Financial institutions will pay a heavy price for ignoring risks

Financial institutions often find themselves navigating treacherous waters, seemingly blind to the lurking risks.

The business of finance is simply pricing the risks. But then, financial institutions often find themselves navigating treacherous waters, seemingly blind to the lurking risks; especially with newer and emerging risks. While they may pay lip service to risk management, especially with regulatory nudge and market optics, many institutions still fail to invest in the full expertise and proactive measures required to safeguard their operations. This is evident from multiple incidents in the Indian scenario that have prompted financial regulators like the Reserve Bank of India (RBI) to step in and caution the entities or even ask them not to onboard newer customers. Be it technology or digital-based regulatory concerns that the RBI had at the HDFC Bank or the Bank of Baroda, or many other entities it regulates, it underscores the need for a more proactive and vigilant stance on digital risks. A partial risk solution is actually no solution.

In an era dominated by emerging technologies, the risks have taken on new dimensions. The advent of cyber advancements, blockchain, cryptocurrencies and fintech innovations has brought unprecedented opportunities but also vulnerabilities. These technologies have created a dynamic environment where risks can materialise at lightning speed, catching even the most venerable institutions off guard. Be it identity theft, phishing, know-your-customer (KYC) challenges, cyberattacks or ransomware, risks abound.

Hurts Consumers, Investors 

Believing that risks are reserved for others is the most perilous risk of all. It's a dangerous cocktail of negligence and arrogance. Financial institutions especially the banks, once regarded as bastions of trust, seem increasingly willing to cut corners when it comes to risk mitigation. The allure of immediate profits often blinds them to the reality that, in today's interconnected world, the domino effect of a single misstep can be devastating. The true cost of this recklessness is borne not by the institutions themselves, but by the consumers and investors who place their faith and finances in their hands. When the inevitable disaster strikes, it's the ordinary individuals who bear the brunt of the fallout. Savings disappear, investments crumble and the very foundations of trust erode. The excuses of "unforeseeable events" or "unprecedented circumstances" no longer hold water in a world where information flows at the speed of light.

Despite the proliferation of newer and more complex risks in the financial sector, coupled with repeated calls from financial regulators for enhanced risk management, it remains an unfortunate reality that financial institutions often remain inert until a painful lesson is learned. This reactive approach to risk mitigation, where substantive changes are only spurred by the tangible consequences of a risk event, underscores a systemic complacency that can have dire repercussions. The financial regulators have to step up penal actions on their regulated entities, by punishing them with high penalties and stopping them from doing business until those identified risks have been plugged.

The reluctance to proactively invest in preventive risk management and resilience measures until an industry peer or the institution itself faces severe consequences is a risky gamble that the banking sector can ill afford in today's rapidly evolving financial landscape. A more prudent and forward-thinking approach, guided by a commitment to pre-emptive risk management, is not just a regulatory mandate but a strategic imperative for financial institutions to thrive in an increasingly uncertain world.

Constant Vigilance Required 

In an era where technology has the power to both empower and endanger, financial institutions must embrace a culture of constant vigilance. They must stay ahead of emerging risks, adapt swiftly to changing landscapes, and uphold the trust that underpins their existence. In the age of digital transformation, financial institutions face a myriad of tech-based risks. The relentless push for innovation has given rise to complex systems and interconnected networks, making them susceptible to cyberattacks and data breaches. When a non-bank tele-caller knows more about your bank transaction than you do, it is a stark reminder that the walls of consumer privacy and data security are crumbling.

Emerging technologies introduce a new layer of risks. While innovations like blockchain and artificial intelligence hold great promise, they also bring unknown vulnerabilities. Smart contracts, for instance, can inadvertently encode flaws that lead to substantial losses, while AI algorithms can make biased or erroneous decisions that impact financial stability.

Banks, in their quest to fortify their defences against ever-evolving cyber threats, require risk management expertise that transcends theoretical knowledge. To effectively counteract the relentless innovation of bad actors, financial institutions must engage experts who have not only studied the intricacies of risk but have also delved into the minds of those who create these risks in the first place. By embracing practitioners who can simulate the tactics and strategies of the most sophisticated hackers, banks gain a unique advantage. To stop a cyberattack, it's essential to think like the best hacker ever. Only by understanding the mindset and methodologies of adversaries can banks hope to develop robust, pre-emptive strategies that safeguard their digital assets and, more importantly, the trust of their clients.

Despite the remarkable strides in technology, human risks remain a persistent and underestimated challenge. Behind every line of code and every transaction, there are humans making decisions. Behavioural biases, insider threats and human errors can still lead to catastrophic outcomes. Overlooking the human factor in risk management can prove costly, as the allure of shortcuts and lapses in judgment can undermine even the most advanced technological defences.

In the end, the choice is clear. Financial institutions can either rise to the occasion or risk becoming relics of an era when trust was abundant and risks were ignored.

Srinath Sridharan is author, policy researcher and corporate advisor. Twitter: @ssmumbai. Views are personal, and do not represent the stand of this publication.