Risk Management in the Era of Digital Banking

Risk Management in Era of Digital Banking

Most banks have already integrated digital in recent years. The banking sector has even pioneered online services. Only, since the digital revolution, new entrants have intruded into financial era and give to traditional banks a hefty shove. Also, the consumption patterns of customers have evolved, and their service requirements are in constant development.

All these elements, united together, make the role of banks, their products and the very profession of banker destabilized and challenged. This work locates challenges and raises fundamental issues in risk management for Bank’s digital transformation.

Introduction

Lot of traditional users think new technologies will completely disrupt traditional financial institutions, allowing entrepreneurs to access banking business. These innovations in financial services, known as financial technologies(fintech) generate a great deal of enthusiasm. The number of searches for the term” fintech” in Goggle has increased more than 30 times over the last years.

Thus, they have the potential to transform a wide range of services within the financial systems. And that’s good thing, because there are big gaps in efficiency that can be fixed. Also, while some technologies may seem revolutionary, their overall effect on the financial system is considered “evolutionary”. All those challenges give the financial institution that adapt a chance to survive, because more and more new providers will integrate into financial ecosystem.

Furthermore, we find that large, well-capitalized companies outside the financial space, such as Apple and Google, are beginning to offer financial services. One of main advantages of traditional institution is the trusting relationship they have built with their clients. The technology giants also have a large customer base and loyalty to their brand, which could facilitate the adoption of the of the services they offer.

These companies use the information they have about their existing platforms to offers attractive services at competitive prices and thereby attract established customers to the most profitable business sectors of financial institutions.

The 4th industrial revolution

Digitalization in the manufacturing industry

Digitalization is “the conversation of the text, pictures or sound into a digital form that can be processed by computer” Nowadays, the digitalization is leading industry to a “Fourth Industrial Revolution” with offering to businesses considerable opportunities of development, especially, with the increasing number of internet of Things devices billion connected devices by 2020 according to Granter, 2017). Thus “industry 4.0” is one of the most important concepts that lead each enterprise to stay competitive becoming a real digital actress in the industrial era (PWC,2016).

Industry 4.0 is defined as the use of automation, big data, cyber-physical systems CPS Internet of things and cloud, to construct an intelligent factory that allows the perfect harmony between people, new technologies and innovation (I-Scoop, 2017). It began, with the Internet of connected objects and cloud computing, to produce products through intelligent systems, such as simulation systems and sensors. The 4th industrial revolution represents the highest level of digitalization and defines a new organization of factories, also named smart factories. Their objectives are to better serve their customers through increased flexibility of production.

Zoom on Digitalization in the banking model

Banking digitalization designates the use of all available digital technologies, in order to improve business performance, and contribute to an overall rise in the standard of living. Today, the digital does not influence only the customer-bank relationship but the banking model as whole.

Thanks to digitalization, the customer experience becomes richer…more interactively simplicity and development are the key principles that govern this relationship. Also, it will be necessary to identify the processes most affected by digitalization to subsequently provide the roadmap for transforming and modifying banking processes. Thus, we could see that the overall organization of the bank may change by using new technologies and communication utilities. Like any new principle…it is very likely that a new regulation will ensure and help understand and follow this digital transformation. As below, the main changes that affect the banking model through digitalization. 

Optimizing the customer experience	·      More interactivity, continuity of service and ease of use ·      Towards more disintermediation ·      Customization
Transformation of process	·      Automation of processes ·      Dematerialization and non-materialization ·      Data mining
Modification of organizations	·      Information sharing ·      Digital Marketing ·      Open Data and Open API
Transformation of business models banks	·      Erosion of margins ·      Regulatory pressure ·      Regulatory developments.

2.3 Why do banks have to digitize?

The arrival of new entrants

In the digital age, banks must struggle to preserve their value and relevance in a rapidly evolving industry. Indeed, many digital technological developments have opened the field to new players, who sometimes do not even come from the banking sector. The strong point of these new entrants is their power on cutting costs, improving the service quality and offering a new and attractive décor to finacial landscape.

