Risk Management in Banking: A Growing Concern in the Philippines
The Philippine banking sector is facing unprecedented challenges as interest rates continue to rise and economic uncertainty looms large.
Rising Interest Rates and Economic Uncertainty
With the country’s benchmark interest rate moving from 2.5% to 6.25% between June 2022 and May 2023, banks are struggling to manage liquidity risk effectively. The rapid evolution of technology and social media has highlighted the need for banks to recognize the additional liquidity risks posed by social media’s ability to fan the flames of customer panic.
Traditional Stress-Testing Assumptions No Longer Valid
Traditionally, stress-testing assumptions have been based on historical data and conservative estimates of bank runs. However, these assumptions may no longer be valid in today’s fast-paced environment. Banks must stay on top of their liquidity management as conditions can change quickly.
Revisiting Funding Risk Management Strategies
Banks need to revisit funding risk in light of the new speed of bank runs facilitated by technology. The recent overnight failure of certain US banks has highlighted the importance of recognizing additional liquidity risks posed by social media.
Growth in Fixed-Income Securities Investments
The Philippine banking sector is facing significant growth in fixed-income securities investments, which are susceptible to unrealized losses in a rising interest rate environment. Securities growth has been 60% from April 2020 to April 2023, and banks hold these securities to collect cash flows from interest and principal.
Unrealized Losses and Funding Risk
Long-term securities with large unrealized losses are not typically sold to avoid realizing a loss. This creates funding risk for banks, which must be managed effectively to maintain financial stability.
Challenging Economic Conditions
Borrowers are dealing with increased loan payments on variable-rate loans, decreased savings rates due to inflation, and general uncertainty about economic conditions. These factors have created tougher economic conditions for customers, making it essential for banks to review their liquidity stress testing assumptions and funding risk management strategies.
Key Risks to Assess
The key is to assess the impact of extreme but plausible scenarios like a 80% withdrawal of deposits in a short period on an institution’s earnings, liquidity, and capital positions. Banks must also ensure that liquidity risk strategies are clearly articulated and understood throughout the institution, especially in business units that generate and consume liquidity.
Concentration Risks
In understanding bank funding risk, management should identify concentration risks, including:
- Large fund providers or depositors
- Concentrations to certain industries
- Concentrations of non-insured deposits
- Concentrations in certain types of wholesale funding
A study of historic deposit behaviors can also help banks understand the expected maturities on their deposits.
Addressing Data Problems
The experience of helping banks assess liquidity risk in institutions around the region highlights the need to address data problems. Accurate risk assessment depends on aggregating data across multiple systems to develop a group- wide view of liquidity risk exposures and identify constraints on the transfer of liquidity within the entire banking group.
Independent Review
Finally, an independent review can be helpful to evaluate liquidity risk management processes for their alignment with regulators’ guidance and industry sound practices. With these efforts, banks will deliver strong returns on their investment, and better manage liquidity, which will ultimately reduce costs and provide a competitive edge in today’s market.