The Evolution of Risk Management: Is Your Culture Keeping Up?

Over the last several years, financial institutions have faced an incredibly volatile economy. According to the FDIC’s 2024 Risk Review, “market risks posed challenges for the banking industry in 2023 with higher interest rates, an inverted yield curve, declining deposits, higher cost of funding, and compressing net interest margins for some banks.”

The importance of strong risk management became especially apparent last year when Silicon Valley Bank saw $42 billion in deposits leave on a single day. This crisis demonstrated how quickly risks can materialize and escalate, which means adapting and responding quickly is crucial. A bank’s ability to do this is largely dictated by its risk culture. Risk culture is defined as an “institution's norms and attitudes related to risk awareness, risk taking, and risk management,” according to PwC.

Having a strong risk culture has always been important in the banking industry but today, it’s evolved into a competitive advantage. Financial institutions that embrace this concept will be more equipped to capture unrealized market share without taking on excessive risk.

There are three core pillars to a strong risk management culture:

1. Accountability Starts (But Doesn’t Stop) at the Top.

Every employee within a financial institution is responsible for mitigating risk in some capacity – from bank tellers to the chief risk officer. Each function will have distinct processes for identifying and managing risk, but it’s important that every team member and department understands its role in curbing risk for the bank.

To do this, employees must first understand what the bank’s risk appetite is, as well as its goals. In other words, what risks will the bank tolerate in order to achieve its growth objectives? Risk comes in many different types – from credit risks and interest rate risks to operational and cyber risks. Not to mention, some institutions may be willing to take on different levels of risk in certain areas, depending on their balance sheet strength, liquidity position and portfolio concentrations, among other factors.

To establish and maintain a strong risk culture, bank leaders must define and clearly communicate the institution’s risk appetite as it relates to its strategic objectives. This ensures that business processes are defined in accordance with the bank’s policies and goals, and lays the foundation for strong governance to enforce those processes and procedures.

2. What Gets Measured (Regularly) Gets Managed.

Small issues can escalate into major problems when institutions fail to monitor how changing economic conditions alter the risk contained within their portfolio. The trouble is that most risk management frameworks are not revisited on a frequent basis because many financial institutions struggle to proactively monitor portfolio performance, waiting until red flags arise instead.

Given how quickly risks can evolve, banks must prioritize regular risk reporting to gain clear visibility into trends impacting their portfolio.

For example, tracking credit score distribution enables a bank to spot trends and patterns in creditworthiness. This can help with assessing the effectiveness of risk analysis tools, comparing credit risk profiles of different industries, identifying high-risk individuals or businesses and ultimately, making informed lending decisions. This gives bankers enough foresight to make exposure adjustments, set updated concentration limits, and take other remedial measures as needed.

3. Identify (and Break Down) the Bottlenecks. 

It’s common for many community financial institutions to track loan requests, documents, exceptions and more through disparate systems and spreadsheets. This limits a bank’s ability to gain a robust view of the client or credit and how it impacts the portfolio. Not only that, it leaves room for human error. What happens if a loan document is missing or data is entered incorrectly? What about collateral requirements? Have those been applied according to the deal type?

When these processes and policies are handled and enforced manually, inefficiencies abound and at worst, mistakes could be made. Technology that embeds risk management into a financial institution’s workflows can help ensure every function and transaction is managed according to the bank’s risk tolerance and defined credit policies. In addition to slower turnaround and decision times, manual processes leave this up to chance, which opens the door for added risk.

In today’s economic climate, risk can be tricky to manage, especially when banks rely on manual processes and stale reports. The nature of risk has evolved dramatically in the last decade and the banks that adapt their risk culture and risk mitigation strategies accordingly will be positioned for more profitable growth in the years ahead.

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Author Bio

Baker Hill empowers progressive financial institutions to increase revenue, reduce risk, and drive more profitable relationships.

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