Financial Risk Management during
Looking beyond the basics can help your financial institution to stay strong
By Philippe Sarfati
May 5, 2020
There is no vaccine against the financial markets’ turbulence and the economic downturn caused by a global pandemic like COVID-19, but some financial risk management practices can strengthen a financial institution’s immunity.
These practices should extend beyond the mandatory foundation of any crisis management program: business continuity and incident management plans, pandemic response plans, crisis simulations and safety training.
From a credit perspective, focus on under-exposures, not just exposures.While you must anticipate the impact to your customers of job loss and real estate market dynamics, you should also consider the impact of the pandemic on their pension funds and other assets, investments, suppliers, and buyers. The analysis cannot stop at the individual exposure level, or a formulation of sector-specific responses, or total portfolio concentrations.
Consider implications of the pandemic on the full supply chain. Canada is an export nation, with close to 80 per cent of our exports going south of the border, and our trade dependence on China is material. The direct and indirect supply chain impacts of COVID-19 on your customers may have a global aspect and you should consider the size and length of expected global macroeconomic imbalances, large deficits and potentially prolonged periods of low-interest rate environment.
Predicting unexpected losses—the tail, how thin or thick—is important.Losses are yet to come. Your most affected customers are deferring payments of their interest or principal and interest payments. While these are not classified as non-performing loans, the risk emanating from a prolonged economic and/or real estate market downturn could quickly proliferate to the rest of the portfolio. The breakdown in risk management practices in this pandemic could be a failure to evaluate worst-case scenarios. You know your balance sheet composition, diversification levels (or lack thereof), and the correlations among your asset classes. Be cognizant of this predicament and accept that the future is not necessarily going to be an extension of the past. Insurance companies that insure large natural catastrophic risks have very long time horizons; for example, they leverage data on earthquakes for hundreds of years. What time horizon should financial institutions use in predicting unexpected losses from this once-in-a-lifetime pandemic? Certainly, not the one you would use in a perpetual non-crisis environment. Have these conversations with your senior management. Capital and liquidity risk management should keep you prepared for the unexpected.
Debate what capital buffer you should have for low-frequency/high-severity events such as this pandemic. Similarly, liquidity planning should take into account normal and contingent liquidity needs, as well as disruptions to liquidity due to adverse market developments.
Availability of data and in particular new data is critical for proactive and systemic risk management through a crisis. Data gives management a frame of reference and enables the most optimal decisions under the circumstances. This data should relate not only to liquidity and capital management, credit performance including PCLs, deferrals, drawdowns and portfolio performance, but also to stress tests.
Stress-test various forecasts in terms of potential liquidity cost, liquidity availability, funding cost and funding availability, timing and the extent of market recovery, etc. It will enable your forward-looking thinking beyond the current cycle.
Be aware of new risks and equally cognizant that old risks, like cybercrime, are emerging in new ways. The COVID-19 environment has given fraudsters new ideas and opportunities to design new scenarios and approaches to cybercrime. The recent Quebec-based $2 million Interac cyber fraud on emergency payments puts a new spin on this. Be a step ahead to stay protected.
Maintaining a strategic focus is imperative. Operational, financial, risk and strategic objectives should look beyond the six-month loan deferral period. In this forward-based thinking, analyze your overall ecosystem, which includes your servicers, suppliers and vendors. Reach out to all your major providers. Understand their challenges, crisis plans, any risk mitigants they have implemented and ongoing changes they are contemplating or executing.
Stay on top of various government stimulus programs and regulatory adjustments to support the financial and operational resilience of the Canadian financial system and to address operational issues stemming from COVID-19. This includes various adjustments to existing capital and liquidity requirements deemed as not appropriate in the current extraordinary circumstances. Concentra and our regulators, OSFI included, have been in daily contact to ensure we supply required information about our performance, hear about the industry-wide issues, and stay abreast of all emergency relief programs the government is implementing.
Make sure your senior management across all functions (Finance and Treasury, Risk Management, Technology, Operations, Business, Human Resources, Trust, etc.) meets frequentlywhile managing liquidity, capital and risks daily. Communicate effectively and regularly with employees, stakeholders, customers, suppliers, your Board and regulators.
Customers are the ultimate driver behind everything you do. Understand their hardship and their individual situations, including cash flows. The 2008 global financial crisis was mainly resolved through government support and regulatory bodies. In this pandemic crisis, we are all one large ecosystem, working together to survive.
As Chief Risk Officer, Philippe Sarfati ensures sound governance and effective controls for enterprise risk management, compliance, corporate policy, credit adjudication and regulatory framework to meet Concentra’s strategic and business objectives while enhancing shareholder value. He provides strategic leadership to support a prudent risk culture focused on growth, development, and market relevance.