Financial institutions face many risks that demand constant vigilance and strategic planning. These risks can potentially disrupt operations, harm reputations, and even shake the foundation of global economies. That’s where risk managers come in.
Risk managers, armed with their expertise, must vigilantly identify potential vulnerabilities and work to mitigate their impact. Due to the numerous risks for financial institutions, teams must be diligent when detecting potential threats to construct comprehensive strategies for tackling them head-on.
From the ever-evolving regulatory environment to the rapid advancements in technology, and the inherent uncertainties of global markets, financial institutions find themselves facing growing challenges. Here are the top 12 risks for financial institutions.
1. Reputational damage
A company’s reputation serves as a valuable intangible asset, influencing customer loyalty, investor confidence, and overall business success. However, reputational damage can arise from various sources, and poor security practices can exacerbate these risks, making it one of the most critical risks for financial institutions.
Building a good corporate reputation is a recipe that includes equal parts time, consistent delivery of quality services, transparent practices, and adherence to ethical standards. Just like adding salt instead of sugar will ruin an otherwise perfect cake, reputational damage can be swift and severe. Financial institutions are susceptible to a range of threats that can tarnish their standing in the eyes of stakeholders.
Reputational damage can also stem from non-compliance with regulations or unethical business practices, as well as unprotected – or improperly protected – security measures that don’t protect sensitive customer data, financial transactions, and intellectual property. Financial institutions must adhere to a web of complex regulatory requirements, such as anti-money laundering (AML) laws and consumer protection regulations. Failure to comply can result in substantial fines, legal repercussions, long-lasting loss of customer trust, and negative stakeholder perceptions.
Cybercrime encompasses a broad spectrum of malicious activities, from data breaches and identity theft to ransomware attacks and fraud. There were a reported 1,489 ransomware incidents involving U.S. banks in 2021, which cost a total of almost $1.2 billion. Financial institutions, given their access to valuable financial assets and sensitive customer information, have become prime targets for cybercriminals seeking illicit gains. The repercussions of cyberattacks extend beyond financial losses, as they can also lead to reputational damage, legal liabilities, and regulatory non-compliance, making them critical risks for financial institutions to mitigate.
Among the array of cyber threats and risks for financial institutions, Distributed Denial of Service (DDoS) attacks stand out as a significant risk, capable of inflicting severe consequences on a company’s bottom line. In a DDoS attack, perpetrators overwhelm a target’s computer network or website with a flood of traffic from multiple sources, rendering it inaccessible to legitimate users. These attacks exploit the finite resources of the targeted institution, such as network bandwidth or server capacity, effectively disrupting operations and causing significant downtime.
3. Economic slowdown
The next risk financial institutions face is a global economic slowdown that can impact their market performance. While they have relatively low market risk compared to other industries, financial institutions are still affected by an overall economic decline. Strategies such as long-term orientation and cost reduction can help prepare for economic turbulence.
The worldwide concern over economic stagnation also affects financial institutions. While there’s typically lower exposure to general market risks, they’re still expected to be impacted by an overall economic downturn. Economic slowdowns can negatively affect financial organizations, leaving financial institutions at risk of reduced profitability and market uncertainties.
To navigate economic turbulence, companies should prepare well in advance, maintain a long-term orientation, and make decisions based on growth prospects and cost reduction. By planning ahead and building financial buffers, financial institutions can mitigate the effects of coordinated economic downturns.
4. Regulatory or legislative changes
Compliance costs in finance have surged over the years, with increasing regulations imposing substantial financial burdens on banks. For instance, the Dodd-Frank Wall Street Reform and Consumer Protection Act significantly impacted the operations of financial institutions, leading to reduced profitability for some smaller banks.
Regulatory changes like the European General Data Protection Regulation (GDPR) also have far-reaching consequences, with compliance costs affecting businesses worldwide. Anticipating and adapting to regulatory changes through contingency planning and staying updated on evolving regulations is crucial for financial institutions to navigate this risk.
Also read: Geo-specific Complexities of Regulatory Compliance for Banks
5. Increasing competition
Financial institutions face intensifying competition in the market. Technological advancements, financial technology (fintech) firms, and industry disruptors pose a threat to traditional financial institutions. Stock trading apps like Robinhood, online loan platforms, and impact investing platforms have disrupted traditional financial services.
