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The current stress environment requires a rapid response throughout the banking organization, including the board, executive management, business and operations, and risk management. As the third line of defense, Internal Audit (IA) also plays a critical role in helping the audit committee and executive management evaluate the institution’s processes for managing and monitoring risk, and testing the institution’s resiliency and controls. Chief Audit Executives (CAEs) in particular can provide the board with an independent perspective that can be pivotal in times of stress.
Actions that Bank CAEs and their IA teams should take now:
The following actions are of immediate priority to CAEs and IA teams:
Independently monitoring the risk impacts of stress. IA functions are well-positioned to connect the dots across risk factors within the organization, including taking an independent view on the potential impact of the current stress environment, forward-looking considerations, and the bank’s capability to manage the emerging risks for executives and the audit committee.
Verifying that the organization’s liquidity and interest rate risk modeling assumptions include the factors that contributed to recent events. In particular, IA teams should assess assumptions related to the impacts of digital banking and the influence of social media, both of which can potentially expedite the rate of deposit transfers in periods of stress. IA should also re-evaluate an institution’s liquidity and capital contingency plans.
Analyzing emerging risks. IA teams should institute more frequent communications with management governance committees and the Board of Directors (including executive sessions) surrounding emerging risk issues as the current situation evolves (see PwC’s Five actions bank directors can take now report).
Forward-looking action items for CAEs and their IA teams:
Beyond the immediate needs of the institution, below are areas where IA teams can support the organization as it makes changes that reflect lessons learned from recent events:
Evaluating the effectiveness of management’s balance sheet scenarios to verify that they reflect the current environment, including the potentially destabilizing impact of the increasing speed of money moving through digital banking channels and the broadcasting of opinions over social media.
Anticipating heightened regulatory focus on liquidity, interest rate risk and the capital planning process. IA teams can employ ad hoc reviews when assessing liquidity buffers, net income at risk, and capital adequacy ratios and risk tolerance limits as part of their determination of whether liquidity and capital could withstand a negative shock.
Scrutinizing the model validation team’s assessment of stress testing models to confirm they are providing an effective review and challenge to management’s evaluation of market fluctuations and their effect on liquidity and capital, including stress test monetization frameworks in light of funding challenges experienced in the current stress environment.
Evaluating the adequacy of the current internal audit plan in light of market events, and based on an evaluation of the organization’s current risk profile consider more frequent and in depth internal audits on liquidity risk, interest rate risk management and capital planning.
What’s next?
It’s difficult, if not impossible, for any organization to react to every question raised by each new headline in the current crisis. Instead, IA teams should seek to understand how risks are morphing as new strains appear and develop a plan to respond. The ideas we are sharing are a starting point.
Circumstances can, and almost certainly will, influence your crisis response plans; however, that should not derail your primary responsibility --- having an independent perspective to share with executive leadership, the audit committee and regulators.
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