Fintech, madeup of start-ups in finace or other fields, is a serious competitior to banks and is gaining more and more market share. Average 95% of banks believe that their work the six fintech business models that have indeed, a direct impact in financial activities: payments, wealth management, crowdingfunding, lending, capital market, and insurance services.

New consumption modes and customer expectations

Banks face cost-cutting pressure and increased competition from new players as customer behaviour evolve. Indeed, customer, especially the Y and Z generations, expect banks to increase their online service offering. Although the majority of people are rather traditional in their realtionship with banks, the agency channel takes the first position during the need for follow-up in th key stages, execution of complex operations, complaining or giving sharp advices. Thus the customer expect their banks to digitalize to be in their new way of life.

Digital banking agencies and advisiors

Customers have adopted the concept of digital banking 4.0 but do not want a dehumannized bank. If each bank undertakes the digital transforamtion of its agencies differently, all have put the valuation and strenghtening of customer realtionship at the center of their objectives. To bring together the right ingredients, the bank agencies must evolve towards a model of digital agencies, integrate solution, digital software but also rely on consultants . Indeed, the banking agencies of the future have to introduce more digital media( such as tablets, intertective kiosks, automated self services..) and complement them by the presence of advisiors with roles more versatile and transverse than in the past.

The impact of digitalization on risk management

    The historical evolution of risk management

Risk management is considered relatively as new function in finacial sector. To understand its development, it is crucial to highlight some historical benchmarks. Since the early 1970’s, the concept of finacial risk management have evolved greatly…

International risk regulation also began in the 1990s, and finacial firms development internal risk managemnt models to protect their business against unanticipated risks and to reduce regualtory capital. It was also during these years that the governance of risk management becomae essential.

Historical dates for development of risk management

Date	Events
1730	First future contracts on the price of rice in Japan
1864	First futures contracts on agricultural products at the chicago board of trade
1946	First issue of journal of finance
1973	Black and scholes and Merton option valuation Formulas
1992	Integrated Risk management
2001	Bankrupcy of Encron
2004	Basel II
2007	Financial crisis
2013	Defination of new capital requirement

Towards Basel III

Due to the inadequacy of Basel I and the considerable evolution of banking activity, the Basel Commitie has proposed a set of recommedations to measure credit risk in a more relevant way, taking into account the quality of the borrower. In addition, he introduced in his device market risk and operational calculations. The purpose of the scheme is to properly asses bank risks through prudential supervision and transperency. Basel II standards should replace standards set up by Basel I 1988 and aim set up the ratio Macdonald ( new solvency ratio) to replace the Cooke ratio. The Basel II recommnetation are based on three pillars: the minimum capital requirements, the process of prudential supervision and financial communication/market discipline. After the financial crisis of 2007, the Basel III reform was implemented to strengthen the finanacial system. The aim of this revision is to restore credibilty in th calculation of RWA by:

·      Improving standardized approaches for credit and operational risk.

·      Forcing the use of internally modelled approaches

·      Complementing the risk-weighed capital ratio with robust capital floor.

The Different risks according to Basel’s vision

·      Credit Risk: Risk of loss resulting from in inability of customers , issuers, or other counterparties to meet their financial obligations. Credit risk may be aggravated by concentraion risk, resulting from a large expouser to a given risk oe one or more counterparties, or to one or more groups of similar counterparties.

·      Market risk: Risk of losses related to changes in the prices of financial products, voilatility and correlations between these risks. These variations may be relate in particular to interest rate flucatutions, as well as prices of securities and commodities derivatives and other assests, such as real estate assets.

·      Operational risk: Risk of loss or sanctions due to failures of internal procedures and systems, human errors or external events.

·      Liquidity risk: refers to the lack of available liquidity to meet the recevivables. To mitigate this risk, the Basel Committee incorportaes into its regulatory framework the implementation of two liquidity ratio: long-term liquidity ratio, short term liqudity ratio.

