Svetlana Borovkova: What will keep CROs awake at night in 2024?

12 december 2023

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

2024 promises to be an interesting year, especially for risk professionals. What are the main issues that will keep Chief Risk Officers of financial institutions awake at night?

Geopolitical risks

What are the issues most likely to occupy Chief Risk Officers (CROs) in the new year? At the forefront are, unsurprisingly, geopolitical risks. The ongoing conflict in Ukraine, along with that between in Gaza, coupled with the impending US presidential election and overall unpredictability of governments, emphasize the precarious nature of geopolitical balance. These events highlight the uncertainty surrounding potential geopolitical tensions in the coming year.

CROs are exploring strategies to address their institutions’ specific vulnerabilities amidst this turmoil. This includes multinational institutions engaging with local partners worldwide, devising tailored strategies for different jurisdictions, and reassessing investments in government bonds or regional stock indices. However, these risks remain elusive and complex challenges, a sentiment unanimously agreed upon by CROs.   

Inflation and rising interest rates

Predictably, the second most important concern for CROs is inflation and rising interest rates. While increased interest rates could boost banks’ interest income, the adverse effects of inflation might outweigh those gains. High inflation might erode financial institutions’ cost-to-income ratios, heighten credit risk due to potential liquidity and solvency issues faced by businesses and households that might struggle with covering higher interest expenses, negatively impact real returns on investments, and erode the value of cash. How financial institutions will deal with these risks remains to be seen, but it is certainly a concern for their risk departments.  

Generative AI

The year 2023 witnessed the meteoric rise of a revolutionary new technology: generative AI such as ChatGPT. This technology is widely regarded as a disruptive force of numerous business models across sectors, including financial institutions. Generative AI has the potential to increase efficiency and help with tedious and time-consuming tasks, freeing up resources for more engaging endeavors.

Financial institutions are formulating their AI strategies, while early commercial applications of generative AI in finance are already emerging. However, the adoption of generative AI also brings forth a multitude of risks. Concerns regarding the reliability of AI-generated information, data security, explainability, fairness, and compliance with impending regulations (such as the EU AI act) are all poised to keep CROs wide awake in the upcoming year.  

Climate risk

Another critical concern for 2024 revolves around climate risk, particularly compliance with emerging regulation in this domain.  The challenge lies, on the one hand, in the escalating regulatory demands, requiring extensive climate stress testing and the integration of climate risk drivers into credit and other risk assessments. On the other hand, there is a lack of approaches or datasets to facilitate such risk assessments.

There is a growing inclination among financial institutions to think of ‘double materiality’ when assessing climate and ESG risks: a framework that considers the mutual impact between climate events and their clients’ financial standing, and conversely, how investments or loans influence the environment. I anticipate this approach will grow during 2024. In the field of ESG, risks range from concerns about greenwashing to green bailouts. Furthermore, the long-term promise of value creation or value protection through ESG is increasingly questionable.

The lessons from the banking turmoil of 2023, notably the predicaments of Silicon Valley Bank and Credit Suisse, demonstrated the key role of liquidity risk in undermining financial stability. This turbulence also showed the significant and potentially destructive impact that social media can play. Liquidity risk will definitely deliver a few extra sleepless nights to CROs in 2024, as deposits – the primary source of funding for banks – become a scarcer and more expensive resource.

Overall, 2024 promises to be an interesting year for us all, especially for risk professionals, as the persistent geopolitical turbulence, high inflation, and the potentially disruptive impact of generative AI will continue to rock the boats of financial institutions.

With that, I extend my warmest holiday wishes to everyone, and here’s to reconnecting in the new year!

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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