty over whether the Trump Administration will seek to renegotiate trade agreements and other alliances.
  • The direction of regulation is more uncertain given recent developments in Europe and the United States. In the post-crisis environment, country regulators have also increasingly moved to protect their own national interests resulting in regulatory fragmentation due to increasingly divergent regulations which increases the complexity and costs for global financial institutions.
  • FinTech startups, which leverage technology capabilities to compete with traditional financial institutions, threaten to disrupt the industry in areas such as loans, payment products, wealth management, and property and casualty insurance. In addition, there is increased competition between banks and nonbanks, for example in areas where nonbanks “own” the customer relationship and can leverage this relationship to provide an integrated customer financial experience. 

At the same time, the ongoing varying growth, low-interest rate economic environment is putting pressure on traditional sources of profitability. Financial institutions are increasingly searching for new avenues for growth, developing increasingly customer-centric service strategies including leveraging new technologies to provide a more targeted and pervasive customer experience. While failing to innovate in this environment may place financial institutions at a competitive disadvantage, pursuing innovation without aligning business strategies with sound risk management capabilities may also heighten strategic risks.

In addition to having integrated strategic thinking and risk awareness, regulators expect institutions to have formalised processes to assess strategic risks to the business model stemming from technology and other changes in the external environment, as well as from their strategic choices.

Read the report to better prepare for what lies ahead in risk management. Please contact a Deloitte executive if you’d like to discuss the report, or learn how we can assess your current risk management strategy and recommend best practices to position you for success.

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