There’s a lot going on in the world today – geopolitical tensions, social and economic unrest, an unrelenting health crisis, and rapidly accelerating climate change – just to name a few. Exacerbated by economic interdependencies, these unfortunate current affairs have combined to create a global stage where market volatility and third-party risks have taken centerstage. Businesses, having experienced severe disruption, are now scrambling to re-evaluate and reformulate their responses to these kickbacks. And while nothing can be done to correct past responses, plenty can be done to ensure better comebacks in the future. For that to happen though, investors and risk teams must take a good hard look at their risk management processes and uncover its shortcomings. Given that adverse global events have been increasing in occurrence, this exercise is much more than a mere suggestion. It is a mandatory one if you want to better crisis-proof your business and portfolio.
The current global state of affairs
When it rains, it pours.
This could very well be one of the defining phrases of the last few years. Bookended by major black swan events (more on that later), the past 2.5 years have seen the world lurch from one crisis to the next. The global Covid-19 pandemic ushered in adverse economic conditions such as higher inflation, slower growth, and tighter purse strings. To stay afloat during the pandemic, countries and businesses alike took on debt in unprecedented numbers. This resulted in record high global debt, that in 2021, touched a staggering $300 trillion. Nevertheless, this was seen as a necessary fiscal step taken to mitigate the economic aftereffects of a once-in-a-lifetime pandemic. Economists hoped that these extraordinary measures would pave the way for a quick post-pandemic recovery and, subsequently, rapid repayment of corporate loans.
The Russia-Ukraine war, which started on February 24, 2022, put-paid to these hopes.
The ongoing conflict has spiked energy prices, caused inflation to rise to a 40-year high, and re-disrupted global supply chains that were recovering from the pandemic. Naturally, all of this creates a pessimistic business climate that could see many businesses struggle to repay or refinance their loans. If inflation and interest rates continue to rise, this could even trigger a tsunami of loan defaults. Unsurprisingly, distressed corporate debt levels have doubled in the US bond market, a reflection of investor skepticism in the corporate bond department.
What’s more, the economic squeeze the world is experiencing right now has even affected businesses that thrived during the pandemic. Sectors such as Buy Now Pay Later (BNPL), EdTech, and Special Purpose Acquisition Companies (SPACs) were red hot investment arenas just over a year ago. Now, even the big players in these fields are reporting losses, laying off staff, and shutting down offices, causing investors to back away.
All of which may have led The World Bank to warn of a looming global debt crisis in March of this year. Sadly, the bank’s forewarning came to pass soon. Just 2 months later, Sri Lanka defaulted on its debt repayments for the first time in its history. Disturbingly, the UN warns that there are over 100 countries with severe exposure to the Ukraine war, some of which could go the Sri Lanka way if conditions do not change soon. And in a recent press release, The World Bank added to the chorus of warnings by stating that many countries were headed towards a recession in the coming months.
6 Risk management lessons from global current affairs
If you’ve just woken up from a coma, you would be forgiven for mistaking the above section as the premise for a dystopian novel. Unfortunately, it is the current global state of affairs. And while we hope that worst case scenarios do not play out, we should be prepared for them in case they do. One way to do that is to incorporate lessons learned from the past into future responses. So, without further ado, here are some lessons that risk managers can learn from global current affairs:
1. Black swan events can and will happen
The term ‘Black swan event’ is derived from the antiquated assumption that all swans are white. It is used to denote an ‘impossible’ event, which when occurs, has far-reaching and devastating consequences. The fact of the matter, however, is that black swans exist, both in the natural and economic world. And just like their natural counterpart, economic black swans are now an increasingly common sighting.
In the past 2 decades alone, we’ve experienced more than our fair share of black swan events. These include the dot-com crash in 2000, the 9/11 crash in 2001, the Great Recession in 2008, the European sovereign debt crisis in 2009, the never-ending Brexit saga that started in 2016, and ongoing situations such as the Covid-19 pandemic and the Russia-Ukraine conflict. One reason for this increase in frequency is our interconnected business ecosystem which can quickly take a crisis from the local to the global level.
What’s worse is that there could be plenty more on the way if inflation and interest rates continue to climb. As it stands, some analysts warn that we are entering a stage of market bubbles that include private equity, venture capital, and cryptocurrency bubbles. Whether these bubbles burst or not remains to be seen. What is certain is that such events should no longer be considered a rarity. It is therefore imperative that risk managers, rather than ignore the possibility, prepare for the eventuality by developing agile risk monitoring systems that can adapt quickly to rapid escalations.
2. Non-financial risk monitoring is important
Non-financial risks (NFRs) are on the rise. What’s more, they can even turn out to be costlier than traditional credit risks. Both the pandemic and the Russia-Ukraine conflict have amply demonstrated this. The UN estimates that the pandemic will slash global economic output by over $8 trillion and the ongoing Russia-Ukraine conflict has caused both the IMF and The World Bank to cut its global growth projections for the next two years. In addition, NFRs such as reputational, cyber, and ESG risks can cost companies billions of dollars in revenue annually.
