Assessing Risk in the Financial Sector

residential development financePart of the fallout from the world-wide economic crisis of 2008 has been a comprehensive reassessment and overhaul of risk management protocols and emergency preparedness by professionals at all of levels of government and financial sectors across the globe. Unlike in previous eras, world markets today are interlinked in such a way that a problem in one area of the world can lead to a financial meltdown that crosses borders and crashes or severely damages even formerly robust economies.

Due to the increased exposure and vulnerabilities uncovered in the most recent financial crisis, Financial Services Risk Management (FSRM) teams from the World Bank/International Monetary Fund are offering risk assessment consultations and advisory services to financial sector professionals in member nations. These risk assessment reports focus in three areas:

– Diagnostic evaluations and development of diagnostic tools
– Policy and practice development
– Providing technical assistance

Determining Financial Viability in a Post-Crisis World

The main tool used on determining a bank’s solvency and crisis preparedness is through macro stress testing procedures. The previous risk assessment procedures came under heavy fire for perceived failures in their ability to accurately determine liquidity and detect or prevent the events in the financial sectors in 2008, and so led to an extensive re-tooling of testing methods and objectives to better reflect the risks and realities of modern macro-economics and their effects on established and emerging economies.

Reviews are conducted by central banks at a macro-prudential level to establish systematic risk and instability in the financial sector in a particular region or country as a whole, and at a micro-prudential level, which evaluates the risk and instability of individual institutions within a particular region or country. Macro-prudential stress assessment is conducted in a top-down fashion, and micro-prudential assessments are conducted from the bottom up.

Since Macro stress testing is a systematic procedure that encompasses the entire financial sector being evaluated, it also seeks to determine the probability of spill-over effects from unstable institutions within the financial sector, as well as the ability of central banks to contain and minimize damage from such institutions.

Current Best Practices

Since the main criticism prior to the global economic crisis was the inability to determine the solvency of banks, a variety of simulated scenarios are now used to assess risk under an array of real-world conditions. The assessments are performed in two stages:

1. The liquidity of the institution after the initial effects of an economic disruption

2. The effects on liquidity of mitigating actions by institutions in the secondary stage in response to the initial disruption.

The ultimate goal of risk assessment is to determine the financial health of each member institution, gauge its ability to withstand losses, and restore public confidence in the financial sectors after global or regional economic disruptions. Banking professionals like Fahad Al Rajaan learn through a combination of experience and training to effectively identify risks on a local level that may impact the bottom line for investors, board members and the general public.

Competent risk assessment and crisis management protocols help ensure the stability of national and local economies on every level. Global organizations like the IMF provide periodic Financial System Stability Assessments to all member countries in order to identify potential problems and make recommendations for limiting exposure to risk and protecting macro-economic vulnerabilities to market disruptions and financial crises.

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