Digitalization as a tool management in industry

The implementation process of digitalization is completed in 3 steps. The first is the definition of company’s objectives, the most common one is: high tool availabilty, low tool availabilty, a low tool inventory and high product quality. The second step consists on the definition of digitalization levers and their impact on the three company’s targets mentioned before. The study of this impacts shows three main levers: the development of employee’s competencies, the integration of databases and the usage of track and trace technologies.

Finally, the third steps presents a readiness model including these levers to bridge the gap between the actual company’s process and the target one.

Digital trends altering the current risk management model

Digitalization brings several changes that impact the banking model of risk management. Today, the data analytics, in the bank as in other fields, begins to have more importance; thanks to the use of new models and technics to extract, store and analyze data…. Also, the development and the change in the customer habits drive any organization to evolve and revisit its whole management model.

Among the trends that can alter also banking model is the arrival of new regulatory standards and new companies that do not necessarily belong to the banking sphere. Finally openess usuallly rhymes with risk.. the bank is today and more than ever exposed to cyber risks and attacks that can damage its system…

We can resume five trends that affects the banks’ current business model: Importance of effective data analytics, evolving customer’s behaviours, tough regulatory control, new entrants in the banking sphere and security risks in the digital transformation age.

Trends altering banking management	Impact on risk management
Importance of effective data analytics	·      Risk-based pricing, targeted segementation with machine learning ·      Developing detection techniques to identify losses and risks exposures
Evolving customers behaviours	·      Peremptory customer request for online and mobile experience(mobile payments are expected to grow four times by 2020..)
Tough regulatory control	Proposing new regulations
New entrants in the banking sphere	Enabling banks to compete and /or collabrate with fintech companies on products and customer experience
Security risks in the digital transformation	Changing security perimeters and cyber risks demand a holistic security approach for digital business

The way to digital transformation

The road to digital transforamtion is winding and requires a good preparation. To reach their goals, financial insitution have to achieve four principles components:

Data management

There is nothing more personal than his banking data… especially when this data evolves throughout the customer’s life. Today’s clients expect their agents to recieves specific support that takes into account their financial, family and patrimonial situation; as a result, a personal response adapted to their own needs. To offer this quantity of service, the sector has no choice but equip itself with big data solutions enabling them to collect process and analyze all the points of contact and best support their customers.

Furthermore proposed a framework that can predict the default probabilty of a bank.

To face these new challenges, banks will nevertheless have to rethink their IT architecture. The digitalization project then relies on the actor’s ability to think of system that does not complicate the customer journey but on the contratry simplifies it. Also, he has to think this systems with the Omni channel logic, seamless where all points of contact are shared in real time and acessible by all stakeholders.

Automating of processes

The emergence of new technologies such as process automation or RPA( Robotic Process Automation), conginitve computing and the internet of Things will pay a key role in the digtalization of finalization institutions. Those who succeed will be those who will adopt these robotics technologies to achieve their goals.

As pressure for digital adoption  intensifies, finacial institutions must make technological advances available to their resources. RPA is at the heart of the human-machine interface and provide finacial services with a virtual workforce governed by rules and connected to corporate system such as users. With robotics, it is possible to automate and build an automation plateform for front office, back office and support functions.

The benefits of robotics for finacial services

Financial institution operate in a highly regulated industry and face significant audit trail, security, data quality… Process automation allows the most innovative institutions to meet these requirements and achieve satisfactory operational efficiency :

·      Cost saving: up to 80%  cost reduction

·      Increase service quality: improving quality by reducing the risk the human error

·      time saving: up to 80%-90% reduction in the exceution time tasks

Which processes can benefit from process automation technologies

Multiple process of financial services could be automated using robotics, these are some examples: Entering a new account on multiple systems, reporting on different systems. VAT declartion, support and validation of the Audit, Loan Not Paying Notifiaction: sending emails to customers…

The impact of automation process on banking risks

Studies shows that we can cut more than 15% of costs of different risks using automating (up to 60% for credit risk ). A great majority sees from increased precision, Believe automation will improve compliance with regulation and expect an increase in customer and employee statisfaction.

