A View From INSEAD
Navigating Uncertainty: Risk Management Trends for 2018
Professor Jean Dermine
Jean Dermine, Professor of Banking and Finance at INSEAD, Programme Director for both Risk Management in Banking and Strategic Management in Banking programmes, discusses the disruptive issues likely to impact the banking sector in the year ahead and how business leaders should adapt.
The year 2017 has been another challenging one for the banking sector, with economic and political uncertainty complicating the completion of the post-crisis regulatory repair agenda. Do you see 2018 bringing more of the same?
A key issue here relates to the Trump administration’s protectionist approach. Because banking is such a global industry, it is very hard to achieve consensus about anything, but for 40 years, the world’s banks broadly followed a trend of working to harmonise regulation and support the opening up of markets, with a view to spurring free trade. The macroeconomic effects of President Trump’s more protectionist plan mean we’re seeing the reverse of all that, with countries finding it increasingly difficult to agree on a level playing field or common rules.
This is one reason why the Group of Central Bank Governors and Heads of Supervision (GHOS) – which oversees the Basel Committee on Banking Supervision – has struggled with so many delays in finalising reforms to Basel III.
This trend will continue to create uncertainty, and could lead to a Balkanisation of markets, where global and international markets are dismantled and replaced by more national and local mechanisms.
Ultra-low interest rates and Quantitative Easing have become semi-permanent features of the economic environment across the world. Is this another area adding an element of uncertainty?
Yes, because if this approach to monetary policies changes and rates start to rise, what will happen to the value of the stock market and real estate markets? There could be some big shocks in store for investors and the financial sector if prices started to go down. Another potentially disruptive issue is that many countries came out of the global financial crisis with very large public debt. Currently, nobody’s talking too much about that – however, I believe it’s a ticking time bomb of a problem that needs to be solved.
What about the impact of digital disruption?
I prefer the term ‘digital enablement,’ as embracing these technologies creates many new opportunities for banks. Put it this way: institutions that resist digital innovation when it comes to automating processes, creating new products and improving regulatory compliance will find themselves punished by customers and financial markets. However, transformation does require significant financial and human investment.
A related issue is that regulators globally have begun to consider risks arising from new technologies and distribution platforms, and how they should respond. So, banks should continue to expect increasingly detailed expectations for how they should assess and respond to cyber and IT risk, and ensure they have the capabilities to be able to adapt to that.
How are developments in the financial system architecture affecting the banking landscape?
During the financial crisis, governments were induced to bail out failing banks with taxpayers’ money to prevent a systemic crisis. Now, we’re seeing global standard-setting bodies address such issues as ‘too big to fail’ and instigate reforms so that banks can no longer use taxpayers’ money to support them should they collapse. In Europe, for instance, such mechanisms as the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism (SRM) have been put in place to ensure the orderly failure of banks.
The good news is that it seems to be working. When Banco Popular, Spain’s fifth-largest bank, failed earlier this year, Eurozone regulators were able to oversee rescue plans without having to tap taxpayers.
However, all this is having a knock-on effect on the kind of skills and capabilities bankers need to succeed in the post-crisis banking environment. For example, senior leaders are now required to present resolution plans that lay out how their institutions will manage risk and ensure transparency, among other things. So, board members and senior executives of banks really need a sound and comprehensive understanding of such issues as risk governance and how risk categories affect capital allocation and value.
What other skills and capabilities do the banking sector’s senior leaders need to survive in today’s volatile environment?
A danger highlighted by the global financial crisis was that with the focus on revenue generation and a culture that feted ‘star’ bankers, banks had limited in developing and promoting senior executives with broad management experience. Specialised skills were seen as more important. So, I think we need more people at the top who can take a holistic view of the financial landscape and avoid a single-minded search for profits. Linked to this is the need for more strong leadership with the moral authority and courage to say ‘no’ to certain opportunities.
I also think most banks would acknowledge, post-crisis, that a fundamentally different business model is now required – one that is focused on clients rather than products. They have realised that clients and regulators expect them to demonstrate a very different type of leadership if they are to win back trust and respect. Excellent communication skills are a fundamental part of this.
 Finally approved on 7 December 2017
 Lessons from the Collapse of Banco Popular, Gretchen Morgenson, New York Times, 23 June 2017, https://www.nytimes.com/2017/06/23/business/lessons-from-the-collapse-of-banco-popular.html