When risks converge, do you know how your financial dominoes will play out?

If you’re familiar with the game of dominoes, then you probably know that there’s more to it than first meets the eye. At face value, dominoes is a simple game of matching tiles. But if you’re playing to win, you need to read the table and think ahead to connect the dots. Only then can you prevent events from ‘chipping you out’. 

We think a similar claim can be made about risk management. While all financial institutions (FIs) work to monitor and mitigate individual threats, not all assess the repercussions of multiple risk events occurring at once. By looking at risks in isolation instead of recognising them as interconnected dominoes, it’s easy for organisations to get caught out by their combined impact – which could pose an existential threat.   

The start – setting and surveying the table

In our experience, firms tend to have well-established and well-thought-out risk frameworks, complete with scenario development and stress tests. However, existing approaches are mostly made for identifying and managing individual risks – and that’s simply not enough to deal with the interconnected nature of risk.  

Gone are the days when a singular event happens and can be neatly contained. In our highly connected world, it’s far more likely that one event will ripple out to affect many different parts of your business, locally, regionally and globally and may trigger multiple waves of shocks. 

As complex, intersecting risks mount, firms cannot afford to be caught unprepared. So, how can firms develop a truly comprehensive and coherent threat response? To start, they need to understand how different risks might intertwine. 

To inspire that thinking, we’ve drawn up a list of scenarios where separate events could come together to form a complex web of interconnected risks. These scenarios are organised across four of the key themes, distilled from our discussions with top banks and financial firms at RiskMinds 2023 – the world’s largest risk conference. Together, they offer a snapshot of what risk management professionals believe to be the biggest threats currently facing the industry and the questions being asked.  

1. Macroeconomic uncertainty: How are you modelling the impact on economic policy and associated regulation of the largest election year in history? Do model outputs support approaches to mitigate potential economic and geopolitical tensions that could affect your business? 
2. Technology disruption from AI: How are you looking utilising the opportunities for cost and efficiency improvements that AI presents? Equally, how are you considering the risks of AI and social media on the financial stability of your firm?  
3. Regulatory expectations: How do you consider broader implications of regulatory changes, such as how certain policies might affect the management of financial risks? How will your infrastructure deliver the capabilities and reaction times required to manage stress events given this is more crucial to stability than the buffers you hold? 
4. People and skills: How are you assessing the future skills and ways of working required to manage financial risks? Are you investing in new skills, adjusting ways of working and workforce planning for structural labour market changes which could leave you short of risk professionals? 

The play – wargaming and embedding interconnected risks 

Addressing the interconnection between risks isn’t just prudent; it's essential for firms to safeguard their financial stability and remain resilient in an increasingly unpredictable world. But how can organisations go about building that all-important view of interconnecting risks and their potential impacts? 

When we collaborate with firms on this topic, we start by a providing a 'house view”, which applies the latest macroeconomic and other quantifiable projections such as interest rates, economic growth, inflation and more specific indicators such as market / product demand, change in consumers behaviour, and credit default spreads.  

We then follow the key steps outlined below to build a fully integrated scenario:  

• Wargaming beyond the desktop: Incorporate the latest emerging risks (like those outlined above) and articulate the interconnections across them to develop a severe but plausible scenario narrative. 
• Scenario expansion and include social media and sentiment analysis: Expand key variables in the scenario and then apply firm-specific social media and wider sentiment information.   
• Modelling and impact assessment: Project the key variables within the integrated scenario to understand the associated impacts on the firm’s balance sheet across short- and longer-term horizons. 
• Action planning and impact assessment: Develop the actions and broader considerations to address such as sources, quality and reliability of data. Update your playbooks (see previous article), resolution frameworks and recovery plans as appropriate. 

The end – embracing risk to build resilience

Just like in dominoes, where players are collectively creating the board, it’s essential to think about the strategic implications of each action, how it will impact the future, and understand how they interplay. Just as it’s important for players to infer what tiles opponents have in their hands, firms need to think ahead to how different threats to financial stability might stack up.  

The good news is that many firms already have the fundamentals in place to achieve this level of risk readiness.  

Stay tuned for our next article, where we share a step-by-step action plan for responding to a risk when it becomes a real-time threat to your business. In the meantime, if you’d like to learn more about how Baringa can help you manage interconnected risk more effectively, please get in touch.