Developing an ERM Framework for Your Financial Institution

Enterprise risk management — or ERM — is a topic of very real strategic consideration for financial institutions such as banks, lenders, and credit unions. Risk is an in-built and unavoidable aspect of the lending and banking business models. But even with an inherent element of risk and vulnerability, these companies must implement proactive measures that serve to neutralize threats, reduce risk, and minimize vulnerabilities. 

Enterprise risk management is extremely dynamic, with new risk factors and vulnerabilities arising on a continual basis. This means that effective risk mitigation is akin to a game of whack-a-mole, with players forced to take aim at a moving target. The solution: an enterprise risk management framework, which will shape and guide an organization’s risk mitigation efforts. 

The financial space is one that is rife with the risk that is due, in large part, to the lending and banking business model. Financial institutions incur a fairly significant amount of risk by virtue of this business model which carries threats that cannot be fully neutralized or eliminated. In these cases, the focus is on minimizing vulnerabilities and managing risks instead of completely eliminating them. 

So how do you launch an effective enterprise risk management strategy at scale for a large corporation? An ERM framework offers the ideal solution, serving as a guide for an organization’s risk mitigation efforts. 

What is Enterprise Risk Management?

Enterprise risk management deals with the threats, risk factors, and vulnerabilities that large companies and corporations confront on a continual basis. The objective for an organization’s ERM-related activities will vary depending upon the nature of the risk factor or vulnerability in question. For example, financial institutions such as lenders deal with an inherent element of risk that arises from the natural course of business. There is always a risk that a borrower will default on a loan, even if they have a stellar credit score and consistent payment history spanning many years. The risk always exists in this equation, but a lender can implement borrower screening practices and policies that effectively minimize risk. 

Enterprise risk management involves five basic steps that can be effectively guided with the use of an ERM framework. 

1. Identifying Risks and Vulnerabilities
2. Assessing the Dynamics of Risk Factors and Threats
3. Prioritizing Risks, Vulnerabilities, and Threats
4. Planning and Executing a Response
5. Continual Monitoring of Threats and Vulnerabilities

These five steps of the enterprise risk management process must be performed at scale, which brings its own unique set of challenges. Enter the ERM framework.

What is the Role of an ERM Framework? 

Enterprise risk management frameworks serve as a guide for an organization’s risk mitigation efforts. A risk management evaluation often leaves business leaders uncertain of where to begin. This is especially true at the enterprise level, where you are more likely to encounter serious large-scale issues that can be very challenging to address. 

ERM frameworks can contain anywhere from four to eight components or more. A simpler framework of four components may focus on the following areas: 

1. Policies, protocols, and governance;
2. Assessment and prioritization of risk factors;
3. Risk management and mitigation efforts; and
4. Reporting and risk monitoring. 

The COSO framework serves as a more in-depth guide, with a total of eight components. They are as follows: 

1. Evaluating the company’s internal environment;
2. Establishing goals and objectives;
3. Identifying events that represent a threat or vulnerability;
4. Evaluating and assessing risk factors and vulnerabilities; 
5. Planning an ERM strategy and risk mitigation response;
6. Performing risk mitigation efforts in accordance with the ERM strategy;
7. Collecting data and metrics for analysis; and
8. Continual monitoring and alerts for new vulnerabilities and risk factors. 

How Do You Develop an ERM Framework for Financial Institutions? 

A well-architected enterprise risk management framework can go a long way toward guiding and organizing a company’s efforts to neutralize threats and minimize risk factors. There are a number of different pre-made ERM frameworks that can be used as-is or customized to suit an organization’s unique needs. 

In the case of a financial institution, you must consider the fact that complete risk elimination is not always possible. Risk minimization and threat reduction may be a more reasonable objectives. Therefore, the company’s ERM framework must reflect this and expectations will need to be adjusted accordingly. 

Enterprise risk management frameworks must apply to the several different types of risk that impact the financial institution. Here is a look at the types of risk that banks, lenders, and financial service providers can expect to confront in the course of business. 

Operational Risk 

Operational risk refers to the threats and vulnerabilities that arise in the course of business. For instance, a teller could accidentally give the wrong amount of cash to a customer. This incidence of human error is an example of operational risk. 

Strategic Risk 

Strategic risk refers to the risk factors that interfere with an organization’s ability to fulfill its strategic objectives. Strategic risk can take many forms, from management changes, mergers and acquisitions, and fluctuations in demand, to changes in financial market conditions, new technology, or cash flow challenges. 

Technology / Cyber Risk

A financial institution’s technology represents a significant area of risk and vulnerability, with challenges arising from the fact that technology is constantly evolving and advancing. Cybercriminals, viruses, malware, ransomware, hackers — the list of tech threats is virtually endless, making this a significant area of emphasis for a bank’s enterprise risk management efforts. There’s also the issue of data management to consider, as banks store massive volumes of sensitive financial data — information that makes financial institutions a prime target amongst cybercriminals. 

Regulatory Compliance Risk

The financial sector is one of the most tightly regulated industries in existence and non-compliance can lead to significant consequences, such as fines totaling hundreds of millions of dollars. Take the recent case of nearly a dozen major banks, which were fined a combined sum of $1.8 billion dollars after bank employees allegedly used consumer-grade messaging apps to communicate with clients. This led to record-keeping law violations, which prompted the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) to hand down a precedent-setting nearly $2 billion in fines. 

Reputational Risk

Reputational risk refers to a bank’s public image and the collective’s view of the financial institution’s reputation and trustworthiness. Reputation and a sense of trust is extremely important in the financial sector, where even the most talented public relations team cannot always repair the damage from an adverse event.   

Third-Party Risk

Third-party risk management — better known as TPRM — involves screening the vendors, contractors, and other third parties whom a financial institution encounters in the course of doing business. For example, an IT contractor could gain access to sensitive financial information while performing work for a financial institution, resulting in a data breach that could destroy customers’ trust in the bank. 

There are also several risks that are specific to financial institutions. They include: 

• Credit Risk – Credit risk primarily refers to the risk of defaulting on a loan. 
• Liquidity Risk – Liquidity risk refers to the potential inability to pay depositors when they decide to withdraw funds. 
• Equity Risk – Equity risk refers to the potential of losing money when an investment — usually stocks — decreases in value. 
• Market Risk – Market risks refer to losses that are associated with downturns on financial markets such as Wall Street.  
• Currency Risk – Currency risk refers to exchange rate fluctuations that ultimately lead to financial losses. 

Technology to Support Your Financial Institution’s Enterprise Risk Management Efforts

To maximize your results, it’s best to deploy technology that supports your enterprise risk management efforts. A risk management software platform can be extremely effective in streamlining a financial institution’s ERM efforts. 

At iTech, enterprise risk management solutions are among our specialties. Our innovative team collaborates with clients with the goal of understanding their ERM challenges and goals. Then, this insight is used to guide the development of a purpose-built enterprise software solution. We invite you to reach out to the iTech team today to begin a dialogue on your financial institution’s ERM framework and risk management strategy.