Most of Europe's biggest banks comfortably passed the Committee of European Banking Supervisors’ recent stress tests and the sector has breathed a visible sigh of relief. However, plenty of uncertainty remains over banks that either squeaked by with just enough capital or passed but did not fully disclose the data that went into their calculations.
The spectre of counterparty risk, last seen in dramatic form in the wake of the Lehman collapse, is not far from regulators’ and investors’ minds amid the continuing eurozone sovereign debt crisis. So, with regulation and stress tests to one side, what else can financial institutions do to convince the market that they are appropriately managing credit risk and thereby encourage more lending back into the market?
Risk is an acceptable, even a welcomed part of trading. Every trade comes with some risk attached - it is just a case of knowing what the potential problems are and being comfortable with them. But as the financial crisis showed, pinpointing where the risk lies is not always so straightforward – even big institutions didn’t always understand the full extent of their exposures. However, better understanding and management of risk, especially counterparty risk, will be key to the ongoing financial recovery and to re-injecting confidence back into the interbank lending market.
A large part of better managing credit risk will come from providing risk managers with increased access to data in order to gain a thorough view of counterparty risk exposure and calculations. The evolving regulatory landscape and greater need to monitor, measure and report, has advanced in such a way that understanding and realizing these risk exposures in real-time has become crucial to a financial institution’s ongoing stability and success. Risk managers need to be able to provide aggregated figures quickly and accurately in order to truly establish the position the business finds itself in.
However, with a multitude of other risk facets to consider, including liquidity, market and operational, many risk managers are struggling to adequately analyze and establish their positions. No-where is this truer than in the front office, where 21 months after the collapse of Lehman Brothers, financial institutions are still struggling to properly calculate counterparty risk. Due to its interconnected nature, counterparty risk analysis must not only take into account various data, including VaR, P&L and sensitivities, but must also integrate a number of asset classes and draw together an understanding of the collective impact that they have.
Once counterparty risk is accurately established, risk managers need to gain better access to and analysis of this data so they can more effectively bridge the gap between ‘quants’ and decision makers. For example, business decision makers need information that goes beyond a single indicator or figure so that they can fit credit risk into the broader perspective for the senior management team and board.
Banks’ traditionally siloed approach however has meant that to date such a scenario is more of a pipedream than a reality. However, aggregating high volumes of data from multiple streams to produce both snapshots and the ability to drill down into the data in real-time is now possible with the right technology solutions. While technology is by no means the panacea to solving all the issues associated with risk management and indeed counterparty risk, if implemented and deployed appropriately, it can provide detailed analysis and ensure that decisions that need to be made quickly are not only well informed but also support the business. In short, the quicker a firm can realize its true counterparty positions and potential exposures in the context of the overall risk picture, the greater its overall market competitiveness and confidence will be.
Of course, implementing this kind of change through a technology refresh will take time. In the short-term, it will be the interbank lending markets that will have the answer as to whether confidence is returning to the European banks. However, in the longer term, understanding where a financial institution’s risk lies, and what would happen in a worst case scenario, through better access to, understanding and analysis of data will reduce the fear of counterparty risk that is currently stifling the market’s fledgling rebuilding of confidence. |
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