Risk is the price paid for progress. As progress drives globalization, firms in the financial services sector worldwide face numerous market, operational, and credit risks. Throughout the industry, companies are seeking effective solutions to address their exposure to risks.
Risk exposure is more glaring in developing countries, but it resides also in the United States. In a January 2004 survey of US banks, Susan Cournoyer, a principal analyst in the Global Industries group at Gartner Research, found respondents currently allocate 8.7 percent of their IT budgets to controls (risk management and security). The survey also revealed that 30 percent of the surveyed banks planned to spend more on controls in the next 18 months. Spending will decrease for three percent and will remain at the current levels for 57 percent of respondents.
As another reference point, consider the world’s top financial services brand — Citigroup, which enjoys enormous competitive advantages. At the February 2004 Credit Suisse First Boston Financial Services Conference, in a Citigroup presentation, business risk management was cited as number two among the firm’s leadership priorities.
Although financial institutions around the world have been taking steps to reduce their exposure to loss as a result of customer default (credit risks), many are turning to outsourcing to mitigate their operational and market risks.
The New Basel Capital Accord in effect in 2004 is causing financial services institutions to mitigate operational risks by adhering to new capital requirements. Basel’s new risk framework focuses on processes, people, and technology, as well as credit rating methodologies and investment management. Cost-effective management of IT and transactional back-office processes has been a key market for outsourcing in banks for years. There is also an uptick in banks and credit card companies shifting the burdens and risk of their collections process onto outsourcing providers. Significantly, as globalization initiatives and terrorist acts have increased, financial services firms are quickly turning to outsourcing to mitigate operational risks in protecting assets and business continuity.
Market risks – such as the Southeast Asian currency crisis a few years ago, are also a notable growth area for outsourcing, especially among banks in developing countries.
According to V. Srinivasan, managing director and chief executive officer of ICICI Infotech, Limited, an IT provider that offers enterprise banking software among its solutions, many banks across the globe and especially those in developing countries are in only the preliminary stages of understanding potential market risks. “Except for the top two or three banks in developing countries,” says Srinivasan, “most have not implemented any risk management mechanisms for evaluating market risk.”
Attention shifts to market risks as the banks become more global. As ICICI Infotech’s CEO recalls, when India opened up its markets to the international financial community a few years ago, it encountered many globalization issues and faced maximum market risk. He says several regulatory, trade, and industry bodies in India now make it mandatory for all banks in India to use some kind of risk model. Another case in point – Thailand – went through a harrowing economic experience when it opened its market to world trade. The nation now has a very stringent regulatory framework, and it has started putting in place several risk measures spearheaded by government institutions.
“Initially, requirements are very rudimentary,” states Srinivasan. “But as the markets advance and the understanding of risk increases, policies are formulated and risk models are put in place.” He adds that the boards of directors at several banks in developing countries now have members who are from developed countries.
Originally the transaction-processing arm of ICICI Bank Limited (India’s second-largest bank and the first company to be listed on the NYSE), ICICI Infotech translated its extensive domain expertise and best practices into its Riskfree solution. Riskfree helps to measure risk by analyzing historical data and using varied risk models to suit a bank’s portfolio profile. It also supports decision making for risk mitigation by providing simulated scenarios.
Srinivasan notes a trend among small to mid-size banks, which lack internal risk-mitigation systems, turning to outsourcing providers with Internet-hosted solutions to “run the numbers, do the data manipulation, and give an analysis back to the bank.” He recommends those banks have an in-house risk practitioner able to verify the numbers and judge whether the financial institution is on the right track.
Outsourcing is an ideal solution for risk mitigation, as buyers can leverage a service provider’s experience in solving problems for numerous other financial services firms; as a result, change can be implemented faster and more cost-effectively. More importantly, a provider’s expertise and resources can be leveraged to go beyond addressing the risk issues at hand and actually create competitive advantage in the marketplace.