2018 is set to revolutionise risk. With significant advancements, such as solutions that solve the ‘black box’ issue for using AI in credit scoring, through to significant reforms in Basel III, lenders will seek change to stay ahead of their peers.
In our latest whitepaper, Seven risk predictions for 2018, we explore which trends lenders are most likely to adopt this year to protect themselves, consumers and the global economies, whilst also going back to the most important aspect of any business: profitability.
Here’s a summary of our seven predictions:
Last year ended with announcements from the Basel Committee on Banking Supervision (BCBS) of reforms which are likely to increase capital requirements for lenders on the Standardised approach particularly those lending in the higher LTV market or with material concentrations of Income Producing Real Estate.
These lenders are already looking at the IRB approach as a means of consuming proportionately less capital with a high likelihood of being in a better capital position even before the application of the BCBS
reforms. The transition to IRB for smaller organisations was never a consideration due to the associated complexity and cost but it is now in reach more than ever.
Last year the PRA implemented regulatory changes removing some cost and data barriers to entry, enabling smaller lenders to reap the benefits. For many organisations embarking on the IRB journey, 2018 marks the mobilisation of their programme. IRB will elevate the status of your firm with investors and regulators alike as it promotes robust risk management frameworks and improves capital efficiency. But for many, this requires an investment in resources such as data, technology and modelling expertise.
With reforms often requiring significant business change, lenders should start to prepare for IRB compliance now to meet the 2022 BCBS reform date.
Artificial Intelligence is big news. Every day generates a newsworthy advance – in self-driving cars, even smarter phones, self-learning thermostats. So far, the credit industry has been slow to adopt. But many companies are exploring what AI means for them, and the regulators are watching with interest.
Advances in computing power and deep learning techniques mean it’s now possible to make use of Artificial Intelligence to squeeze more value out of predictive data. Now that AI is also capable of generating transparent, explainable models that can follow business rules, the regulatory hurdles to adoption are finally being met.
AI stands ready to revolutionise the way that credit scoring is undertaken: better, faster models, more regularly updated, with the business in control. With an eye on Open Banking, the availability of more data makes it imperative that lenders take a look at this trend in 2018.
The seven largest UK banking organisations have been participating in the annual Bank of England Concurrent Stress Test now for 4 years. They are developing appropriate structures to meet more stringent stress testing requirements.
In 2018 with an increased focus on consumer indebtedness it is expected that smaller lenders will need to up their game and assess carefully the suitability of their current ICAAP framework. Increased scrutiny will be placed by the regulators not only on modelling, but also on process and policies around stress testing, with particular attention to senior management and board members and the implications of stress testing for both strategic and capital planning.
For this reason financial institutions must engage in a careful planning and define clearly all the events that need to happen in a successful stress test or ICAAP. The ICAAP is, by definition, an internal process but organisations need to consider if they have the proper setup and resources needed to show the PRA they mean business and are not a risk to the future stability of the UK financial sector.
Open Banking has the potential to level the playing field between providers. This will result in a gradual shift towards new aggregated services and a marketplace of regulated providers who will offer appealing services to consumers based on their own banking data.
Established players face a challenge from innovative organisations targeting their customers using their own data. Customers may get used to using third party intermediaries; increasingly, they will bypass the use of individual lenders’ apps and websites, with the associated loss of marketing opportunities.
New providers will need to make best use of open data, but may face some modelling and assessment difficulties in the absence of outcome
data. What does this mean for the traditional credit reference agency? And let’s not forget that we now operate in a GDPR-compliant world in which permission is everything. Providers must ensure that customer data is being handled appropriately; it must be clear to the consumer who is the custodian of their data.
In the last couple of years, the scale and complexity of cybercrime in particular has risen with too frequent announcements of banks who have fallen victim. This growth has come about due to the increased digitisation of our daily lives, with many of us now paying our bills, managing our banking and paying our taxes online.
Whilst this digitisation brings many benefits both to individuals and businesses, it also brings increased levels of risk, with the financial services sector at particular risk of an evolving and fast-growing threat. Many banks have made significant progress in their fight against cybercrime, with some having vast amounts of data collected from across their digital platforms, enabling them to have a much clearer viewpoint on who their customers are and their regular patterns of activity.
Some are even using real-time Artificial Intelligence (AI) techniques to spot suspicious activity, as a function of this explosion of data and the fact that many payments now take seconds, rather than the days previously taken to process.
Most organisations will have their IFRS 9 framework fully embedded into their business practices following model development, validation, implementation, testing and execution in preparation for the 2018 deadline. For lenders of all sizes this is the culmination of a momentous amount of work so does this signal the end of IFRS 9?
Lenders may have more work to do to satisfy auditors. The audit at yearend may highlight model weaknesses, particularly those associated with the forward-looking requirements after sensitivity or benchmarking tests. Auditors have shone the spotlight on the end-to-end process which may force lenders to revisit their data processes and system setups to improve controls and efficiency.
There will be more to do on IFRS 9 in 2018. The models must be monitored and validated to ensure they remain optimal and accurate and IFRS 9 provisions must be forecast and stressed for planning and ICAAP purposes. Model refinements may be necessary as the approaches adopted to meet the complexity and novelty within the standards are understood better.
Over the last few years there has been increased focus on regulation within lending, driven by the financial crisis and an enhanced scrutiny on unexpected and expected losses. As a result, banks are now better capitalised than ever but efforts previously focused on optimising customer and portfolio value have been diverted to address the increased regulatory burden.
Advancements in Artificial Intelligence (AI) and data science promise to revolutionise the way lenders operate. Better use of data and of mathematical approaches to solving business problems mean that lenders can adapt to new regulations and increase portfolio profitability simultaneously.
With IFRS 9 predicting losses over the lifetime of the customer, the time has now come to understand and optimise revenue.
You can download a copy of our Seven risk predictions for 2018 here.