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With 2019 nearing a close, the big four accounting firm has shared 10 major banking risks that it believes will need managing over the next decade.
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EY flags 10 banking risks to look out for
11 December 2019
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EY and IIF’s 10th annual global bank risk management survey has identified 10 major risks that it says will greatly impact the banking industry over the next 10 years.
“These issues are akin to those that many, both inside and outside the industry, missed or understated prior to the last financial crisis,” EY wrote.
“They are known, crucial issues that banks will need to manage as well as they do now for capital and liquidity. These are not unknown-unknowns.”
The first major risk flagged was the likelihood of banks having to weather a financial downturn.
“Notwithstanding efforts by central banks and policymakers globally, it is a near certainty that the next financial downturn will occur within a few years. Cycles may have been altered through tougher regulation, stronger central banking prudential powers, and more active interest rate management, but economic cycles are inevitable,” EY said.
“A severe economic change may challenge banks… Regulatory stress-testing models suggest that banks can withstand severe economic shocks, but when asked, some banks are less confident about the quality of their playbooks during a severe downturn.
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“They also acknowledge they still have relatively inflexible cost structures. Banks would do well to revisit their playbooks now and make necessary enhancements.”
Operating in an ever-expanding ecosystem was the second major risk highlighted by EY, who noted the financial services sector has “long depended on a complex web of external providers for core and peripheral services”.
“Pressures on banks’ economics — and management decisions to focus on core competencies — have propelled many banks to outsource key activities. Still, the current level of dependence on third parties is only a small fraction of what it will likely be in the future,” the big four added.
“The extended, or rather ‘hyper-connected’, third-party ecosystem looks set to grow, perhaps exponentially, as the industry’s value chain disaggregates.”
The third major risk identified was the need for banks to protect privacy in order to maintain trust.
“Large-scale breaches remain banks’ main concern,” EY said.
“Banks recognise the reputational damage caused every time a firm in any sector has to admit to a major breach and loss of data. The quality and speed of response certainly matter, but a breach is a breach.
“As the industry has seen in numerous instances where the bank did not suffer a breach but rather a third party, the reputational damage can be the same. Customers often blame the bank.”
Similarly, the need to fight a “cyber war” will become a much greater risk to the banking industry, according to EY.
“Without question, cyber risks top CRO and board agendas. Five years ago, in 2014, cyber security did not even make the top 10 priority list for either group. Now it’s by far the most significant risk and has been at the top for three years in a row. No other risk comes close.”
Navigating the “inevitable” industry transition to cloud is the fifth risk management will need to be conscious of, the report found.
“For a variety of reasons, the banking industry is increasingly moving to cloud, but to date only a few banks have gone all-in,” EY said.
“Most have been exposed to cloud through third-party providers supporting enterprise-resource planning, human resource or other such services. This is changing quickly. The benefits are simply too appealing — cost efficiencies, gains in reliability and resilience, the ability to leverage highly sophisticated analytics, and faster software deployment.
“Arguably, if implemented effectively, information and cyber security safeguards are also stronger. These benefits are hard to achieve if banks maintain their own data and backup capabilities.”
The sixth risk identified by EY was a need for management to industrialise data analytics across their business in a controlled manner.
“For several years now, the industry has been excited about the potential of ML and AI. Until recently, the promise has been greater than the reality,” EY noted.
“For sure, banks have been identifying and testing proofs of concept and piloting them. There are ample use cases: anti-money laundering, fraud, conduct surveillance and credit decisions, to name but a few. However, only some of these pilots have moved into full-scale production across banks.”
Delivering services to customers, clients and markets without disruption was the seventh risk highlighted by EY, who noted “the fact that so many factors can precipitate a disruption has brought firm-wide governance of resilience to the fore”.
“At some level, this means the way in which boards of directors oversee and challenge the bank’s resilience strategy and framework. But more practically speaking, it means how management will integrate resilience across the bank. Many of the firms are moving to centralise aspects of resilience.”
Adapting to the effects of fast-shifting geopolitics on banks and their customers was the eighth risk identified, with EY noting banks need to realise they will be more subject to political risks in the future.
“Geopolitical analysis is not simply for those with arcane policy knowledge. Rather, banks have to establish robust capabilities to evaluate political risk and determine potential actions to address identified risks,” EY said.
Addressing the impact of climate change on banks and society was the ninth risk identified by EY, with the big four noting banks are increasingly recognising the importance of this issue.
“Over half (52 per cent) of banks view environmental and climate change matters as a key emerging risk over the next five years, up from just over a third (37 per cent) a year ago,” it said.
“Yet, levels of understanding of the potential impact on banks — for example, on credit defaults or corporate loans — vary significantly from bank to bank and continent to continent.”
Finally, the 10th risk set to impact the banking industry is the need to meet emerging customer demands for “customised, aggregated lifetime offerings”.
“Consumer preferences and buying behaviors for financial products and services are changing. EY NextWave financial services research shows that the average consumer is shifting away from owning and buying, to renting and using,” EY said.
“The impact on banks will likely be a shift from delivering and pricing specific products and services, to delivering and pricing a comprehensive bundle of products, services and value-added capabilities.
“The pricing model may become subscription-based (i.e. in which financial products are bundled, often with non-financial products, and purchased on a per-period subscription basis) versus a flat-fee basis (i.e. in which financial products are purchased on a per transaction or activity basis).
“This shift to a new model for meeting consumer needs will affect how banks operate and call for new approaches to managing inherent risks.”
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