EY’s annual risk management survey of major financial institutions, Shifting Focus: Risk Culture at the Forefront of Banking, shows that in the past year, banks have made dramatic shifts in their attention to risk culture, but much more work remains to be done.
The report is the fifth in a series of surveys carried out by EY in cooperation with the Institute of International Finance (IIF), surveyed 53 IIF members across 27 countries, to look at changes in risk management since the release of the IIF recommendations on improving risk culture, risk aggregation and risk management after the financial crisis.
The most significant finding in this year’s survey is the large extent to which the industry is focused on risk culture.
More than eight in 10 (84%) global systemically important banks (GSIBs) are actively changing their culture.
Moreover, there was a clear shift in this year to agreement that culture can be deliberately changed and effectively managed and enforced.
Over two-thirds (68%) say they are strengthening accountability regarding risk roles and responsibilities, 58 per cent are aligning compensation with risk-adjusted performance metrics and 86 per cent state that severe control breaches will trigger serious disciplinary actions.
What we are seeing is the reworking of banking,” Patricia Jackson, head of financial regulatory advice for EMEIA Financial Services, EY, said.
“This increased focus on culture began in the aftermath of the financial crisis, but has intensified as a result of the conduct and reputational events which have come to light over the past several years, especially as the costs of fines and remediation programs have started to hit home.”
Half of GSIBs report operational losses of more than $500 million in the past five years, with respondents indicating that these losses are driven by a combination of conduct fines (47%), operational failures (24%), and the costs of remediation (12%). An overwhelming 93 per cent of GSIBs agree that weak oversight and controls led to these failures.
Since the financial crisis, there has been an ongoing effort to strengthen risk governance. But the heightened focus on culture and conduct is driving further changes in risk governance structures as banks seek to tighten controls.
A number of banks are establishing very senior level or board-level committees to oversee conduct and ethics. Nearly three-quarters (72%) of banks are strengthening risk roles and responsibilities and 68 per cent indicate they are working to reinforce accountability regarding risk management. Many banks have also increased the involvement of the chief risk officer and risk function in conduct issues.
The most significant finding in this year’s survey is the large extent to which the industry is focused on risk culture
More than half of banks (56%) say that achieving a balance between a sales-driven front-office culture and a risk culture is the key challenge to strengthening culture. This is leading banks to create programs to enhance accountability in the front office. Banks are working to ensure that the front office owns the risks and feels responsible for the entire process, which requires changes to culture, systems and structures.
More than eight in 10 (82%) banks have reduced target ROE since before the crisis and more than half have reduced it further since last year.
“Unfortunately for them, almost three quarters (72%) say that investors are not accepting these lower ROEs, so striking a balance between a sales culture and a risk culture will continue to be challenging,” Jackson said.
More than half (52%) of banks across the world agree that embedding risk appetite is important for changing the risk culture. But, despite an enhanced focus on risk appetite over the past several years, fully embedding risk appetite throughout the enterprise remains a challenge for many banks. Nearly six in 10 (58%) banks report they are having difficulty moving firm-wide risk appetite into the businesses and 70 per cent are still struggling to link business decisions to the risk appetite.
“This is critical because if banks are unable to embed risk appetite, it will hamper the changes being made to risk culture,” she said.
“But strengthening risk culture is also essential to make the risk appetite effective. The two go hand in hand.”
Regulatory changes, in particular those related to Basel lll, are placing increased pressure on traditional business models.
Nearly two-thirds of banks agree that the combined liquidity and capital changes under Basel lll will have a significant impact on the cost of doing business, and more than half are targeting lower ROEs.
More than four in 10 banks are exiting entire lines of business that are no longer sufficiently profitable, and 12 per cent are exiting geographies and retreating back to core markets.
And, with 82 per cent of GSIBs reporting they are still evaluating portfolios, these changes will continue. More than half (52%) of banks indicate they are considering increasing pricing for customer loans.