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Risk It or Play Safe?

 

Risk It or Play Safe?

Tapan Agarwal – Risk Product Council Chair, iGTB

13 April 2016

 

Getting Riskier and Riskier

Banking can be a very risky business indeed; the recent leaks of the Panama Papers are a case in point. Countries from Russia to Australia to Argentina have come under scrutiny, governments are under pressure to answer allegations and banks are facing the brunt of not having really known their clients. Having your name associated with a controversy is never good; having your name associated with a wrongdoing, in this case tax avoidance (or "evasion"?), is even worse. UK’s Financial Conduct Authority has asked around 20 banks and financial institutions to hand over any information about their dealings with the law firm at the centre of this issue, by Friday.

Any bank’s primary focus is centred on remaining healthy, liquid and profitable by holding portfolios that contain risks that can be effectively managed. If it isn’t money laundering that is bothering them then it is the probability of their clients defaulting that has a banker up at night. Be too willing to take risks and you may be inviting a financial crisis that can take on global proportions. Be too risk-averse and you are stifling the economy– by stemming funds needed for growth and innovation. What is a banker to do?

It is a vicious cycle really - weak businesses that lack proper financial reporting and start-ups that are unknown, make banks hesitant to onboard them; banks counter this by charging high interest rates or high collaterals for short maturities, leaving their clients with cash flow problems and low rates of return on investments. Such businesses continue to remain unattractive to the banking sector, no one wants to invest in them and they remain exposed to the risk of exiting the market completely.

Given the rising costs of complying with regulations and the risk of facing hefty fines, banks are reluctant to handle payments for certain companies or in certain locations where they fear that the money might end up in the wrong hands or be used for funding terrorist activities or for establishing safe tax havens.

Risk aversion is only getting stronger for banks.

How to Play Safe

While taking big risks might be detrimental to the bank’s finances and reputation, being risk-averse isn’t an ideal situation either. Instead of ceasing to do business with high risk countries banks must put in place measures for better and enhanced due diligence and screening techniques. Instead of refusing to grant a correspondent banking account to an entity in Africa or open an account for a corporate dealing in dual use goods, banks must improve operations, technology and processes to manage this risk. In the area of payments, instead of being conservative and setting up payment limits for each product, banks must use technology which allows setting up complex limit structures at client level and give a pay/no-pay/refer decision based on limits and balances across accounts. In the area of lending, technology should enable banks to measure probability of default at various levels including the industry, region and country, and continuously monitor that based on changes in market variable; all this instead of becoming risk averse and denying a loan.

One must not throw the baby out with the bathwater.

Unrealised market opportunities can be debilitating to the economy, the banking sector and the bank’s own bottom line in the end. Being too risk averse isn’t the philosophy to adopt. Using technology to manage and mitigate risks is a more powerful approach to operate in the risky environment in which banks find themselves in.

 

This post is a part of the blog series: Commercial Risk – The New Normal. Read more here.

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