Risk trends and opportunities in the financial services sector
Cyber, inflation and compliance are top challenges but sustainability is a huge opportunity in this sector.
Recent years have seen the financial services industry have to deal with the unprecedented levels of uncertainty caused by COVID-19. Banks, asset managers, insurers and capital markets, together with other financial services organizations around the globe, all played their part in helping to weather the storm.
Still, many clouds remain on the horizon. Financial services companies are not immune to the challenges facing other sectors such as geopolitical tensions, the war in Ukraine, inflation and the hike in interest rates, supply chain disruptions, potential recession, the heightened cyber risk landscape and the growing competition from Big Tech companies providing more financial services.
Then March 2023 saw problems surface in the banking sector with the collapse of Silicon Valley Bank (SVB), which specialized in loans to startups, including fintechs, as well as Signature Bank, sparking investor fears, lawsuits, falling share prices and government intervention in the U.S.
Meanwhile in Europe, the Swiss government allowed the acquisition of Credit Suisse by UBS fearing that a failure to protect depositors would trigger a new global banking crisis. Many analysts consider systemic risk to the sector to be low as large lenders are much stronger financially than they were before the financial crisis in 2008. Others have said more shutdowns, particularly in the U.S., may follow. In the wake of SVB’s failure, banks will become even more conservative in their lending according to Allianz Research, which will also likely have a knock-on effect on corporate bankruptcies this year. Credit insurance specialist Allianz Trade now expects global insolvencies to increase by 21% in 2023. What is also certain is that regulators will be more attentive to the signs of more instability in the financial services sector.
Every year, we ask risk management experts in the financial services sector (and a host of other industries as well) to rank their top risks for the year ahead as part of our annual Allianz Risk Barometer 2023. This year the top-ranked challenges are cyber incidents (42% of respondents), followed by macroeconomic developments (34%), changes in legislation and regulation (26%), the energy crisis and business interruption (21%).
Despite investing in significant levels of cybersecurity spend each year, respondents continue to view the financial services industry as highly-exposed — a fact mirrored by a consultant report that stated cyber threats are 300 times more likely to target the financial sector than others. Another study estimated that the banking industry experienced an increase of 1,318% in ransomware attacks alone during 2021.
Cyberattacks can often include a human element, where employees, contractors or customers are unwittingly complicit in incidents with just one click on a link or a download leading to a costly ransomware attack or data breach. Building resilience and business continuity planning is absolutely key to reducing the impact from any incident.
Financial services respondents also believe that inflation will remain one of the most difficult risks to manage this year, although the survey was carried out before the recent crises in the banking sector.
A detrimental consequence of inflation is the impact that it can have long term. Even after the economy seemingly recovers, investments may take a while to regain value. And while inflation triggers higher interest rates, which increases net interest income, on the other hand it likely slows down loan demand and brings a higher default risk. SVB’s failure also highlights banks’ general macro-financial challenges from restrictive monetary policy, which essentially removes diversification, according to Allianz Research. Negative returns from bonds and equity put pressure on assets while quantitative tightening has led to a contraction of money supply, resulting in greater competition for deposits (as banks lend less).
In addition, compliance ranks as one of the biggest challenges for financial services companies, with legislation and regulation around digitization, climate change and environmental, social, and governance issues, among many other examples, constantly evolving. The compliance burden for financial institutions has increased significantly over the past decade. Regulatory enforcement has intensified as banks and senior management are more readily held to account by lawmakers, prosecutors and shareholders.
At the same time, increases in sanctions, such as in response to Russia’s invasion of Ukraine, also bring unprecedented challenges. Ultimately, the multiple regulatory and reporting challenges facing financial institutions requires them to improve the effectiveness and efficiency of their compliance activities and make wise use of data and technology.
Looking a little further ahead, and on a more positive note, agreements such as United Nations 2030 Agenda for Sustainable Development, which has 17 Sustainable Development Goals at its heart, and provides a shared blueprint for peace and prosperity for people and the planet, represents a huge opportunity for the financial services sector as significant private investment will be required to achieve these goals. However, established principles for sustainable investment/insurance will need to be followed.
Martin Zschech is global industry solutions director of financial services at Allianz Global Corporate & Specialty (AGCS).
A version of this article originally ran on the AGCS website.
Opinions expressed here are the author’s own.
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