Volatile is one word to describe the risk landscape for banks as inflation in the US and Canada rises to an almost 40-year high – but that’s not the only challenge for bank executives and directors to contend with.
“We’re living in very unprecedented times,” said Anton Lavrenko, North American head of financial institutions at Allianz Global Corporate & Specialty (AGCS). “We’re still coming out of the COVID-19 pandemic, the interest rates are going up, there’s a lockdown in China due to COVID, there’s military unrest in Eastern Europe and a bunch of other geopolitical factors - and it’s all happening at the same time. It’s all unprecedented.”
When faced with such a complex and shifting risk landscape, Lavrenko said there are five key risks that banks should focus on today:
Interest rate risk
On June 15, the Federal Reserve raised interest rates by 0.75 percentage points, the third hike this year aimed at countering the fastest pace of inflation the US has faced in over 40 years. The June hike was the largest since 1994. Meanwhile, the Bank of Canada increased its policy interest rate by 50 basis points on June 1, following a steady stream of hikes intended to return inflation to target.
According to Lavrenko, the question the banks are asking with regards to interest rate risk is: Will the net interest margin growth that they expect to assume as a result of the rising rates offset the potentially lost income from things like mortgage origination, mortgage refinancing, trading revenue and M&A activity?
“This is going to be an interesting test to see what’s going to happen with banks’ revenues and net income in this rising interest rate environment,” he commented. “Nobody has a crystal ball, so it’s a little difficult to predict what’s going to happen with the interest rates. But I think for banks, the risk revolves around disclosures and conversing with shareholders.
“Banks need to set expectations: ‘We expect our income for mortgage origination to drop. We expect our revenue from refinancing activity to drop etc.’ I think right now the banks should be talking to their shareholders very actively, especially from the D&O perspective, and explaining what they expect in terms of profitability and what the balance sheet is going to look like as these rates are going to continue to rise. It’s about consistent communication with shareholders.”
While interest rate risk is dominating the headlines, Lavrenko believes the biggest exposure banks face today is cyber risk, whether that comes in the form of an external threat vector penetrating a bank’s security systems, or a rogue employee, or the inadvertent release of personally identifiable information. “I think banks still remain, to this day, the largest target for cyber criminals because of all the financial data they have, and of course, the money,” he told Insurance Business.
Cyber insurers are struggling to “find equilibrium” amid the increase in frequency and severity of cyberattacks against banks and financial institutions, according to Lavrenko. He explained: “I’m not sure that insurance companies have found that sweet spot equilibrium where they’re willing to write cyber insurance for X premium, and they’re confident it will compensate them enough to cover cyber claims. That’s because the frequency and severity of attacks on banks seems to be continuing to creep up.”
Executives and directors at banks generally have “a deep understanding” of cyber risk, Lavrenko said, thanks partly to heightened regulatory pressure in recent years. The risk lies in whether or not banks are able to safeguard their institutions by securing adequate insurance limits and having adequate levels of cyber security controls and defenses.
The third largest area of concern for banks, according to Lavrenko, is geopolitical risk. He said: “A lot is happening these days in the geopolitical sector, and the banks need to keep up with technology to stay in compliance with the ever growing requirements for things like Know Your Customer (KYC) and anti-money laundering (AML) related risks.
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“Every day, there’s something else happening. The sanction lists are growing day by day, and so the banks are working hard to make sure they have adequate internal controls and adequate technology to make sure they’re compliant with all these different laws, rules and regulations as it comes to sanctions, KYC, AML and other geopolitical risks.”
A changing climate can affect default risk and potentially have a negative effect on putbacks and liabilities under mortgage-backed securities (MBS). Banks originate mortgages, many of which are supported by government entities like Fannie Mae and Freddie Mac in the US and the Canada Housing Trust, while others go to private label MBS. A changing climate “can definitely have an impact on the volume” of MBS, Lavrenko emphasized.
Talent attraction and retention are challenging for every business in every sector. Since the onset of the COVID-19 pandemic, North America has experienced a ‘Great Reshuffle’ in the labor force, where people have quit their jobs in search of more meaningful employment, better compensation and benefits, and more flexible working arrangements.
“Starting with COVID, banks had to step it up when it comes to talent attraction and retention to keep their employees happy,” said Lavrenko. “People discovered that working from home is very convenient, very pleasant, it’s safer, and a lot of the employees are finding themselves to be more productive. So, the banks are currently learning this new way of satisfying their employees and keeping them happy and keeping them employed.”