Industry
Banking
Banking Services Transformation: Unlocking Exponential Value
Highlights
- Global geopolitical tensions, trade disruptions, and regulatory uncertainty are heightening market volatility, driving higher risk weighted assets and forcing institutions to reassess market risk frameworks.
- Rising regulatory expectations demand stronger data integration, model recalibration, and more dynamic, realtime risk monitoring.
- AI/ML, automation, and platform modernization are becoming essential for improving market data quality, scenario generation, model precision, and operational efficiency.
- Building a future ready risk ecosystem requires phased transformation, proactive compliance, rigorous stress testing (including climate related risks), and transparent model governance.
On this page
On this pageinpage
Shifting tides
Recent worsening geopolitical conflicts and increased trade tariffs may not only cause moderate consumer spending and a rising unemployment rate but also lead to weak business investment that could dampen growth in the global economy. Subpar economic growth, ongoing geopolitical shocks, and persistent regulatory uncertainty over the last few years since COVID 19 have forced financial institutions to continually revisit their overall risk management strategy. Market risk management has been no different as recent spikes in market volatility and pronounced movements in historical data have caused most major financial institutions to report higher risk-weighted assets (RWAs).
While the breadth and depth of the regulations (such as FRTB as part of Basel III endgame or Basel IV) continuously rise, the call for more data to be churned through in some cases, reduces the complexity of the internal models. The acceleration of technological advancement, especially the ability of AI/ML to churn more data and improve efficiency of the models has allowed financial institutions to proactively monitor and manage risks on a dynamic basis.
Major Focus Areas
Emerging trends and credit valuations adjustment he leveraging of new technologies to counter challenges has given rise to several key focus areas for financial institutions.
Key Focus Area |
What it calls for |
Compliance to new reforms like fundamental review of trading book (FRTB) |
|
Market risk limit management |
|
Market data quality and calculation of value at risk (VaR) / credit valuations adjustment (CVA) / debit valuations adjustment (DVA) |
|
Scenario analysis and stress testing |
|
Climate risk impact
The impact of climate risk on market risk management has added another dimension with a special focus on building scenarios for stress testing.
BCBS committee suggested as part of its guidance on effective management and supervision of climate-related financial risks, that banks should have the ability to analyze the impact of climate-related risk on their market risk exposures, calculate volatility and measure potential risk of losses in their market risk portfolio. In this process, they must also ensure that their market risk management systems and processes take into consideration material climate-related market risks. Stress scenarios should be designed to capture the relevance of climate-related financial risks to their trading book. These stress scenarios include both the physical and transitional aspects of climate risk.
- Physical – Severe weather events can erode asset values and drive greater volatility in commodity prices or forex instruments.
- Transitional – New climate policies, technologies and market sentiment may generate assets for carbon intensive industries which trigger an abrupt repricing on equity or bond markets.
Risk Response
Financial institutions should develop the right capabilities and design a roadmap to build the futuristic eco-system for effective management of market risk.
Figure 1: Key capabilities to drive market risk transformation.
However, these capabilities can neither be built overnight nor is it practical to conduct a complete revamp without proper due diligence. The implementation roadmap must be designed logically keeping in mind dependencies and priorities and approached in a phased manner for short term and long term.
Tech interventions
As mentioned above, technology plays a key role in market risk transformation. There are several areas where the financial institutions are leveraging technology and building business use cases for AI / ML that offer the expected return on investment.
Technology Lever |
Business Use Case |
AI / ML |
|
Automation / RPA |
|
Architecture andData rationalization / Platform Modernization |
|
The road ahead
As the turbulent geopolitical situations and uncertain climatic changes continue to keep the global economy apprehensive, market risk management teams must remain vigilant and nimble. They must continue to benchmark against the best practices around governance, risk management framework, risk architecture and disclosure to maintain a comprehensive and resilient process for managing market risk.
- Embrace new technologies such as AI /ML to generate better insights and identify risks proactively to be ready with the proper controls to manage those risks. However, those business use cases must be based on proper due diligence and taken up after rigorous cost benefit analysis.
- Inculcate a proactive approach to compliance (compliance by design) and ensure proper coordination between business and technology teams to operationalize that.
- Develop comprehensive set of plausible scenarios for stress testing for both regulatory stress tests and company run stress tests.
- Ensure transparency in the market risk models and build a sound model validation framework to govern and validate the market risk models.
By embracing new technologies with proper due diligence, regularly refining risk measurement methodologies, and developing a proactive approach to regulatory compliance, the market risk team can safeguard the operations of the organization, take timely measures to avoid or control certain risks and help the organization to thrive in the dynamic and turbulent market conditions.