But banks are expected to spend 7% more on risk technology this year than they did last year, according to IDC Financial Insights. The firm predicts that worldwide financial services information technology spending on risk management technology will exceed $74 billion by 2015. The analysts expect IT spending on risk management to top 15% of total IT spending in financial services in 2012.
New regulations calling for stronger risk controls and reports, such as Dodd-Frank and Basels II and III, are a big driver. "In the big picture, Dodd-Frank has huge implications for banks' technology spending," says Jaroslaw Knapik, senior industry analyst, banking technology at Ovum. "Right now, banks are preparing the foundation for future changes." For instance, Knapik sees some larger banks upgrading their core banking systems to adjust to new risk rules.
Banks are generally unhappy with their current risk technology. Only 9% of community bank executives (at companies with less than $100 million of assets) think their risk management technology is effective, according to a survey of the American Banker Executive Forum conducted in August (in partnership with Total System Services, Tata Consultancy Services and Jack Henry). Large banks are more satisfied: 48% believe their risk technology works; among midsize banks the rates were in the low 40s. To close this gap, 72% of all banks plan to increase their spending on risk management technology in the next 12 months, according to the survey, which polled 303 U.S. retail bank executives.
These investments will be guided by several trends in risk management approaches.
TREND No. 1: Adoption of enterprisewide risk management software among smaller banks. Such software gathers risk data from different parts of an organization to provide an enterprisewide view of risk. A survey of the American Banker Executive Forum found that large banks are saturated with ERM - 87% of banks with more than $10 billion of assets have enterprise risk management software. Among banks with less than $100 million of assets, only 24% do. However, 36% of small banks plan to introduce an ERM program in the next 12 months.
The market for enterprise risk management and infrastructure solutions as defined by IDC Financial Insights (hardware, software, internal and external services) is $2 billion-plus and is expected to grow more than 8% per year through 2015. "Firms continue to want to chop down the silos and provide more information across disciplines," says Michael Versace, research director of IDC.
"There's an evolution toward personal accountability and responsibility of board members," says Todd Cooper, vice president and general manager - enterprise risk and compliance at Wolters Kluwer Financial Services. "It's part of the need for an organization to be a good steward of all its investors' and customers' funds. This has been coming in the U.S. since the Enron and WorldCom scandals. The financial crisis and Dodd-Frank put an increased emphasis on the ability for an organization to wrap its arms around what its true risk picture looks like. Federal regulators insist that banks effectively manage risk and have programs and technologies that demonstrate their mastery of the situation."
BANK DOING THIS: Blue Hills Bank of Hyde Park, Mass., is using Wolters Kluwer ARC Logics for Financial Services to measure, monitor and manage risk across all of the bank's business lines.
TECH PROVIDERS: The large business intelligence software companies, e.g., International Business Machines (OpenPages), Oracle and SAS, all provide ERM software to large banks. For smaller banks, MetricStream and Wolters Kluwer's ARC Logic are among the options.
TREND No. 2: Adjustment of credit risk models for procyclicality – in other words, the impact of the distressed economy. Procyclicality is a fancy word for the way the actions of policymakers and businesses to adjust for a recession often make the downturn worse.
The financial regulations of the Basel II accord have been said to cause procyclicality because the agreement requires banks to increase their capital ratios when they face greater risks. Basels I, II and III all require banks to calculate risk weightings for all their assets - including consumer and commercial loans - under various economic scenarios to determine how much capital they need to set aside in case of default. This can cause banks to lend less during a recession, which can aggravate the downturn.
"When the economy gets worse, risk gets worse, and when the economy gets better, risk profiles and risk levels improve," says Andy Jennings, the chief analytics officer and head of FICO Labs. "One of the drawbacks of the way we model risk today is that it amplifies both cycles." As risks increase, banks' capital requirements increase when it's too late to make a difference. "You have to put capital away when times are good, not when times are bad," Jennings points out.
This vicious cycle has thrown the normal use of credit scores and credit risk modeling into confusion. Today a credit score of 700 might mean a customer has a 1 in 20 chance of not repaying. If the economy were to get worse, the odds would change to 15 to 1 or something like that. "The problem arises, how do you predict what that the odds ratio might be under a given set of economic factors?" Jennings says. New or modified credit score models can help. The catch? Someone in the bank has to take a stand on what the economy will do - the models cannot forecast the future.
BANK DOING THIS: Raiffeisen Bank International is using FICO's economic impact service to overlay macroeconomic information on top of its traditional credit scoring system, adjusting risk scores based on recent and projected economic conditions.
TECH PROVIDERS: FICO (economic impact service) and SunGard (Ambit credit portfolio).
