Risk management in banking industry today

Dhaka,  Tue,  22 August 2017
Published : 17 May 2017, 19:32:45

Risk management in banking industry today

Shah Md Ahsan Habib
The banking industry is changing very rapidly and becoming very challenging than ever before in response to technology infusion, globalisation process, rising competition, and growing financial crime. As a whole, several risks have come up in the forefront and to deal with such an environment, banks need human resources with well-developed leadership abilities. It is well recognised that policies and procedures for forecasting, assessing and managing risk are important.  But if the boards and top management of banks do not seek out a diversity of opinions and perspectives and if they do not act with integrity, these policies and strategies shall not make any difference. In the absence of due leadership, the blame for the damaging consequences rests on different key stakeholders of banks. This article briefly addresses the nature and importance of bank leadership in addressing risks associated with banking services. 

In regard to top leadership of banks, it is about a team, i.e., leadership network. This network can effectively guide banks to the right direction for effective risk management. 'Leadership Network' combines a bank's board and top management that may take its entity to a desired performance level by sustained operation. For sustained operation, the network is expected to ensure a combination of realistic policy and enforceable strategy to attain a set of rational long-term objectives. Generally, only a short-term goal is never expected from a responsible leadership network, rather it should formulate a set of long-term targets covering financial and social issues. Short-term targets may be segregated based on long-term goals.  Board and the top management must consider the interests of all stakeholders that mainly cover a balance of the wellbeing of shareholders, depositors, employees, borrowers, and common people of society in formulating the strategies of the banks. It is crucial to balance short-term financial and operational needs of the organisation with the longer term strategic opportunities. Leadership integrates vision, creativity and innovation necessary for long-term success with the operational focus and understanding that is the key for stability. 

Fixing profit targets are amongst the expected behaviours of banks that are related to the future expansion of the businesses by the banks and shareholders' expected returns on their investments. Identifying profit goals help direct the bank management its actions and strategies to reach targets. Banks are usually ambitious in determining profit targets. Banks and financial institutions generally set these at levels that exceed both current returns and analysts' expectations and are at least as high as those achieved over recent years. Some recent global evidences reveal that sometimes boards of banks and financial institutions are extremely irrational in shaping their future goals and profit targets, and in most cases these are short run marks. 

In determining profit expectations and returns, it is very important for a bank and financial institutions to be rational, because the target follows strategies to attain the goal that are directly related to the risk-taking activities by the banks. It is evident that lofty expectations for future profitability by banks' boards and top managements offer incentives to the managers and credit executives to be aggressive and to involve in over-risky activities.  On the reverse side, boards and top managements may restrain themselves in certain times in determining profit targets as part of their risk management strategy to ensure that the bankers do not have incentives to engage in overly risky activities. 

Irrational profit target is expected to affect directly the most crucial and critical banking activity, that is, granting of any form of loans or credits, the most common source of risks the banks are exposed to. Higher profit target by a bank means higher lending targets for all credit executives and managers, greater probability of compromising with the borrower selection process by the credit officers, and higher likelihood of loan losses. Guiding banks through prudential regulations and offering right risk environment are crucial because risk-taking is the main source of economic return for banks. If banks fail to perform in risk management, they would have little ability to earn profits and their role in mobilising savings and facilitating investment would decline. 

Understanding of the key services by the leadership network of banks is crucial for effective risk management in banks. The leadership should also have thoughtful insight regarding overall fund management of banks covering asset, liability, liquidity, and capital management. Unfortunately, many top executives and board directors may not understand the economics behind many of their financial services and products. But effective leaders understand, investigate, and analyse how their financial products and services were designed.  If underlying assumptions supporting any financial product is wrong, or if they do not understand them, they should chose not to offer them. Lack of understanding and thoughts on banking products and asset-liability management issues is a key barrier in offering right kind of policy and strategic directions by the boards in the context of global economy. 

True leadership targets the risks that may disrupt the strategic assumption and condition of a bank. In particular, concerned committees of a board, chief executive and senior management must make strategic decisions and create organisational context which can lead to long-term organisational success. From this perspective, the senior managers and the top management team are important strategic resources for the organisation. Unlike operational and compliance risk, strategic risk is not inherently desirable. Target of the strategic risk in not really prevention, it is about understanding. Leaders must make plan how to respond to the changes as part of the strategic risk management. Strategic risks are clearly connected with future potential of the profits of banks. Integration of stakeholders, who are responsible for formulating and enforcing strategies and risk management, is particularly crucial to address strategic risks. Effective strategic leadership, and the responsibility for strategic thinking and decision-making, rests at the top of the organization, i.e., on the leadership network. 

Creating right culture is a much needed role of leadership for operative risk management. A strong risk management culture can only be created when the board of directors is not hesitant to challenge management and is involved in facilitating this culture throughout the organisation. Working closely with risk committees, the board must move towards a more tactical and anticipatory approach in helping to identify and mitigate organisational risk.  Particularly, a board's responsibility for risk management begins at a point where it insists that the management create and maintain a strong risk management culture throughout the company. Without a strong risk management culture, no amount of investment in risk information, risk analytics, risk compliance systems will protect a bank from potential disaster. A strong risk management culture displays the values, behaviour and capabilities that are necessary for effective risk management. Having the right people in the right spots, operating under an appropriately risk-based culture might yield a strong institution for tomorrow. The responsibility to change that culture falls on a bank's leadership, but the right leaders must be in place to effect such a change.

Dr. Shah Md Ahsan Habib  is Professor and Director Training, Bangladesh Institute of Bank Management (BIBM).


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