Risk management awareness improves, but budgets static

Despite the rise in the importance of risk management, less than half of European financial institutions surveyed have increased spending

LONDON - Although 87% of respondents to a recent survey of risk managers at financial institutions, conducted by insurance broker Marsh and independent research group Ipsos, stated senior management now perceives risk management as more important, only 47% said budgets for risk management expenditure were growing.

"The global financial crisis revealed a breakdown of certain risk management controls in financial institutions," said Carrick Lambert, industry practice leader for the financial institutions practice, Europe, the Middle East and Africa, at Marsh. "The results of our research demonstrate just how little confidence European financial institutions have in their current risk management procedures. Despite over four-fifths of respondents stating that their organisations are now reviewing their approach to risk, it is disappointing to note that 'new thinking' is not being backed up by financial investment in more than half of the organisations surveyed. More money needs to be invested in risk management as business practices are fundamentally overhauled, which is crucial in terms of strengthening the overall risk management function and restoring stakeholder confidence."

The survey, the results of which are detailed in Marsh's paper, 'New risk management insights for financial institutions' - the first in a series of industry sector reports to be published over the coming weeks, was compiled from interviews conducted with risk and insurance professionals employed in more than 120 financial institutions across Europe. It examined their attitudes towards risk management in the current economic downturn, risk priorities, risk strategy, and management and risk solutions.

Among the key challenges facing financial institutions, 68% of respondents expressed concern about the level of risk associated with their customers. Among the steps being taken to manage this risk are rigorous credit checks (33%), better communication (31%), and stricter payment terms and conditions (25%).

The report also identified the most significant operational risk for the next 18 months. The foremost of these was business continuity, with 58% of respondents predicting it will be a very or fairly significant operational risk. The next most significant risks identified are liability and legal risk (52%) and fraud (44%). "Unlike the threat of terrorism or the physical perils that featured prominently in historical risk agendas, these risks arise from reduced liquidity, and credit and counterparty risks, and manifest themselves differently across specific industry segments," says the report.

In such an unstable financial environment, firms are reporting a dramatic increase in litigation and criminal activity, particularly as investors seek to recoup their losses and investigations into poor lending practices reveal increased internal and external fraud.

"While most respondents were concerned about business continuity issues over the next 18 months, management liability and legal risks were also seen as priorities. Nearly 45% of respondents rated fraud a significant concern over the next 18 months, both in relation to the global financial crisis and the fact that such activity is historically shown to increase during any period of economic downturn," said Charles Beresford-Davies, a head of Marsh's UK financial institutions practice. "This correlates with the recent experience of many of our own clients, who are showing increased incidence of claims in areas such as mortgage fraud, breach of mandate allegations, mis-selling, Madoff-type events, shareholder disquiet and regulatory investigations. With all this evidence, it is our strong recommendation that all financial institutions review and update their risk management infrastructure."

One of the key recommendations made by Marsh is for firms to consider the use of insurance techniques for external risk transfer, which only 58% of firms interviewed confirmed they were already using. Marsh recommends firms align the procurement of risk-transfer solutions with business objectives and the associated risks. "Many financial institutions have not made an explicit link between the purchase of insurance and risk management. Financial institutions must develop closer working relationships that allow co-development of risk models and integration of risk management efforts," says the report.

Making the risk function more visible and driving costs savings through the use of insurance are other recommendations made by the report.