“We live 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, interest rates are going up, there’s a lockdown in China due to COVID, there’s war unrest in Eastern Europe and a bunch of other geopolitical factors — all happening at the same time. All of this is unprecedented.”
When faced with such a complex and changing risk landscape, Lavrenko said there are five key risks banks need to focus on today:
Interest rate risk
On June 15, the Federal Reserve raised interest rates by 0.75 percentage points, the third increase this year, aimed at countering the fastest rate of inflation the US has faced in more than 40 years. The June hike was the largest since 1994. Meanwhile, the Bank of Canada raised its interest rate by 50 basis points on June 1, following a steady stream of hikes designed to bring inflation back to target.
According to Lavrenko, the question banks are asking about interest rate risk is: Will the net interest margin they expect to take as a result of rising rates offset the potentially lost revenue from things like mortgage origination, mortgage refinancing, trading income and M&A activity?
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“It will be an interesting test to see what happens to banks’ revenues and net income in this rising interest rate environment,” he commented. “No one has a crystal ball, so it’s a bit difficult to predict what will happen with interest rates. But I think for the banks the risk revolves around disclosure and talking to shareholders.
“Banks need to set their expectations: ‘We expect our mortgage income to decline. We expect our income from refinancing activity to decline, etc. I think banks need to be talking to their shareholders very actively right now, especially from a D&O perspective, and explaining what they expect in terms of yield and what the balance sheet is going to look like as those rates continue to rise. It’s about consistent communication with shareholders.”
While interest rate risk dominates the headlines, Lavrenko believes the biggest exposure facing banks today is cyber risk, whether it comes in the form of an external threat vector penetrating a bank’s security systems or a defrauded employee , or inadvertent release of personal information information. “I think banks still remain, to this day, the biggest target for cybercriminals because of all the financial data they have and of course the money,” he said Insurance business.
Cyber insurers are struggling to “find a balance” amid an increase in the frequency and severity of cyber attacks against banks and financial institutions, according to Lavrenko. He explained: “I’m not sure that insurance companies have found that balance in the sweet spot where they are willing to take out cyber insurance for X premium and are confident that it will compensate them enough to cover cyber claims. This is because the frequency and severity of attacks on banks appear to be continuing to increase.”
Bank executives and directors generally have a “deep understanding” of cyber risk, Lavrenko said, thanks in part to increased regulatory pressure in recent years. The risk lies in whether or not banks are able to protect their institutions by providing adequate insurance limits and having adequate levels of cyber security controls and protections in place.
The third biggest area of concern for banks, according to Lavrenko, is geopolitical risk. He said: “A lot is happening these days in the geopolitical sector and banks need to keep up with technology to keep up with ever-growing requirements for things like Know Your Customer (KYC) and Anti-Money Laundering (AML ) associated risks.
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“Every day something else happens. Sanction lists are growing every day and so banks are working hard to make sure they have adequate internal controls and adequate technology to make sure they comply with all these different laws, rules and regulations when it comes to sanctions, KYC, AML and other geopolitical risks.”
A changing climate can affect default risk and potentially have a negative effect on mortgage-backed securities (MBS) returns and liabilities. Banks issue mortgages, many of which are backed by government entities such as Fannie Mae and Freddie Mac in the US and the Canadian Housing Trust, while others go to private label MBS. The changing climate “definitely could have an impact on the volume” of MBS, Lavrenko stressed.
People take risks
Attracting and retaining talent is a challenge for every business in every sector. Since the start of the COVID-19 pandemic, North America has experienced a “Great Displacement” of the workforce, where people have left their jobs in search of more meaningful work, better compensation and benefits, and more flexible work arrangements.
“Starting with COVID, banks have had to step up when it comes to attracting and retaining talent to keep their employees happy,” Lavrenko said. “People have found that working from home is very convenient, very enjoyable, it’s safer and many employees find themselves more productive. So banks are now learning this new way to satisfy their employees and keep them happy and keep them engaged.”