4.3 External ecosysytem

The work of notices the crucial role of a bank in the financial sector and it’s clustering with other banks for predicting risks of contagion and protecting the financial sphere balance against crashes. To perserve this perfect harmony, we must identify bank business lines that market-leading digital(fintech…) may snatch:

Impact on banking business lines

Leader of financial institution and infrastructure operators make stratgeic decisions about which areas of their organizations they want to protect and grow, and which they want to reduce. More, the digital impacts various businesses of banks but requires that all employee evolve on certain fundamentals: communication, tool, riskd…

A.   Selling Power

Account Manager (individual and professtionals) are significantly impacted

·      Development of new forms of interactions with customers in all channels

·      Strenthening of the advice posture towards the most connected (and therefore knowledgeable) client and tutors with less technophile customers

·      Strenghtening the mobilty of sales teams

·       

Management Advisiors have taken a lead and are more moderatlely impacted

The activites of receptionist and customer service could gradually disappear with the digitalization of their activity

Agency Directors are the most heavily impacted

·      Mangerial model switching from a control approach to a commercial coach approach using digital tools to animate the team

·      Vigilance to develop on digital risks

The managers of business unites are confronted to the same issues

b. Processing jobs

Digital reinforces the roles of computer sciencetist and projects managers

·      Necessity to be continutiy aware of developments (infra and soft) due to the development of innovation cycle

·      Less competency internally and on the market and more specializing profiles

·      New development methods(Agile, Open API, Open Data…)

The strengthing of treatment automation should increase operational efficiency in the back and middle office and could reduce the number of those resources

·      Increased interactivity with internal customers to meet the requirement of instant

·      Reinforceing the level of control of the management teams

·      Conduct of change to be acquired at management team level

4.4 Skills, qualifications and risk culture

The digital transforamtion is now a reality whether in the retail banking sector or in the corporate finance and investment bank. The major developments in digital banking are undoubtedly the change in behaviour and customer practices and a profound restructuring of operating model of these banks. In constrats to the image of innovation reflected today by banks, Human Resources jobs in the banking sector are not always perceived as functions at the forefront of new technologies.

In the digital age where all HR functions are affected digitalization(recruitment, skills, management, training), HR needs to revisit their their model and their model and their own needs.

Digitalization and adaptaion of business lines

HR functions have undoubtedly benefited from digital innovations and largely transformed their business processes. The use of social networks in the recruitement process is commonplace. With digital, a new conception of the defination and evaluation of competences appears. It is necessary to imagine the jobs of tommorow and the skills expected in connection with digital strategy of the company.

Digitazation is actually creating new business lines or even transforming existing businesses with digital startegy of the company.

For example: In the marketing, data scientists are appearing on the frontier between the exploitation of data, a domain previously reserved for CIOs, and marketing.

A roadmap to lead risk management in the digital era

Dealing with the new dimensions of digital risks

1.    Cybercrime: the priority number one of banks

For more than ten years, cybercriminals have been paying close attention to the banking and financial sectors. They target both institutions and their clients for (obiviously and) eminently economic reasons. During these years, their technique od attack or scam evolved: to a hardening of the security measures and to new norms of the sectors, the responded by an increasing sophistication of their methods.

Threats to banking institutions and their clients are ubiquitous in time and geography. Better knowledge and constant monitoring of them certainly provides better protection. This is not only the fight against bank cybercrime, but also and above all the confidence of customers, gurantee growth in the short, medium and long terms.

Data security

No need to remember that data is a major issue for companies. At the beginning of the summer an IBM study showed that 73% of CEOs were convinced that data would play a major role in their business in the coming years, with an expected ROI of 15% on their initiatives in congitive computing.

However, if everyone is passionate about what data can bring to business it seems that awareness about security /privacy is still not enough.

Conclusion

When the web appeared in the late 90%, it was hard to imagine how much the internet would dramatically change the business ecosystem and consumer habits. In just a few years banks-like other industries- have seen their business model strongly impacted.

Banks will need new ideas to help them transform their model, because the Fintech force the historical players of banking and financial sectors to quickly achieve their digital change.