RiskCredit RiskCredit risk ranked top concern by financial institutions

Credit risk ranked top concern by financial institutions

Credit risk ranked number one concern, ESG most included in top three

One in five financial institutions said that credit risk is a paramount concern that will only increase in importance over the next two years. According to a report by Deloitte, 62 percent said that credit risk management will become a “very high priority” for their institutions over the next two years.

“Credit had the largest jump individually, of being ranked in the top three, coming out as the number one risk,” says JH Caldwell, global risk advisory leader for the financial services industry at Deloitte. In contrast, only three percent of firms indicated credit as the number one growing risk in 2018.

“It doesn’t mean they don’t think they’re prepared and ready to handle it, but they’re concerned credit will become something that grabs the attention for much of 2021.”

Commercial lending, asset valuation, commercial real estate and unsecured lending were the four leading causes of higher credit risks, says Caldwell.

Financial institutions have been preparing for greater credit risks since the beginning of the pandemic with banks last Spring increasing their bad loan reserves in anticipation of a rise in defaults. However, government support and signs of an economic recovery have reduced the risks of defaults, with some banks releasing reserves.

“When banks made those decisions, we really didn’t have a clear viewpoint as to how the economy would be impacted,” says Caldwell.“Uncertainty is a major factor in trying to lock up your allowances.”

Also highlighted in the report was that firms needed better definition and methodologies for non-financial risks (NFR). Only 44 percent of firms said they have a single individual responsible for NFR oversight. Caldwell says this is because NFRs act as a “wrapper” for many risks like data quality and geopolitics.

“What you’re going to see organisations do is build better mechanisms to mature NFR. It’s difficult to quantify, but many institutions will need to commit more time and effort to develop the methodologies and techniques around determining their appetite for non-financial risk.”

He expects, as NFRs grow, more firms will centralise risk assessment.

“There will be a lieutenant to the chief risk officer (CRO). You’re going to see an owner of NFR, that is going to take all of those sub areas and bring them together and report them up to the CRO.”

The ESG priority

While credit was ranked the number one risk by most firms, more than a third of those surveyed (38 percent) placed ESG risks in their top three. 47 percent of the financial institutions said improving their ability to manage ESG risk was at least a very high priority.

“The reason it’s a big issue is because it covers three massive agendas all at one time, it covers a political agenda, a social agenda and an executive commitment,” says Caldwell.

Managing ESG risks may also start to become a regulatory requirement, with the European Central Bank telling eurozone banks they will begin stress testing for their ability to withstand climate change risks from 2022. Furthermore, the credit rating agency Moody’s said that ESG risks were a material consideration in 33 percent of its rating actions for private sector issuers.

However, the main concern for financial institutions is not only having to be aware of their own ESG commitments but those of their clients too.

“There are third-party ramifications,” says Caldwell. “People they lend to, who they do investment management for, and who they insure. As a result of that, you’re going to see a major concentration on ESG over the coming couple of years.

“It would not surprise me if [ESG] becomes a number one focal point, the next time we do this survey in two years.”

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