Banks are one of the most heavily regulated business sectors, with stiff regulatory compliance obligations and close scrutiny from regulators. As such, managing regulatory compliance has become challenging for banks in recent years. Compliance failures can result in significant fines, reputational damage, bad publicity, and even lawsuits. It’s vital for banks to conduct regular compliance risk assessments to identify, evaluate and mitigate emerging risks.

In this article we will discuss the concept of bank compliance risk assessment, its significance, the most common compliance risks for banks, and how it can help banks enhance their risk management strategies.

What is compliance risk in banks?

“Compliance risk” refers to the risk of regulatory sanctions, financial loss, or damage to reputation that may arise from a bank’s failure to comply with laws, regulations, and industry standards related to that sector. This includes risks associated with anti-money laundering (AML), know-your-customer (KYC) requirements, data privacy, consumer protection, financial stability, and other areas. 

Banks ust manage compliance risk by implementing policies and procedures to assure that they comply with applicable laws and regulations, as well as by conducting regular monitoring and testing to detect and address potential compliance issues.

A well-developed compliance management system with effective risk controls should establish and communicate compliance responsibilities to employees, the board of directors, and senior management; incorporate legal requirements and internal policies into business processes; and, ultimately, improve the effectiveness of the bank’s compliance programs.

What is a banking risk assessment?

A banking risk assessment is  the process by which a bank assesses the potential risks it may face in conducting its business activities. The risk assessment often entails: 

  • identifying and analyzing high-risk areas, 
  • assessing the likelihood and potential effect of those risks, 
  • comparing those risks to an organization’s overall risk appetite, and 
  • developing risk mitigation plans.

The primary goal of bank compliance risk assessment is to assure that the bank can operate safely while protecting the interests of its stakeholders. Done skillfully, the assessment should help bank executives make informed decisions about how to mitigate the risks effectively. 

Overall, banking risk assessment, including consideration of regulatory changes, is crucial to help identify security and operational risks and to develop risk management programs. Given the critical nature of banking and its role in the economy, managing risks is paramount. 

Here are the key categories of risks commonly assessed in the banking sector:

  1. Credit risk. The risk that borrowers or counterparties might default on their obligations, leading to financial loss for the bank. This includes both individual loan defaults and broader trends affecting portfolios of loans.
  2. Market risk. The risk of losses arising from adverse changes in market prices and rates, such as interest rates, foreign exchange rates, equity prices, and commodity prices.
  3. Operational risk. Risks arising from failures in internal processes, systems, people, or external events. This includes risks such as fraud, system failures, human errors, and natural disasters.
  4. Liquidity risk. The risk that the bank may not be able to meet its financial obligations as they come due, without incurring unacceptable losses.
  5. Interest rate risk. The risk that changes in interest rates will harm a bank’s financial condition, particularly its net interest income.
  6. Reputation risk. The risk that negative perceptions or publicity could harm the bank’s reputation, leading to a loss of customers or revenue.
  7. Legal and compliance risk. Risks arising from potential violations of laws, regulations, or prescribed practices. Given the heavily regulated nature of the banking industry, compliance is vital.
  8. Strategic risk. Risks arising from poor business decisions or inept implementation of business strategies.
  9. Country and sovereign risk. The risk associated with a particular country or jurisdiction, including its economic, political, and social environment, which might affect the bank’s operations or its investments in that region.
  10. Model risk. Risks related to the potential inadequacy or errors in models used for decision-making, valuation, risk management, and capital charge specification.

To conduct a banking risk assessment, financial institutions use a combination of qualitative and quantitative methods. They collect data, apply models, conduct scenario analyses, and stress tests, and frequently review and update their risk profiles. Effective risk management in banking assures the stability and resilience of the financial system and protects the interests of depositors, shareholders, and other stakeholders.

Common compliance risks for banks

Banks have four high-priority compliance risks.

  • Data privacy and cybersecurity breaches. The ultimate purpose of data privacy is to uphold public expectations, so banks have a duty of care when handling personally identifiable information (PII). The absence of robust cybersecurity procedures, effective policies, or internal controls can all expose banks to risks, ranging from potential data breaches and financial fraud to the endangerment of confidential client information.
  • Anti-Money laundering (AML) violations. Banks found guilty of AML violations can face significant legal and regulatory consequences, including fines and reputational damage. The 2019 statistics on penalties levied against banks revealed that more than 60 percent of fines were the result of non-compliance with AML regulations. AML compliance refers to processes, regulations, technological solutions, and other initiatives that combat money laundering efforts, keeping illegitimate funds from entering legitimate financial flows. 
  • Customer due diligence (CDD) failures. A bank’s failure to identify and authenticate its customers’ identities adequately, and to understand those customers’ business activities, financial transactions, and risk exposure, are referred to as CDD failures, which can greatly affect the bank’s risk profile. Inaccurate client identification and verification, poor record-keeping, and inadequate customer transaction monitoring are the most common causes of CDD failures.
  • Consumer protection violations. Banks should deal fairly and honestly with consumers at all stages of their relationship to avoid consumer compliance risks and causing consumer harm, whether through deceptive practices, unfair fees, or other forms of mistreatment. Consumers should receive up-to-date information from financial services companies about new products and services; that information must be easily accessible, simple to understand, and not in any way deceptive. Banks that are found to be violating consumer protection laws can suffer damage to their reputation, which might result in a loss of clients and business opportunities.

Manage compliance risk with ZenGRC

Risk assessment is crucial to risk management. Once the risks have been identified, appropriate controls can be put in place to mitigate them. That said, relying solely on manual processes and solutions such as spreadsheets can make these steps time-consuming and prone to errors.

Enter ZenGRC, a governance, risk management, and compliance (GRC) software tool that makes bank compliance risk assessment easier and more efficient by automating many manual tasks. 

ZenGRC delivers complete visibility into how your compliance efforts change your residual risk position. It also helps you identify and mitigate compliance gaps to assure ongoing compliance with regulatory requirements, including regulations such as the EU General Data Protection Regulation (GDPR), California Consumer Privacy Act (CCPA), Health Insurance Portability and Accountability Act (HIPAA), and more.

Schedule a demo of our software today to learn more.