
By Karim Parra
When it comes to risk management, we need to understand how the adoption of new technologies has allowed financial institutions to face the massive impact of the pandemic, and in the near future can help them to obtain a more stable income stream and also define a set of strategies to absorb unexpected losses capable of making even the most relevant players in the industry disappear.
Surviving the next ‘tsunami’
Before we turn to risk management, it is important to refresh some basic aspects of a bank’s operational cycle (that can also be applied to other financial institutions). It is safe to assume that the profit generated for a bank (lending the money received in the form of deposits) is enough to cover its “expected losses”, those losses that the bank regularly faces because of delinquency in loans and increase in its provisions[1]. When the bank is not able to meet this condition either because the profit was lower than the estimate or because the losses were higher than the average of the preceding few years, the bank is forced to use its capital. The Covid 19 pandemic has had a significant deleterious impact on the quality of loans, since many people have lost the capacity to repay them. This triggers a critical situation for most of the banks around the world, especially since a global pandemic is a very rare event that was out of the scope of any model or forecast.
How can banks be better prepared for unexpected events? The answer to this question is offered by technology—new technologies. In its report “Creating a Digital Treasury in Banking”[2], BCG states that the new allies for banks to optimize the effectiveness of their usage of financial resources are innovative technologies such as Artificial Intelligence and Advance Data Collection. In the next few years, most of the financial institutions around the world will prioritize in their agendas topics such as how to estimate the impact of an unexpected event, also known as “black swans”, how to develop better management of resources that absorbs losses based on an adequate estimation of capital, how to simulate different scenarios including an universe of variables and assumptions able to emulate the complexity of real life, how to correctly measure the potential risk of a client, and how to allocate credit lines with more accuracy based on risk profile schemes.
Facing these challenges is where cutting-edge technologies like Quantum Computing, Prescriptive Security, Machine Learning, RPA (Robotic Process Automation) or even Blockchain can offer a huge transformative impact for their adopters. In the same report[3], BCG mentions that less than 15% of a sample of 44 banks analyzed used advanced digital technologies in central areas as treasury—this figure reveals the entire immense field that these technologies have to conquer.
A promising after Covid-19 era
The Covid 19 pandemic will be remembered as a drastic event that claimed the lives of more than two million people around the world, destroyed hundreds of thousands of jobs around the world, and caused us to rethink our way of life. But, at the same time, this pandemic will be the seed of a transformative process for humanity, with events such as the shortest development period of a vaccine and the beginning of the golden age for electronic commerce—let’s not forget that during this pandemic Amazon became in one of the most valuable companies in the world. In the financial industry this transformative wave will be reflected in a new mentality, with institutions more open to working with smaller and more dynamic companies that will refresh and transform corporate cultures, replacing anachronistic ideas and practices and turning these institutions into agile companies, able to adopt, develop or merge new technologies or products with minimal resistance.
Another factor that will force financial institutions to be more agile and adaptable is the dilution of the limits that once defined a company in this sector; new potential competitors from other industries such as Google, Alibaba, Amazon or Mercado Libre, capable of offering credit lines to acquire products and services will test the ingenuity and ability of many companies to adapt to this new ecosystem. In the end, as Charles Darwin says in his masterpiece[4], “It is not the strongest species that survives, not the most intelligent, but the ones that respond better to change”.
REFERENCES
- BCG, “Creating a Digital Treasury in Banking”. May, 2019. Elgeti, Clemens. Schäfer, Robert. Vogt, Pascal. Broemstrup, Ingmar. Lai, Chi. Granzer, Mireia. Strauch, Tobias.
[1] A provision is the amount of money that the bank reserves to cover a possible drop in payments from clients.
[2] BCG. May 2019
[3] “Creating a Digital Treasury in Banking”. BCG, May 2019
[4] Charles Darwin, “On the origin of species”. November 1859.