Risk management is the process of identifying, assessing, and prioritizing risks; and then applying economic resources in minimizing, monitoring, and controlling the probability of unfortunate events in order to maximize on opportunities. After the financial crisis, there has been increased attention to risk management in the financial sector. In addition to governments putting in place stricter regulations, financial institutions have also been more cautious than before.
Types of Risk in the Financial Sector
Both banks and fintech startups face three main types of risk. These risks are discussed below.
In the financial sector, there is always a risk that borrowers will fail to repay the amount borrowed or repay later than required. If this happens, the lender stands to lose as its financial plans are interfered with. To minimize this risk, lenders need to assess the creditworthiness of a borrower before approving an application for credit. Before the advent of fintech, the process of credit scoring and evaluation used to take long. However, the process has been shortened by the application of fintech credit scoring making it possible to approve an application for a loan within a day. Additionally, fintech credit scoring is more accurate than the traditional methods because it makes use of a variety of information including social media behavioural analysis and spending history of an applicant.
Market risk is not limited to the financial sector but extends to other forms of businesses. it arises from the unpredictable nature of markets. Therefore, managers should have a thorough understanding of every risk that they take. Application of big data analytics in the financial sector minimizes the risk associated with market unpredictability. Individual investors can also minimize risk by hiring the services of robo-advisors.
There are numerous operational risks that financial institutions, whether the traditional banks or fintechs, face on a day to day basis. They range from cyber-crime to human errors. Therefore, financial institutions are investing substantially in operational risk management for a number of reasons. Firstly, there is the need to avoid the huge fines and penalties imposed by regulators for operational failings. Secondly, the increasing emphasis on personal accountability where senior executives are personally charged with strategic decision making is contributing to the focus on operational risk. Moreover, modern financial operations are rather complex, running on different IT systems. Therefore, financial institutions must have a clear picture of their operational risk exposure across the fragmented operations.
The Future of Fintech Risk Management
As technology advances every day, customers expect more from their financial service providers. As such, financial institutions have no option but to provide real-time solutions to customer requests, say to take a loan. This mean that there must be automatic ways of assessing risks. To have a well-erforming risk function, financial institutions will need to:
- Digitize core processes to minimize manual interventions
- Make use of advanced analytics and machine learning
- Enhance risk reporting to cope with the ever broadening regulations