Technology and crime shoot up the risk charts

The latest ‘Banana skins’ report on bank risk from the Centre for the Study of Financial Innovation and PwC highlights growing back-office concerns.  George Littlejohn MCSI looks at the findings

The biennial Banking Banana Skins survey from Centre for the Study of Financial Innovation (CSFI) puts regulation and political interference at the top of the list of 28 possible risks to banks.  The poll is based on responses from more than 650 bankers, banking regulators and close observers of the banking industry in 59 countries.

A key conclusion is that the heavy volume of new banking regulation since the global financial crisis and the accompanying political backlash against banks could damage the banking industry and hold back the global economic recovery.

A fast-rising risk in the Banana Skins pantheon is technology risk, which has shot from No. 18 to No. 4 since the last survey in 2012, largely on the back of strengthening concern about cybercrime.  This is a problem which, as one respondent said “can only get bigger” and cost banks heavily both financially and reputationally.  Technology concerns also centre on back office systems which are seen to be ageing but also a low priority for investment.

A breakdown of responses shows that all major respondent types (bankers, observers and risk managers) are strongly concerned about regulatory excess and political interference, as well as the state of the global economy. However non-bankers are more worried about institutional risks in banks such as the quality of governance and management; bankers play these risks down.

“Although there are encouraging signs in this survey, the strength of concern about regulatory overkill needs to be taken very seriously.   It would be ironic if new banking rules ended up snuffing out the recovery”, said David Lascelles, the survey’s editor.

Dominic Nixon, Global Financial Services Risk Leader at PwC, which sponsors the survey, explained: “While some viewed the growth of regulation as necessary, the majority felt it had gone too far and presents banks with unnecessary costs and produces unintended consequences.  Onerous regulation could slow profitability and innovation- during a time when the banks’ contribution to the global economic recovery is most needed.” 

The fragile economic environment

This year’s survey reveals considerable uncertainty about the strength of the economic recovery because of the heavy debt overhang in both the private and public sectors, and the persistence of severe sovereign debt problems in a number of countries. The EU and emerging markets were singled out as potentially problematic. This risk is closely linked to interest rate risk (No. 12) where the prospect is for higher financing costs as central banks phase out their quantitative easing programmes. One respondent said that borrowers “are woefully unprepared for a ‘normal’ rate environment”.

Another strong concern in this area is bank profitability (No. 5) both in the short term because of the legacy of bad debts, many still not fully recognised, and in the longer term as banks adjust to the costly structural and regulatory changes that have been imposed on them in the last two to three years. Although concern about credit risk has receded from the high position it occupied during the crisis (down from No. 2 to No. 7), respondents stressed that debt levels remain high in all the major categories, and could easily get worse if the economic recovery falters or interest rates rise sharply. There is also concern that bankers may be pushed to misprice risk (No. 6) by the pressures of competition and an abundance of central bank-provided liquidity.

Liquidity risk is one of the big movers in this survey, falling from position No. 3 in 2012 to No. 15 in this survey. One respondent said: “I can't imagine the central banks are going to stop giving liquidity assistance any time soon, including to technically insolvent banks...” There has also been a decline in concern about the banks’ ability to raise fresh capital to meet higher regulatory requirements (down from No. 4 to No. 10), though this adjustment is also being achieved by deleveraging, which has implications for the availability of credit more widely.

The institutional risks in banks show a generally easing trend. The quality of corporate governance continues to be the strongest concern at No. 8, driven by perceptions that boards do not have a sufficient understanding of modern banking practices, and give strong executives too much rein. The quality of risk management (No. 11) is a particular concern, though it is recognised that this is an area where much work has been done to raise standards. Both of these risks were a greater worry to non-bankers than to bankers. Concern about management incentives is also easing (No. 21). A rising issue in this area is the quality of sales and business practices (up from No. 20 to No. 16), driven by the recent revelations of abuse in LIBOR setting and other markets. Interestingly, however, concerns about banking ethics and reputation rank low (social sustainability at No. 25), though not for very inspiring reasons: many respondents said that banks’ reputations could hardly sink lower.

Trouble in the back office

Chief among the rising risks this year is technology risk (up from No. 18 to No. 4) because of growing concerns about the vulnerability of outdated systems to cybercrime and outages, and the low priority assigned to this risk by managements. This is a new development: technology risk has historically been seen as low order.

Another strong riser is criminality (up from No. 24 to No. 9) on the back of growing concern about cybercrime (hacking, identity theft and phishing) where banks have become the criminals’ main targets and where the opportunities are expanding all the time.

Concern about emerging markets is also on the rise (up from No. 22 to No. 17) because of the growing risk of economic slowdown and financial instability, particularly in China.

Among the low ranking risks, a number are worthy of mention. Derivatives (down from No. 8 to No. 18) are no longer seen as the threat they once were thanks to tighter management and regulatory controls. Social media (appearing for the first time this year at No. 19) reflected low, though guarded, concern about the potential impact of Twitter, Facebook etc. on bank business and reputations. Shadow banking (No. 20) is now seen more as a potential than an actual threat, depending on how much business is driven from the regulated to the unregulated sector by the tide of new regulatory controls.

Banking Banana Skins 2014 is available (£25, $45, €35) from | +44 20 7621 1056 |

Published: 07 May 2014
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