There is growing unease in the banking industry that a possible failure of the global economic recovery will hurt the still fragile banking system.
A global survey of bankers and their advisers, carried out by the Centre for the Study of Financial Innovations and PriceWaterhouse Coopers, has identified concern about the macro-economic environment at the top of 24 possible risks to banks.
Regulation, which dominated previous results of the biannual survey, dropped to third place.
The Banking Banana Skins 2015 poll was based on responses from more than 670 bankers, banking regulators and close observers of the banking industry in 52 countries.
High debt levels in most parts of the world, slowing economic growth in China and the developing world, softer commodity prices and uncertainty over low interest rates and quantitative easing is driving much of the concern in the industry, together with the realization that a wider economic slowdown could severely impact a banking system that, despite improvements, is still highly leveraged.
“Higher indebtedness brings greater financial fragility. Regulators and banks have made some progress in reducing leverage in the banking sector. But it remains high nonetheless,” said a senior banking supervisor quoted in the survey report. “And the increasing indebtedness of borrowers leaves banks vulnerable in the face of economic shocks.”
The return to positive growth in the majority of countries after the financial recession has not softened the disquiet about the general state of the economy, the report noted: “Indeed it seems to reinforce the view that growth is only occurring because of the artificial conditions created by abnormally low interest rates, and could easily fail as asset bubbles burst at a time when central banks have run out of monetary ammunition.”
The report quotes the risk manager of a Canadian bank who warns that “the low rate, low growth environment is going to put pressure on banks to either move out the risk curve, or reduce their cost base which might make them less able to mitigate/monitor the risks they are taking.”
The significance of macro-economic risks was particularly pronounced in Europe because of unsettled conditions in the eurozone, and to a slightly lesser extent in North America.
Cybercrime risk surges
Banks are also seen as highly vulnerable to the growth in financial crime, particularly cybercrime.
Criminality, which includes the risks to banks in areas such as money laundering, tax evasion and cyberattacks, now trails the economy as the second most named risk to the industry after surging from ninth position in the last survey. In North America and the U.K. it was the biggest concern. The reason for the sharp rise is clear: cybercrime.
“Tax evasion and money laundering are two threats that can be managed and controlled. Cyberattacks are a different animal,” said an industry observer in the U.S.
Simon Samuels, a banking consultant in the U.K., said, “We may at some point see a cyberattack so powerful on an individual bank that it has the power to bring down the institution, necessitating a state bailout.”
Respondents worried that banks have little power to prevent attacks because of the wide variety of cybercrimes, especially as banks start to experiment with new technologies such as crypto currencies, distributed ledges and real time payments.
Underinvestment in technology is exacerbating the problem, but even if banks’ technology spending were higher, criminals would still target the weakest link in an increasingly interconnected financial system.
“While banks ready their cyber defenses, suppliers and other financial market infrastructure (i.e. payment systems) will need to be prepared, but are not subject to the same regulatory/supervisory authority as the banks,” said a Canadian risk manager.
Although much work has been done by banks and their regulators to strengthen risk controls, banks still have more to do to address the scale of risk and its ever-changing nature, said Dominic Nixon, global financial services risk leader at PwC.
“The survey shows a fairly strong global consensus that the main threats to banking safety come from areas such as criminality – which has shot up the rankings quite dramatically – technology risk, and conduct practices.”
Regulatory risks still dominate in Cayman
Survey responses from the Cayman Islands show that bankers are equally aware as industry stakeholders in the rest of the world that cyberattacks and money laundering remain key risk areas to the banking industry.
Other responses from the Cayman Islands, however, related to its status as a financial center. Foreign regulation affecting the industry in Cayman, the industry’s low reputation and vulnerability to social media as well as political interference were considered the top risks locally.
One Cayman respondent said, “The fear is that the U.S. and later other jurisdictions limit who they allow their banks to do business with, and I can see it including banks in perceived tax havens.”
Another perceived risk is that the regulatory preference in leading financial countries for large domestically based banks will lead to concentration and loss of diversity, which could end up raising risk levels rather than reducing them.
A strong local banking concern is the management of human resources, which placed No. 5 compared to No. 22 globally, as survey respondents said they were losing knowledgeable staff, particularly to high-tech companies.
By contrast, the outlook for the world economy is less of a worry than elsewhere and ranks lower, at No. 6 compared to No. 1 at the global level. Cayman respondents were also less concerned about a number of issues that affected more traditional banking industries, such as shadow banking, capital availability and credit risk.
In response to the question about how prepared local banks are to manage the identified risks, Cayman scored below average, which could be attributed to the larger regulatory agenda faced by an offshore financial center, the report’s authors speculated.