15 November 2019

Margarita Delgado: The management of non-financial risk

Opening remarks by Margarita Delgado, Deputy Governor of the Bank of Spain, at the11th edition of the European SSM Roundtable, where she spoke about the management of non-financial risk - an issue which is always in the spotlight and, at the same time, is quite hard to tackle.

Banks are certainly familiar with the regulatory requests to understand, measure, hedge, control, assess, address or mitigate risk. I believe it is fair to say that any firm that has survived the crisis and its long aftermath, without public support, has been largely successful in fulfilling these risk-related tasks. Of course, supervisors are also permanently concerned about risk; to some extent, it is what we are paid for.

The concept of risk is always linked to a loss which is, by definition, uncertain. Any loss which is certain is not a risk anymore; it is simply a cost. Nevertheless, financial risk is always the consequence of specific financial choices; namely, the decision to purchase an asset or grant a loan gives rise to certain risks for the institution.

Despite the uncertainty, the financial risks posed by that given transaction can generally be measured, in the sense that losses tend to be limited and associated with known events, which are likely to occur with a certain probability.

The rationale of banks’ business models is to take on this financial risk and generate profit from it. Of course, banks should assess this profitability jointly with the level of risk assumed in order to take informed decisions.

In my view, the mitigation of non-financial risk is linked to the quality of internal procedures, IT systems, governance structure or compliance function of a bank. In other words, it is not so much about what banks should do, but how they should do it.

Let me refer briefly to business conduct. The crisis has reminded us, rather painfully, that conduct is another key factor to consider in any sustainable business model. I would like to point out that conduct change is the only means of responding to the challenge the sector faces to restore its image and reputation.

The losses experienced during the crisis and its aftermath should act as a powerful reminder that we cannot relax or lower the bar. There is no room for complacency if we want to avoid repeating past mistakes.

In this regard, I wanted to convey a few messages today. First, maintain your fundamentals and keep on improving your three lines of defense; make sure that accountability and ownership for each risk is defined and well-understood within your institution. Second, remember that improving essential risk management and controls, including data quality, should not be seen as a cost, but as an investment for the future. Finally, keep on working towards appropriate balances between risk and reward, making this sustainable over the cycle.

I believe it is revealing that the title of the conference refers to the management of non-financial risk as ‘the next big challenge’. As I have noted today, these risks have been in the spotlight of banks and supervisors at least since Basel II, so an observer may question whether they can still be characterised as the ‘next big challenge’.

I actually agree with the statement made in the title. The pervasive and ever-changing nature of non-financial risk turns it into a permanent challenge for banks and supervisors. The most recent and obvious example would be the emergence of environmental risk as a source of concern for all of us.

Full speech

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