Svetlana Borovkova: What will keep CROs awake at night in 2023?

January 31, 2023

By Dr. Svetlana Borovkova, Head of Quant Modelling at Probability & Partners

We are now one month into the new year, so my traditional column on what will keep risk managers busy in 2023 is long overdue. As usual, my observations are inspired by my conversations with various risk professionals – our clients – and by my visits to prominent risk events such as the annual RiskMinds conference, which last took place in November 2022 in Barcelona.

The main risk themes this year are different from those that dominated the risk agenda in 2022, and they reflect our turbulent times. The number one risk on everyone’s mind is geopolitical risk – and the resulting societal risks. Deglobalization and the end of the unipolar world are seen as real trends, and geopolitical instability, fuelled by the Ukraine war, makes our world (and the consequences for the financial system) highly volatile and unpredictable.

However, Ukraine conflict and the resulting sanctions are not yet seen by CROs as a major credit event, but this can change in the course of 2023. The main challenge here is how to map geopolitical risks into industries and sectors and into the corresponding credit and investment portfolios.

The second and perhaps more existential risk for banks is the rising inflation, cost of living and energy crisis. The main question here is: what is the impact of these risks on asset valuation, downgrades in credit and retail customers? Rising inequality, poverty and erosion of the middle class are seen as a threat to the resilience (and even existence) of smaller, retail and emerging market banks.

It must be said, however, that, although rising inflation and interest rates are seen, on one hand, as risks (particularly for credit), on the other hand this new regime is also considered as a kind of ‘return to normality’ and better margins by large banks.

A major risk which is still there from previous years is the cyber risk. This risk is still in the top three worries of CROs of all banks – large and small, investment and retail, digital and incumbent, and I expect that this risk will not disappear any time soon.

Climate risk

Predictably, climate risk is the theme that dominated the conversation at major risk events. But, interestingly, it is not seen by CROs as an existential risk. Banks are predominantly interested in how to design climate stress tests and how to map them into their credit portfolios and losses. Slowly but surely, approaches are emerging that will allow them to do it in a systematic way, with a central role for the so-called stressed PDs, which result from mapping the six well-known NGFS carbon scenarios into companies’ fundamentals such as leverage and profitability.

For asset managers, the corresponding task is to map climate stress scenarios into risks for their equity portfolios – for example, considering region/sector cross-sections – but, contrary to credit, no clear methodologies have emerged here yet. In all, however, climate risk is not seen by CROs as a major risk that will keep them awake at night, but more as a slow process with occasional regulatory-driven shocks.

Reputational risk and ESG

Another big worry of CROs is reputational risk, due to many factors (fraud, money laundering, sanctions against Russia), but also greenwashing in the ESG debate. Interestingly, the focus of the ESG theme has changed dramatically from the last year. The main ESG-related concern of CROs and asset managers is that ESG is now a major source of reputational and legal risk due to unlimited opportunities for greenwashing and ongoing lawsuits in the US against large asset managers such as BlackRock.

To tackle greenwashing, financial institutions are looking for ways of incorporating objective ESG signals, obtained from, for instance, social and traditional media, rather than using ESG scores by the likes of Moody’s or Sustainalytics, obtained from companies’ self-reported information and hence prone to greenwashing. This opens a wealth of opportunities for smaller, faster ESG data providers that base their ESG data on media content, in combination with AI and NLP capabilities.

Discrepancy between views

Finally, another interesting observation is a large (and growing) discrepancy between main risks as perceived by different groups of CROs: those of big incumbent banks in developed countries versus retail banks and banks operating in emerging economies versus digital banks. Digital banks, whose increased presence in the financial system cannot be ignored, are concerned about digital security, competition with incumbent banks and financial inclusion of all layers of the population.

On the other hand, the risk of rising inflation and cost-of-living crisis is much higher on the agenda for retail banks serving private and SME customers. Emerging markets banks’ CROs are concerned that high energy prices and interest rates might lead to downgrades of EM sovereigns, directly impacting borrowing costs for those banks.

Also, views on climate risk are very different for different kinds of players: while large banks from rich and ‘green’-dominated countries (such as UBS or Deutsche Bank) are almost ‘evangelical’ about their climate risk views, retail and emerging market banks call for a much more realistic and balanced approach, where equal priorities should be given to the wellbeing of their (often vulnerable) clients, already negatively affected by rising cost of living and inflation, and climate goals.

To conclude, there seems to be a large variety of risks and worries at the top of CROs’ minds, reflecting our current turbulent and fast-changing times. One thing is certain: risk professionals will be very busy in 2023!

Do you want to get better insights into risks your organization is currently facing? Contact our risk professionals at Probability & Partners and let’s discuss how we can help!

Probability & Partners is a Risk Advisory Firm offering integrated risk management and quantitative modelling solutions to the financial sector and data-driven enterprises.

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