Traditionally, NFRs and non-financial risk monitoring were low priority items on a lender’s risk management agenda. Given today’s changing risk climate and the fact that several recent risk events have stemmed from NFRs, it would be prudent to pay more attention to them and move them up the priority list. The good news is that there is plenty of non-financial data available today. What’s more, digitalization has ensured that most of this information is now at your fingertips, making it easier to keep up with the times. A necessary step, then, is to establish an effective system that can identify and capture all pertinent NFR-related incidents as they occur. This way, you can make timely de-risking decisions that protect your profit margins.
3. Don’t rely only on traditional forecasting tools
Traditional risk forecasting methodologies that rely on standard financial estimates can be effective when markets and economies are stable. In times of volatility, however, they can prove woefully inadequate. A key problem with traditional risk forecasting is its overreliance on historical data. But as current events have taught us, studying past events cannot adequately forecast future risk, especially when the future is volatile. When a crisis strikes, most historical data becomes redundant. This was the case with the Covid-19 pandemic. The sudden economic slowdown caused by the health crisis made most business risk forecasts completely obsolete.
Crisis scenarios aside, there’s a valuable lesson here for risk teams moving forward. Risk forecasting practices now need to go beyond quantitative examinations of historical financial data alone. Such conventional risk predictions are lagging in nature and its accuracy is contingent on the economy being stable. Since market volatility is almost a given now, risk forecasting techniques need to be modified to include leading-indicator data analysis too. Leading indicators are mostly non-financial risk KPIs which essentially act as Early Warning Signs of business distress. Including them can produce a system that is inclusive of current events rather than past happenings alone, thus giving you more accurate risk predictions.
4. Anticipate and detect changes quickly
We live in a world of instant gratification. Fast food, live-streaming, e-commerce, and 24-hour news cycles are now part and parcel of 21-st century living. Today, there is an overwhelming push to make processes faster, smoother, and more accessible. Sadly, risk monitoring has fallen behind on this trend. Even with all the
technology around, most organizations still rely on manually collecting data and recording it on spreadsheets and other paper documents to generate risk reports. The problem with this methodology is that because of the time it takes to collect, organize, and analyze all this information, the data used in these risk reports is mostly outdated. And working with antiquated risk profiles is never a good idea, even when markets are stable.
To keep up with rapidly evolving times, risk teams should now shift to on-demand monitoring processes. In addition, risk reviews need to increase in frequency as well. The traditional bi-annual or annual risk monitoring schedules must be replaced by weekly, if not daily, risk rundowns. Taking these steps can provide businesses a real-time picture of their counterparties’ risk exposures. Fortunately, the availability of real-time data streams and AI-augmented advanced analytics can make this kind of instant or near-instant risk monitoring a reality today.
5. Improve risk resilience
The best way to manage a crisis is to prepare for it beforehand. No matter how much you bolster your risk monitoring and forecasting abilities, there are some things you just cannot predict. For example, a sudden, devastating environmental event like a Tsunami or earthquake is hard to predict well in advance. So, preparing for a crisis is just as important as monitoring for and predicting them. For financial institutions, this obviously means establishing and maintaining adequate capital buffers. Since this is now a regulatory requirement, it is a mandatory step to improving risk resilience and maintaining your ability to lend even in unstable conditions.
From an investor perspective, age-old techniques such as portfolio rebalancing and diversification are simple yet effective practices that can go a long way in creating a portfolio that is more resilient to market fluctuations and shocks. Another technique is to invest using, what is called, a ‘barbell strategy’. This agile strategy basically involves investing only in assets that are at two ends of the risk spectrum (high-risk and low-risk entities), with the high-risk part of the portfolio never exceeding 10%. This allows investors to enjoy the best of both worlds without experiencing the pitfalls of either.
6. New risks present new opportunities
Risks and opportunities go hand in hand. This is another reason to invest in risk monitoring systems that are agile and efficient. They can free you up to look for newer business opportunities and help you identify emerging trends sooner. For example, current global supply chain issues can make domestic-oriented organizations a more attractive, safe, and alternate investment avenue. Similarly, the Covid-19 pandemic has seen sectors such as healthcare and digital connectivity boom. The investors who identified and invested in these trends early will have likely received good returns on their investments. Furthermore, the ongoing Russia-Ukraine conflict has forced governments everywhere to look for alternative sources of energy. This could accelerate growth in the renewable energy industry. The key here is to be on the lookout for these opportunities. After all, every cloud has a silver lining. You just have to search for it.
If history is any indication, it's not a question of ‘if’ but ‘when’ the next crisis will strike. In addition, risks that were once termed unlikely now require a closer look. This level of unpredictability and disruption can only be handled by a paradigm shift in risk management systems. In other words, risk management can no longer afford to be a rigid set-up driven by manual processes. Instead, it must now evolve to become a flexible system that can adapt to changes quickly. This shift can be hastened with the use of tech-driven risk management platforms such as TRaiCE which uses AI-augmented programming to harness real-time data streams and advanced analytics to generate Early Warning Signs of business distress. This can greatly help you navigate the tumultuous times we live in and even emerge stronger from it.
Need help with crisis-proofing your business or portfolio? Schedule a demo with us today and experience the TRaiCE way.