The financial crisis had a devastating effect on the financial sector and, in turn, the global economy. After the dust settled, it became clear that many firms had failed to invest enough resources to formulate effective early warning systems, which are critical in detecting the initial signs of credit deterioration and default. Although capital markets are returning to conditions suggesting that the crisis is finally subsiding, the best institutions should remain cautious. All banks should continue to strengthen these early warning indicators, which necessitates proactive and dynamic systems and metrics that are regularly updated.

Key Findings

• Strengthening Early Warning Systems – Though the banks have adopted different methodologies to strengthen their early warning systems, all the participating banks have realised the importance of early identification of deteriorating credit in insuring the bank’s longevity.

• Metrics and Forecasting – The respondents use a variety of variables, CDS spreads being the primary one, to detect credit decline of counterparties, industries and regions.

• External Data – Internal findings receive precedence over external data sources. External data, however, still plays a big part in the participating banks’ methodologies. External data is used mostly as a marker to check the consistency of internal methodologies.

• Results – All of the responding banks have processes in place to escalate risk to senior management. Only three of the participating banks, however, are confident that these results are being used to influence the setting of risk appetite and business strategy.

Conclusion

All of the four participating banks are currently rectifying the various weaknesses in the detection of credit deterioration, which the financial crisis exposed forcefully. This is being done through the strengthening of existing systems or the development of new ones. Whilst one of the participating banks is still developing its systems, another created an independent group in 2008, which is specifically tasked with managing emerging risks proactively. At the other two banks, internal credit methodologies have been strengthened over the last 36 months, which should lead to much more proactive credit risk management.

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Over recent years financial services organisations tended to focus more on innovation and sales revenues. As a direct result, the front office has been very much at the fore in terms of investment and expenditure. At many leading tier institutions, prioritisation of front office initiatives had not been mirrored across the rest of the enterprise. Ultimately, banks were more focused on front office architecture, to an extent neglecting other functions. However, firms are now more attentive and realise the importance of more cohesive enterprise architecture.

Key findings

• Broker-dealers – The case of the Russian broker dealers is an interesting example to consider and several firms mentioned relying on proprietary technology in the Back Office.  

• However, talking about future initiatives, a number of broker-dealers mentioned vendor systems that will be leveraged to replace legacy back office platforms. This is interesting given that quite a few of the Russian broker-dealers are growing rapidly, entering new markets and on-boarding new products, (such as FX).

• It certainly seems that an in-house approach is no longer feasible or appropriate and that the incumbent in-house infrastructure is no longer capable of supporting this growth. Expansion looks to be driving the transition towards a vendor based approach. Only one broker-dealer indicated that there are no plans to replace the current in house architecture at the moment.

• Investment Banks – The two top tier European firms that Lepus spoke to have already been live with vendor solutions for a number of years. One institution mentioned Diasoft and the other, New Athena. A number of other leading tier European and US firms have also implemented vendor solutions in this space.

Conclusion

Russian protocols and the regulatory landscape seem to be some of the key drivers of IT strategy. A number of firms confirmed that Russian vendors are very useful, given that they are fluent in terms of Russian requirements and standards. Naturally, different organisations will have different requirements and priorities, and deciding whether to leverage internal resources or third party solution providers will depend on the overall IT strategy of the firm.

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Emerging markets can be defined as a nation’s economy that is progressing toward becoming advanced, as shown by some liquidity in local debt and equity markets and the existence of some form of market exchange and regulatory body.

Emerging markets generally do not have the level of market efficiency and strict standards in accounting and securities regulation to be level with advanced economies (such as the United States, Europe and Japan), but emerging markets will typically have a physical financial infrastructure including banks, a stock exchange and a unified currency. 

Key findings

• Overview of the market – Key areas of emerging market territories where banks are active include the Middle East, Brazil, Argentina, Africa and particularly in Asia still too. Banks spoken to for this report commented on the importance of a presence in Dubai and also Hong Kong and Singapore.
• Popularity of risk – Due to recent events in the markets, the risk control departments in general were definitely more important than in the past. Finally staff and their influence have greatly increased as a result of the financial turmoil. This was also highlighted earlier this year in much of the mainstream press. 
• Major risk issues – There are several major risk issues that are effecting banks at the moment across the emerging markets. Across the board, banks mentioned liquidity as a key issue. Also of concern was reputational risk, which was considered of paramount importance in emerging market countries. Banks said that they did not expect these issues to change over the coming year.
• Challenges in emerging markets – Emerging market challenges were considered plentiful. In short, they are people, competition and economic climate. Another issue was attempting to prize people away from other banks and also making sure that once they worked for the company that they stayed there. Recruitment and retention was a major issue that all banks discussed as a major challenge in emerging markets.

Conclusion

Emerging markets have been and continue to be, a topical area for risk departments in major financial institutions. Back in 2003, its importance was recognised when 10 international banks adopted the Equator Principles that dealt with the thorny issue of reputational risk in emerging markets.

The coming year in the emerging markets sector looks to be an interesting one but future initiatives will be minimal as the financial industry treads more carefully in the wake of the crisis.

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