Moreover, cryptocurrencies could bring significant changes to financial intermediaries. To stay ahead, companies must foster innovation, constantly adapt to changing consumer preferences, and offer superior products and services. Embracing new technologies and exploring partnerships can help financial institutions remain competitive in a rapidly evolving landscape.
6. Failure to innovate
Innovation is vital for companies to remain relevant and competitive. Companies that fail to innovate risk losing their market position and stagnating. Embracing change means encouraging advancements, allowing for more personalized services, products, opportunities, and a better way to manage risk, reduce costs and fraud, and enable transparency and compliance.
One way organizations can keep up with or surpass their competitors is by investing in Artificial Intelligence (AI). With multiple existing risks for financial institutions to mitigate, AI solutions like cloud-based software, machine-learning algorithms, and predictive analytics can help companies stay ahead of the curve – and the competition.
7. Disruptive technologies
Disruptive technologies can reshape entire industries, including finance. An example of this is blockchain technology, which is increasingly becoming more prominent within the industry. Blockchain holds promise for transforming various aspects of the financial sector. It has the potential to streamline and enhance multiple processes such as cross-border payments, trade finance, and securities and asset management.
Blockchain is a decentralized and transparent digital ledger technology that enables secure and immutable record-keeping of transactions across multiple parties. As for mitigating risks for financial institutions, blockchain has gained significant attention for its potential to transform various processes and improve efficiency.
8. Failure to attract or retain talent
Attracting and retaining top talent is a recurring risk for financial institutions and nearly every other industry. In a low unemployment environment, companies must offer appealing workplace cultures, competitive salaries, professional development programs, and other incentives to attract and retain the best employees. High turnover rates result in increased costs, lower morale, and difficulties in establishing a positive company culture.
9. Business interruptions
Business interruptions can have severe consequences in the financial sector. Downtime due to security threats or extreme weather events can lead to lower productivity, reduced profits, and potential brand damage. While some companies opt for business interruption insurance, avoiding interruptions through robust risk management measures and disaster preparedness.
10. Political risk and uncertainty
Political risk and uncertainty pose challenges for companies, impacting business prospects and market stability. Sudden changes in political landscapes can have tangible consequences financially, just as sudden changes in financial landscapes can have tangible outcomes politically as was seen when three major U.S. banks collapsed at the beginning of 2023.
Companies must make contingency plans, monitor political developments, and diversify markets and supply chains to minimize the impact of political uncertainty. When managing this risk for financial institutions, it’s imperative to employ risk management strategies, including scenario planning, diversification of operations and investments, rigorous due diligence, hedging against currency or country-specific risks, and maintaining robust risk mitigation frameworks.
11. Third-party liability
Third-party liability is a significant factor in this list of risks for financial institutions, especially when relying on external vendors for services. Financial firms face potential liability for the actions of their vendors, emphasizing the need for rigorous evaluation and ongoing oversight of third parties. Implementing vendor risk management processes, conducting risk assessments, and carefully drafting contract provisions are crucial to mitigate third-party liability risks.
12. Commodity price risk
Fluctuations in commodity prices, such as oil, corn, cotton, aluminum, and steel, present risks to companies and consumers alike. Commodity price risk impacts financial results and profitability for firms that rely on or produce commodities. Hedging through futures contracts and closely monitoring global commodity exchanges can help companies mitigate the impact of commodity price fluctuations.
Mitigate risks for financial institutions with Resolver’s ERM solution
With the multitude of risks for financial institutions to be aware of, robust risk management solutions are paramount. Resolver’s Enterprise Risk Management software offers a comprehensive and cutting-edge platform designed to address the diverse challenges financial institutions face.
While risks cannot be entirely eliminated, comprehensive risk management solutions can help mitigate their effects and protect financial institutions from catastrophic events. Our integrated platform allows financial institutions to effectively identify, assess, mitigate, and monitor risks across their operations, ensuring enhanced resilience and regulatory compliance.
From managing security threats and reputational risks to navigating regulatory changes and geopolitical uncertainties, Resolver provides the tools and insights necessary to make informed decisions and protect the bottom line. Don’t wait to safeguard your institution against potential risks — join an upcoming showcase today and experience the power of proactive risk mitigation in banking and finance firsthand.