Oh Crystal Ball! What's the biggest Financial Risk of them all?
Now 2019 is knocking at the front door, it’s time to have a look at the European Central Bank’s Supervisory Priorities for what might be a very volatile year fuelled by complex trade talks, Brexit, economic slowdown, etc. What risks are ahead of us? Which are the main Supervisory Priorities of 2019? In which aspects do they differ from those of 2018? How will the (Belgian) market be impacted? Let’s find out.
Supervisory Priorities 2019: Say What?!
The ECB releasing its yearly ‘Single Supervisory Mechanism (SSM) Priorities’ – driven by its annual Risk Assessment – has become a tradition that risk enthusiasts don’t want to miss out on. Let’s recap the 2019 high-level priorities:
- Credit Risk: Although the level of Non-Performing Loans (NPLs) dropped in 2018, the ECB kept the monitoring and addressing of NPLs at the top of its priority list. Additionally, the ECB Banking Supervision is planning to strictly review financial institutions’ underwriting criteria and lending practices.
- Risk Management: To limit variability of risk-weighted assets the ECB will continue to carry out its targeted review of internal models (TRIM), including on-site inspections. Furthermore, the ECB recently released its updated finalised guides on the Internal Capital and Liquidity Assessment Processes (including its expectations) which aims to assist banks in adopting sound practices regarding ICAAP and ILAAP methodologies and processes. Banks are expected to assess the risks in a forward-looking manner. Additionally, it’s important to note that the 2019 stress tests will focus on banks’ liquidity risks.
- Activities comprising multiple Risk Dimensions: A third category of priorities groups the supervisory activities aiming at addressing multiple risk dimensions such as the implementation of Brexit plans and preparation for the upcoming Fundamental Review of the Trading Book rules. Quite an important number of Belgian companies might be impacted by the Brexit. We wonder whether bank risk data are sufficient comprehensive and reliable to include this impact in stress test scenarios and forward looking capital levels.
2019: Another 2018?
Next to its SSM Priorities, the ECB also released its 2019 Risk Map, which summarizes the key risk drivers affecting the euro area banking system over a two to three-year horizon. Are they any different from those listed one year ago? We identified four major shifts compared to the 2018 risk driver mapping:
- Geopolitical Uncertainties: Both the risk impact and risk probability of (geo)political uncertainties have increased over the past year. The ECB points at increased trade protectionism, sovereign risk and Brexit-related concerns as main drivers of this evolution. Furthermore, it warns for further regulatory fragmentation.
- Cybercrime & IT Disruptions: Nowadays, banks (need to) invest a lot in the modernization of backbone IT systems, development and improvement of mobile applications, etc. However, this era of digitization has made banks more vulnerable to cyber threats, resulting in a significant (potential) losses. The ECB stresses the importance of improved cyber security and will, throughout next year, perform on-site inspections to assess the related risks and the status of preparedness of banks.
- Repricing in Financial Markets: The ECB shows on its Risk Map that both the probability and impact of a repricing in financial markets have increased. Recent spikes of market volatility, fuelled by geopolitical uncertainties (see above) and drop in economic growth estimates, are a good example of how high-sensitive financial markets currently are. The ECB warns for multiple-round effects (including systemic risk) in case of a severe market correction.
- Climate-Related Risks: For the first time ever, the ECB mentioned climate-related risks on its risk map. On the long term, environmental risks can significantly impact the financial system in various ways. The ECB recommends banks to manage their collateral located in regions sensitive to extreme weather phenomena. Furthermore, they should also estimate the impact of a low-carbon economy on all their business lines.
“Quite surprisingly, we notice that ‘Outsourcing Risk’ was not mentioned in the ECB’s 2018 & 2019 risk map.”
The low interest rate environment, tighter regulation and structural business challenges maintain their spot on the risk map when compared to 2018, but nevertheless remain significant risk drivers.
Quite surprisingly, we notice that ‘Outsourcing Risk’ was not mentioned in 2018’s & 2019’s risk map. Given the European Banking Authority’s (EBA, 2018) Consultation Paper and updated guidelines on Outsourcing (which will become effective in the coming months), one would have expected increased attention for this field within Risk Management.
Additionally, the 'business models and profitability drivers' – which was one of 2018’s priorities – didn’t make 2019’s risk map. In their November 2018 Supervision Newsletter, the ECB (2018) clarifies that banks “… expect the current favourable macroeconomic environment to support their profitability”. Additionally, the banks believe strongly that their income from lending activities will grow, while they plan to “continue increasing the share of fee and commission-generated income in their revenue mix”.
Belgium: What kind of impact to expect?
When looking at Belgium’s financial system we find several evolutions related to the main risk drivers published by the European Central Bank’s Supervisory.
From a Belgian customer’s perspective, the ECB notices an increase of household debt, accompanied by high Loan-To-Value ratios. This evolution, in combination with a highly priced housing market, will be a worsening booster when economic downturn kicks in. The National Bank of Belgium repeatedly expressed its concerns about this evolution. The NBB already put the increase of loan standards and limitation of both household debt and LTV of as one of its main macroprudential policy priorities.
Belgian Financial Institutions on the other hand, within the low interest rate environment, are confronted with several other challenges. Firstly, in their search for yield, several Belgian banks (i.e. smaller retail banks), aim to complement their decreasing net interest income by the activation of fee income activities (see Supervision Newsletter 2018 above). Others opt for leveraged – and riskier – loan issuance. Secondly, banks in 2019 will not only face the competition of fintechs, but also bigtechs. Large technology companies, which can bring along numerous economies of scale, will force (Belgian) banks to further improve their efficiency, data quality, technologic advancements, etc. Capturing and understanding all of the needs, behaviour and data of 2019’s customers will be key in survival.
European Banking Authority (2018). EBA Draft Guidelines on Outsourcing arrangements (Consultation Paper).
European Central Bank (2018). ECB Banking Supervision: SSM Supervisory Priorities 2019.
European Central Bank (2018). ECB Banking Supervision: Risk Assessment for 2019.
European Central Bank (2018). Supervision Newsletter 2018.
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The practice ‘Risk Management and Compliance’ practice focuses on supporting banks and insurance undertakings in anticipating and addressing the tighter regulatory standards relating to risk management, compliance and internal control by monitoring the different European and local regulatory and supervisory bodies.
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About the authors:
After finishing his Master in Banking and Finance at UGent, Wouter started his professional career at TriFinance. As a member of TriFinance’s Young Hub Program, Wouter worked on several projects at three major clients within the Belgian financial sector. He first gained initial experience within the field of credits and mortgage loans at a large Retail Bank. Next, he got the opportunity to put his product risk management knowledge into practice at a Belgian Asset Manager. Currently, Wouter is working at the risk management department of one of Belgium’s largest insurers. Apart from risk management, Wouter is passionate about investing, trail running and vinyl.
Want to know more about Wouter’s first 3 years at TriFinance? Read more here.
After holding a wide range of management functions within BACOB Bank and Artesia Banking Corporation, Rudi Sneyers joined the operational risk management division of Dexia Bank Belgium (currently Belfius) in 2002 as deputy Head of the division. In 2004, he became Director of the Credit Risk Management division. He was appointed deputy Chief Risk Officer of Dexia Group in May 2007 – a challenging journey in view of the emerging banking and sovereign crisis of 2008 and 2011. From May 2014 untill mid -January 2018, he held the position of General Auditor of Dexia Group also in charge of internal model validation and the ECB Office. Rudi joined TriFinance in 2018 to lead FI’s Risk Management & Compliance Practice.