Navigating Credit and Market Risk in Tumultuous Times

Hosted by Asia Risk on September 28, 2023 in-person in Singapore at the Marina Bay Sands, Asia Risk Congress attracted over 600 APAC-based risk, regulation and investment professionals.

Michelle Cheong who leads S&P Global Market Intelligence’s Credit Solutions Thought Leadership team was invited to participate on a panel on “Navigating Credit and Market Risks in Tumultuous Times”. She was joined by the head of the collateral risk management team (Bank of Singapore), the head of counterparty credit risk (ANZ), and the former head of market and liquidity risk (DBS).

Below are some key takeaways from this panel. Note, the viewpoints expressed by the panelists from outside of S&P Global are their personal views and do not represent the viewpoints of any organizations they are currently affiliated with or were previously.

Question: The Federal Reserve announced last week it was leaving its benchmark interest rate unchanged and signalled it could hike rates again in its fight to bring down inflation. How has this affected Asian markets, and what trends or shifts in risk have emerged as a result?

• The legacy of persistently low interest rates has resulted in record-high levels of corporate and household debt, possibly impeding "creative destruction" and enabling the survival of "zombie firms." This is increasing the risk of payment defaults, especially among weaker corporations.
• Recent rate decisions have led to cautious reactions in stock markets that are concerned about slow economic growth, resulting in moderate to high market volatility.
• Additionally, several Asian markets are grappling with currency pressure and capital outflows due to soaring U.S. interest rates.
• Elevated inflation, driven by supply shocks rather than strong economic growth, is expected to keep policy interest rates stable or rising, introducing additional risks. Rising rates may raise servicing costs for borrowers in the Asia-Pacific region, impacting loans, bonds, mortgages, living expenses, and discretionary spending, potentially reducing demand for goods and services.
• Globally, many corporations have insufficiently accumulated earnings and cash reserves to withstand higher interest costs, leading to higher Debt-to-EBITDA ratios and a clustering of credit ratings at lower levels, with a significant portion rated ‘B’ or lower. Even unrated corporations exhibit low credit scores with a median credit score of “b+ to b-” for most industry/country groups.

Question: The pandemic had a significant impact on supply chains in Asia, which serves as a major hub for global manufacturing and production. Considering Asia’s response to the pandemic, what are the expected economic implications for the region over the next five years, and how might this impact credit and market risk decisions?

• Supply chain risks remain elevated, influenced by factors like geopolitical tensions, ESG disruptions, and cyberattacks.
• Discussions on "globalization," "decoupling," and risk reduction are impacting asset allocation decisions for investors and banks, emphasizing the need for risk hedging and for corporates to lower concentration risks on suppliers and customers.
• Cybersecurity risks have emerged as a key risk due to the shift to remote work and process automation. Accordingly corporations are increasing their investments in this area.
• On average, entities with a better “Competitive Position” (see S&P Ratings Criteria here) appeared to be better in hedging out such volatility and supply chain risks. Their ability to meet debt obligations with cash flows resulted in a smaller decrease during this period.
• Finally, regionalization is a growing trend (versus globalization), bringing production closer to consumers.

Question: The continuously changing regulatory environment led to increased challenges to keep up with the changes and ensure compliance. In light of the evolving regulatory environment and increased capital requirements, what strategies can banks employ to effectively navigate these challenges and ensure compliance, while optimizing their operations?

• Regulatory Capital Boost: Asian banks are recognizing the need for higher capital reserves to ensure stability and preparedness during economic downturns. Many have started building up capital buffers to comply with updated regulatory rules, focusing on strategies like capital increases and risk-weighted asset reduction. Capital efficiency optimization and asset deleveraging are key themes in this pursuit.
• Basel III/IV Implementation in APAC: The implementation of Basel III reforms is staggered in the Asia-Pacific region. Banks are developing their implementation roadmaps, emphasizing senior management support and cross-functional teams to address technological and cost considerations.
• Data Efficiency and Scalability: Asian clients are increasingly concerned about improving data management, processing, and reporting efficiency. This aligns with Basel III guidelines that stress data accuracy, completeness, and effective risk data collection and reporting.
• Backend and Technology Enhancements: Banks are making investments to improve data handling and reporting that include reducing manual data transfers between systems, implementing data update audit trails and archives, and strengthening data record linkages across different databases/systems.
• FRTB and SA-CCR Compliance: As the deadline for compliance with the Fundamental Review of the Trading Book (FRTB) approaches, banks looking to deal with the complexity of FRTB guidelines (e.g., modeling of risk sensitivities, Counterparty Credit risks, and Counterparty Valuation Adjustments) can use turnkey services, hosted in the cloud, to scale up data integration, data aggregation and analysis, and risk modeling/computations.

QUESTION: Data analytics and predictive modelling have become essential tools. What are the innovative approaches banks can explore for managing both credit and market risk, and how might these approaches enhance their risk management strategies?

• Advanced Risk Management Tools: Banks are armed with advanced tools for credit and market risk management, leveraging multidimensional analyses and highly automated platforms to model diverse scenarios. They are shifting from retroactive approaches to proactive, fast-reacting metrics to detect and address risks early.
• AI/ML Adoption: The banking sector is set to embrace AI/ML models to enhance credit surveillance, early warnings, and automated customer financial assessments, extracting more value from data resources.
• Data Analytics and Predictive Modeling: Clients are looking to further utilize data analytics and predictive models, which offer valuable applications such as exception reporting and unstructured data analysis, akin to personalized recommendations.
• Promising Frontiers:
  1. Natural Language Processing (NLP) is gaining traction for sentiment analysis, drawing insights from sources like news and analyst research. For example, we see some evidence that lower research sentiment leads to higher default risks even within the same credit rating category.
  2. Some banks in developed Asia are adopting AI-driven translation facilitates to access non-English (Chinese, Japanese, and Korean) content for more timely updates in these local markets. We are seeing this especially in developed markets.
  3. Data science and visualization tools unearth valuable correlations between financial data and other disciplines, enriching analysis and insights.