The aftermath of the 2008-09 financial crisis has made industry players consider real-time (or near-real-time) risk monitoring as a business imperative, rather than just a good-to-have feature. During the crisis, national regulators and senior executives at several banks sought real-time information on risk levels relative to the enterprises risk limits, to facilitate decision-making. However, such information was not forthcoming since risk management departments back then were not adequately equipped to respond to this need.
Today, the ability to understand counterparty credit risk and carry out scenario analysis on an intraday basis, during times of market stress, has become particularly important. Realizing this need, industry regulators have now mandated banks to build real-time risk monitoring and intraday risk reporting capabilities at the enterprise level, the same being specified by the Basel Committee on Banking Supervision (BCBS), the European Securities and Markets Authorities (ESMA), and the Dodd-Frank Act. Some examples include real-time risk data aggregation, intraday reporting under Basel such as counterparty credit risk report, real-time monitoring of trading under ESMA, the Dodd-Frank Act, real-time pre-deal check for risk-adjusted pricing, and online dissemination of swap data for Dodd-Frank Act. Though not a regulatory requirement, the intraday liquidity risk management under Basel also implies intraday liquidity stress-testing and real-time tracking.
Real-time integrated risk management at the enterprise level will soon become the norm for banks and financial firms because of the myriad ways in which it helps businesses improve their operations and stability, as well as ensure regulatory compliance. With a real-time risk monitoring system, deviations can be identified almost as soon as they occur, making it possible to take timely corrective actions. By helping financial institutions safeguard against impending threats or prepare for upcoming opportunities, these systems can be instrumental in creating competitive advantages. With pre-deal checks in place, a bank will be better equipped to accurately price the risk in any counterparty transaction, thereby averting uncompensated risks. Real-time tracking helps identify trading patterns, thus making it easier to detect rogue trading and initiate corrective actions to reduce potential losses.
While a real-time risk monitoring system extends several advantages to a bank, implementing it poses several challenges. Not all challenges are of a technical or monetary nature, some relate to the traditionally followed organizational models. For instance, real-time risk adjusted pricing requires integration of the front and middle offices. Besides, beyond the obvious technology considerations, this task also requires a buy-in from all stakeholders since it is bound to result in functional modifications at the front office, which are daunting to say the least. Secondly, the reliability of the information obtained from a real-time risk monitoring system depends on the data that is fed into it, hence data quality becomes an important factor. A third issue is that the implementation of a real-time risk monitoring solution requires extensive use of various emerging technologies. Existing infrastructure and IT complexity can come in the way of overcoming this challenge. All these issues, coupled with the increased regulatory oversight and stringent deadlines, could translate to increased implementation costs and timeline pressures.
Recent advances in technology have made it easier and far more feasible for banks and financial organizations to implement real-time risk monitoring. While some of these technologies are still in a stage of infancy, there are others that have been around for some time now and are being applied to different scenarios. In-memory database, high performance computing, complex event processing, and Big Data are some next-generation technologies that financial institutions can look at while conceptualizing real-time risk monitoring and intraday risk reporting systems.
Thus, as markets become increasingly dynamic and organizations face the relentless pressure of ensuring profitable performance amid crisis situations, the importance of real-time risk monitoring is magnified even further. Banks that do not build sufficient capabilities to address this aspect will be at a competitive disadvantage, along with being vulnerable to regulatory actions and penalties.