Building a warning system

In the wake of the US subprime mortgage crisis and the southern European sovereign debt crisis, it is now clearer than ever that risk and cyclicality are inherent attributes of banking. Volatility in the industry, however, is only intensifying: a typical banking crisis cycle can be viewed as having four stages (a positive macroeconomic environment, a substantial growth phase, then a sudden shock, followed by economic downturn) and a number of economies can currently be seen on the brink of entering stage three. This list includes Brazil, Nigeria, the UAE, Indonesia, and Turkey, but Italy is also entering dangerous waters after years of economic stagnation and questionable lending. How can another crisis be averted?

Today’s banks need more than preventative measures; they need a road map to steer through the turbulence. In this publication, we start by outlining the factors that make a difference – obtaining a solid understanding of the potential impact of economic downturns on the bank's loan book and income statement, undertaking preventive measures and closely monitoring the development of the loan book, and taking swift action to prevent and minimize losses. We walk you through the immediate gains (including early identification of risky clients), the mid-term benefits as processes and standards improve, and finally how those insights can be built into an effective early warning system (EWS).

The three key factors

Based on our assignments in several markets, we have developed a proprietary Loan Book Risk Cockpit (LBRC) which provides an overview of loan book risk levels in real time. This exclusive approach begins with top-down preparation and finishes with bottom-up implementation – and the whole process takes an average of 8-12 weeks. A major component of this risk cockpit is the EWS, which when combined with the loan book review becomes a lasting tool for banks and their futures.

Risk management is essential in today’s volatile banking industry, and you need the right tools. In addition to our LBRC system, we conclude this publication by revealing the three key factors to ongoing success: know your customer, look beyond traditional financial indicators, and always customize your approach.

If you want to know more about the most pressing issues for banks, please read our dossier: Costs, regulation, and technology: the potential of end-to-end digitization in financial services

• Photo credits: peshkov, iStockphoto; zhijian Huang, iStockphoto