BANKING UTILITY BELT

A brief guide to tools available to mitigate risk

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Introduction

The term ‘too big to fail’ was often thrown around freely in conversations five or ten years ago. Of course, in reality it was an extremely naïve statement used by many to mean certain organizations were ‘untouchable’. Such public and monumental collapses, Barings Bank and Lehman Brothers as examples, sadly there were many more casualties; change the banking environment and risk appetite dramatically. Barings and Lehman’s ceased to exist for very different reasons though ultimately both left gaping holes in the market.

Barings scandal highlighted the need to govern not only customers on the outside but also systems, controls and employees on the inside. Lehman Brothers was subject to huge credit risk in the subprime market, was unable to meet capital requirements and ultimately the collapse may be somewhat correlated with the credit crisis itself. This brings us to the issue of understanding risk and what it might take to mitigate this concept.

 

The Issue:

Risk can manifest itself in many ways, which unfortunately we can never fully understand prior to initiating a relationship with a customer. With the ever-changing regulatory landscape in which we live comes increased risk to an institution’s infrastructure (systemic risk), irrespective of size or market share. Whilst the percentage of ‘wrong-doers’ in the industry is minute in comparison to those operating in good faith, within the rules and using best practices – the select few who are attempting to gain from ill use of the system, change the way we operate, and how we are governed in terms of risk management

Regulated companies are increasingly required to hold more information on the counterparties with which they transact, with the aim being to truly understand customers, as well as the risks they may pose to an institution. Customer Due Diligence (CDD) checks are generally seen as the first line of defence to safeguard a Bank / account operator against customers using funds from an illegitimate source; proceeds of crime or laundered money. The majority of institutions are risk averse – they are accountable not only to shareholders but also to their customers and the regulator(s) (plus stock exchanges in some cases). Varying techniques are used to vet clients at the inception of a relationship to ensure a prospective client is who they say they are, owned by who appears to own, and are controlled by who appears to control.