Banking Matters: An essential guide to commercial banking in an age of disruption by Knowles Duncan

Author:Knowles, Duncan [Knowles, Duncan]
Language: eng
Format: epub
Published: 2021-04-07T16:00:00+00:00

These operational risk and control activities are often described as forming “three lines of defence”. The first line of defence are those employees and teams who operate the controls and on whose business processes any risk event would impact. The first line of defence includes not only the operation of controls, but also activities to gain assurance that these controls remain effective.

The second line of defence are specialist risk management functions who assist with the design of controls and provide oversight of their operation and effectiveness. The third line of defence is internal audit, who conduct independent testing of the overall risk and control environment to provide assurance that the bank is operating within its risk appetite.

As risk events occur, reviews take place, or controls are tested, the outcome is used to improve the risk and control environment, either by enhancing control, or by reducing the cost of control. For significant events or control failures, these enhancements will be implemented immediately. In less critical situations, they may simply provide input into the next iteration of risk and control assessment.

Managing other risks

Although the definition of operational risk is broad, it is not all encompassing. In addition to credit, market and operational risks, banks remain exposed to further risks that they must manage. Liquidity and funding risks are examples of these, with their management having been considered earlier. Two other risks are of particular importance: reputational risk and strategic risk.

Banking as a business relies heavily on trust, which is itself founded on the strength of a bank’s reputation. It takes many years for a bank to build a strong reputation for probity, professionalism, expertise and soundness; but only a small number of negative news articles to undermine this. “Reputational risk” is the risk to a bank’s reputation arising from its business activities. Banks cannot eliminate reputational risk, but a bank’s executives should be aware of the potential impact of their actions on the bank’s reputation, and should carefully weigh this in their decision making.

As with any other business, banks make and execute strategic plans, trying to position themselves in the right products, services, segments and markets, with the right customer propositions for long-term success. Whether through poor planning or unfortunate circumstances, banks’ strategies can be flawed, resulting in long-term decline of the business. Managing such “strategic risk” is a core responsibility of a bank’s senior executives.

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