Banks around the world have high risk exposure from various sources. And as we all learned from the financial crisis in 2008, risks in the financial industry can have a massive impact on the worldwide economy. To monitor against those threats, banks need to employ key risk indicators.
A key risk indicator (KRI) is a metric that monitors the state of a certain risk: both the chance that the risk event might happen, and the potential consequences if the risk event does happen. KRIs are early warning signs that a risk might affect the bank’s ability to succeed.
KRIs play crucial roles in risk management for banks. KRIs help a bank to assess and mitigate risks to its portfolio and to lower operational risk. Financial institutions of all sizes use these indicators to predict risks, provide an early warning, or offer a backward picture of risk events to help guide future initiatives.
Categorizing Key Risk Indicators for Financial Institutions
These are the main risk categories considered by financial institutions:
Credit risk refers to the danger of losing money due to a defaulting loan or the chance that the loan holder will not repay. Loan delinquencies and non-performing loans, for example, are both strong indicators of credit risks.
Credit-related KRIs are among the most important for banks, since these KRIs are highly predictive. For example, they can assist mid-sized banks in better understanding the pandemic’s effect on the local business community. Bankers have easy access to the data and may be the first to grasp the local economies’ financial state and future.
The second most important category of KRIs for banks related to operational risk. Operational risk is the risk of loss arising from the inadequacy or failure of internal systems, controls, procedures, or policies due to employee errors, breaches, fraud, or any external event that disrupts a financial institution’s processes.
In banking, the most important operational KRIs are derived from:
- Cybersecurity threats, including ransomware and phishing;
- Third-party relationships, especially third parties that provide IT or other mission-critical services to the bank;
- Internal fraud arising from misappropriation of assets, forgery, tax non-compliance, bribery, and theft;
- External fraud including check fraud, theft, hacking, system security breach, and data theft;
- Business interruption and hardware or software system failures, power outages, and telecommunications disruption.
Operational risk management is a continuous process that involves assessing risk, making decisions about risk, and adopting internal controls to help mitigate or avoid exposure.
A financial institution must evaluate its risk profile and construct a database to develop an effective risk management program, reduce operational risk in banking, and improve information security.
Market KRIs differ from credit-related KRIs, in that market KRIs help to analyze significant challenges affecting the current market.
For example, bankers closely watch unemployment numbers. The economic cost of rising unemployment is considerable. High unemployment not only indicates that businesses are facing weaker demand, but it also indicates that the unemployed are not able to participate in helping to recover the economy.
Examples of KRIs for Banks
Banks can use KRIs to improve risk reporting and decision-making. Here are some examples of quantitative KRIs for banks:
- Mean time between failure (MTBF). This is an operational KRI that measures how often a system fails and how quickly the bank can restore the system back to normal. Conceptually, it assesses the IT department’s capacity to develop and distribute stable services.
- Budget variance (budgeted vs. actual). This operational KRI assesses the risk of underestimating or overestimating expenses, resulting in issues with short-term compliance liquidity or capital allocation in the company.
- Number of deviations from Generally Accepted Accounting Principles (GAAP). This KRI assesses the risk of deviating from GAAP in the accounting and financial reporting processes. Failure to follow GAAP can lead to financial reporting problems, potential fraud, and regulatory concerns.
- Percentage of key performance indicator (KPIs) targets not met. This indicator measures how well the organization is accomplishing its KPIs goals. Meeting KPI targets means that departments are functioning according to the organization’s strategic goals; the higher the percentage of KPIs not met, the more the business is struggling to execute.
- Value at risk (VaR). This KRI determines how vulnerable a business is to future losses, and how much cash it should have on hand to meet those losses. This measurement allows senior management to consider their risk of lost income and potential brand damage due to poor investment decisions.
Why It’s Important to Identify Banking KRIs
Knowing the potential risks of a business unit helps a bank to determine its degree of vulnerability. As we have seen, a risk indicator can be any metric used to detect a change in risk exposure over time.
Banks are exposed to an immense amount of risk, so identifying the bank’s KRIs can provide information on events that happened in the past and help to understand the current state of its operations, financial position, and regulatory compliance.
Tracking KRIs will also allow you to predict failure, so you can avoid that failure by allocating more resources, such as employee training and implementing appropriate management processes.
In addition, using KRIs enables you to develop risk mitigation plans, which provide an action plan to reduce threats to business objectives and improve your bank’s chances of success.
ZenGRC Is the Ideal Risk Management Software
ZenGRC’s enterprise risk management (ERM) software delivers real-time threat detection. Financial institutions can use advanced features such as risk heat maps, and these tools help keep track of crucial system modifications required to secure information and implement a comprehensive risk and compliance management plan.
Moreover, as banks expand their business, they may be subjected to additional certifications and regulations. For example, suppose a bank becomes a payment processor for a healthcare provider; it then needs to be HIPAA compliant. Risk management tools help assess data controls to ensure they meet the healthcare industry’s requirements.
Banks can use ZenGRC’s risk management platform to perform a gap analysis, build business continuity plans and a risk framework, and document risk mitigation activities.
Contact us for a demo to learn more about how ZenGRC empowers financial institutions.