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Portfolio Risk

4 Unpredictable Financial Risks You Can Prepare For

Cynthia Roy
May 24, 2021

In banking, there is, of course, always uncertainty and there are always unknowns. The current economic climate is no exception, and there are many reasons to make a special effort now to be proactive regarding financial risk. It’s time to reduce the worry by preparing for variables that might send surprises your way.

As with most uncertainty today, the biggest unknowns surround recovery from the pandemic. We hope that COVID-19 is on the wane with vaccinations, we see signs of recovery with various states reopening, but we also see new contagious variants of the virus that could cause some lengthening of economic woes. Even if we assume that the pandemic is quickly receding, many uncertainties remain for banks and credit unions:

1. What’s next for commercial real estate? It’s hard to predict the need for business offices when it isn’t clear how many employees will be returning from remote work. And will in-person retail shopping bounce back to where it was pre-pandemic?

Strategy: Diversifying your loan portfolio into other markets is key and can even help you discover underserved markets. Technology can help you adopt a proactive, strategic approach to portfolio management, enhancing portfolio performance, and minimizing risk.


2. What will happen regarding loan repayment and demand? While temporary forbearance and relief from the Paycheck Protection Program (PPP) have certainly provided relief for borrowers, credit risk will continue to be a central concern over the next 12 months or more.

Strategy: Banks and credit unions need to stay close to their borrowers, working through loan repayments, forgiveness, and forbearance. Technology to easily model the worst, best, or most likely impacts across your entire portfolio is crucial to risk management.


3. What will happen if deposits stay at their current elevated levels? How long these deposits stay on a balance sheet is a critical component of Asset Liability Management (ALM), since it impacts key metrics including capital, earnings, and liquidity.

Strategy: Banks and credit unions should focus on stress testing surge deposits that end up on the balance sheet. Those deposits could become hot money, resulting in an abnormal departure from the bank or credit union. Model risk management solutions provide the valuable insights necessary to understand both the potential risk associated with the observed high deposit balances now and the ensuing decrease in deposits as the economy reopens.


4. Can the current low rate environment be sustained indefinitely? After a decade of low rates, banks and credit unions continue to have significant interest rate risk exposure to low rates and downward rate shocks.

Strategy: Consider best practices like analyzing depositor sensitivity to rate changes annually, focus on growing your net interest margin, and develop non-interest income strategies to diversify sources of revenue. The key is to grow baseline income to a level that can absorb adverse scenarios.

Mitigating Unpredictable Risk with Data and Collaboration

The best way to prepare for financial resilience is to get control of your data – know what data is available and how much trust can be applied to it. It’s likely that the information you need is scattered across different sources. Technology to merge and evaluate this data is critical, and that is what enables better decisions and flexible pricing strategies.

Your data technology provider should offer an integrated management framework and automated tools with built-in risk mitigation. These tools can accomplish tasks such as capturing important data, verifying that required data elements are available and accessible, tracking and comparing what-if scenarios, and analyzing and forecasting market and credit risk.

In addition, it’s helpful if your tools can stress test:

  • Impacts on liquidity
  • Lingering cash flow effects from pandemic forbearance
  • Increases in interest rates as the economy starts to open up
  • The effect on capital as CECL is taken into consideration

The strategies I’ve covered here, along with data evaluation, can go a long way toward taming uncertainties and reducing unpredictable risks.


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