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“Joined-up thinking” will be necessary in the future of risk management

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Future risk

RiskMinds International saw the successful launch of FutureRiskMinds, where up and coming risk managers share their views on where the risk industry is moving. Karl Michael Hanzl, ICAAP Expert at Erste Group, discusses his thoughts. 

The last decades of risk management were primarily focused on the development of models and methodologies for the appropriate quantification of risk. Merton and Vasicek spearheaded credit risk, Black-Scholes allowed the correct pricing of options for the first time and JP Morgan established the value at risk concept, thus strengthening market risk. In contrast, the recent decade has clearly been driven by regulatory requirements and the ambition of competent authorities to withstand any future financial crisis by making the financial industry more resilient. The regulatory framework introduced a so-called level playing field which now allows a direct comparison of banks and determines unambiguous thresholds for recoveries and resolutions of credit institutions.

The true vulnerability of financial institutions for the next decade [is] slow adaptability and slow response time with its many reconciliation steps.

Even though the full scope of Basel IV is still under discussion, its effect is already far-reaching and will foster the usage of standardized approaches, hence reducing model complexity particularly in those portfolios which exhibited substantial variances in the past. Despite this reduction in complexity, risk management’s inputs remain crucial and will continuously drive the bank’s steering process. Data accuracy as well as timeliness are a prerequisite for proper decision-making. However, the still heterogenous data infrastructure poses a significant constraint to this process and reveals the true vulnerability of financial institutions for the next decade: slow adaptability and slow response time with its many reconciliation steps.

In addition, the low interest rate environment serves as an accelerator and has unveiled not only weaknesses of individual bank’s business models but also revealed which ones are deemed unsustainable. The growing pressure on the income side, without the possibility of lowering the cost base at the same pace, has already started to materialize and triggered a new consolidation wave which will arguably increase the persisting data heterogeneity through mergers and acquisitions even further. Admittedly, the linkage to the future of risk management might not become apparent at first sight. In fact, risk management with the ability to cope with complexity can overcome the challenges stated and must develop further. Firstly, stronger cross-divisional cooperation also beyond the risk area is necessary to broaden the view in fast changing markets. Secondly, closer ties to IT are necessary to define the streamlining of processes and a clean-up of fragmented databases. Bearing this in mind, the decision making-process can run substantially faster and encompass a wider range of feasible options based on most accurate data.

Consequently, the future risk management will not only be very much IT-driven, but also require much joined-up thinking. The future can be bright in the risk community and we should start working on it together.

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The views expressed herein are the views of the author and do not necessarily reflect the opinion of Erste Group Bank AG. The information herein cannot be used to infer any opinion about the future financial position of Erste Group Bank AG.This document does not constitute an offer or invitation to purchase or subscribe for any shares or other securities issued by Erste Group Bank AG or any of its subsidiaries and neither it nor any part of it shall form the basis of or be relied upon in connection with any contract or commitment whatsoever. The information contained herein and this presentation shall not be further disseminated without written consent of the author.

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