Optimising balance sheet management in today’s market conditions

Financial institutions are going to continue struggling with challenges and volatility in 2023

The past three years have shown financial institutions how quickly the tables can be turned in the general operating environment and how this can affect their profit margins. With geopolitical uncertainty, economically challenging conditions and financial market volatility very much the order of the day, the panellists taking part in the SAS/Risk.net webinar, The balance sheet risk conundrum: optimising balance sheet risk management processes for current market conditions, agreed that financial institutions are struggling to cope with the risk that rapidly changing market conditions have brought on in the past year.

“The low-for-long rates situation created a search for yield and the underpricing of risk,” said Nicholas Wood, founder of FinTorque. “That is now playing out in a very seriously elevated risk scenario where the rapid rise in interest rates is exposing flaws in governance across a variety of institutions. We are in very elevated risk environment at a time when a lot of excessive risk has been put on the books.”

Under the previously low interest rate environment, many financial institutions underinvested in the proper technology and staff to deal with this risk, explained Donald van Deventer, managing director, risk research and quantitative solutions at SAS. “And so now, with a sudden increase in volatility and the recurrence of a very risky interest rate environment, people are scrambling for help.”

With further risks emanating from quantitative tightening, and the winding of pandemic relief lending and certain reporting requirements, the panellists highlighted the importance of stress-testing institutions’ exposure to a variety of risks and scenarios to measure their vulnerabilities. And, in the current volatile environment, Steven Smallsman, director for financial services treasury at KPMG Australia, emphasised the need for stress tests to be as comprehensive as possible across an institution, rather than conducting siloed risk assessments of individual business segments. This, he said, requires closer collaboration between the teams that model customer behaviour and the product managers in charge of day-to-day portfolios.

In this respect, technology is key. It plays a vital role in driving efficiency within financial institutions while also improving their capability to model risk scenarios and analyse the increasing granularity of data available to them.

“That analytical capability to do scenario analysis to a high quality is an under-represented aspect of treasury and asset-liability committees,” said Smallsman. “There’s a lot of business benefit that can be realised that would help treasuries to better manage their balance sheets.”

“The best balance sheet is one that, on a risk-adjusted basis, maximises the value of the organisation,” said van Deventer. “And benchmarking models on multinational databases to take advantage of the international experience rather than merely relying on the confines of a single country’s data helps when simulating a firm’s optimised balance sheet.”

The use of technology can also be particularly useful to maintain the institutionalised memory of a firm. “History repeats itself. Mistakes are repeated,” pointed out Wood. “Using technology to bring that memory into a usable and particularly relevant manner is very important. You can’t just rely on the memory of people who leave, it has to be institutionalised, and tech is a great place for that to reside.

“In the very dynamic risk governance situation we’re now in, we’re really going to be seeing the difference between those who have invested in the proper technology to help them through these conditions and those who haven’t.”

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