Disaster Risk: Relatively Newer Identified Risks in Banking
(Published in the Financial Express 2018)
Dr. Shah Md Ahsan Habib
Disasters cause direct damages by partially or totally destroying immovable assets and stocks. Disasters also give way to indirect losses by affecting the flows of goods and services, including financial service delivery. This type of losses results from the direct damages to social and economic infrastructure and to production capacity. Some serious risks concerning disasters especially that originated from external environment and sources may cause havoc to the banks and their clients and thus as a whole the banking and financial industry. From the risks perspective, among the external risks, disaster risk is of particular relevance to a bank’s clients and the institution itself. Certain sections, that are typically low-income clients, suffer from both a higher disaster risk exposure and a lower risk bearing capacity than other population groups.And unaddressed disaster risks causes huge damage not only to the clients, their enterprises, income streams and ability to repay loans, but also the bank’s portfolio, their service delivery capacity and the sustainability of their impacts. Natural disasters – along with economic crises and civil conflicts – are among the main sources of aggregate shocks to society, and often lead to dramatic losses. In the financial sector, a bank, its services, and the physical infrastructure might be directly affected by the disasters. Indirect losses to a banking institution result from the effects of the disaster on clients. Especially, natural disasters have the potential to devastate entire regions and massive damage of property. Severe natural disasters have always occurred, but they were considered low-probability events two decades ago; however, experiences from the last two-decades have changed this perception and now it becomes crucial to understand the consequences of natural disasters and their management. It is being increasingly proven that a country’s gross domestic products could be severely affected by the disasters. From the perspective of financial sector, when a country’s national production and its future growth can significantly be impacted by disasters, the financial institutions and their regulators/supervisors should definitely ask themselves if they and the financial system at large are resilient enough to withstand sizeable natural disasters or not.
Disaster risk is one of the most neglected external risks faced by banks and financial institutions, which tend to be unaware not only of their own levels of exposure but also of those of their clients. Disaster risk exposure is intrinsic to banks, adding to the overall vulnerability level of the banking and finance industry in both developed and developing countries. Banking and financial sector of the developing countries are relatively more vulnerable when a good portion of financial services are delivered locally to the low and small scale enterprises; these institutions directly assume their clients’ high disaster risk exposure levels. These facts have become more significant due to the global increase in frequency of disaster occurrence and volume of losses in recent decades. Experiences indicate that banks cannot avoid disaster risk, let alone ignore it, and with the growing visibility of the climate change impact the necessity of addressing the disaster risks became even crucial.
On the way to address disaster risks and the associated vulnerabilities, Disaster Risk Management is getting growing importance in all economies, which is a dynamic process that requires continuous adjustments, decision making and interaction amongst variety of institutions and actors in an economy. In regard to the DRM in the banking and financial sector, there are voices from the industry expert for an urgent integration of disaster risk management into macro-prudential supervision, by accommodating certain provisions in policy documents and operations of both financial institutions and their regulators/supervisors. There is growing recognition of understanding the importance of the impact that natural disasters can have on assets quality and financial stability, and how DRM, which includes issues such as insurance penetration, public sector continuity planning and business continuity planning and the ability of Government, businesses and communities to handle disasters, should be considered as part of macro-prudential supervision and regulation. And there are also feelings in several quarters that to be realistic, the disaster risks should explicitly be tagged with capital requirements in the banking industry. The growing concerns rightly call for installing and using financial arrangements and appropriate products-savings, credit, investment, insurance and special social funds, as part of the spectrum of disaster risk management.
Published data of German Watch and Swiss Re reveal that of the global regions, Asia is the most vulnerable in terms of natural and manmade disasters, and economic losses in responses to these. And the economic losses estimated are abnormally high in Asia as compared to other regions in the globe. Developing countries found place in the top ten in terms of number of events (natural disaster) and economic losses; and Bangladesh is in the list- According to the most recent survey of German Watch, Bangladesh is in the top third climate disaster affected country in number of events; and in terms of per unit GDP, Bangladesh is in fourth position.
From the perspective of the banking and financial sector, disaster risk is the probability that an adverse event (or events) will occur and will potentially affect an exposed element or system, such as a household, a community, or a country, on the one hand; or the banks and financial institutions and/or some of its institutions, on the other. Disasters cause direct damages and indirect losses to banks and financial institutions. Direct damages are reflected in the partial or total destruction of offices, equipment, information systems and records. Indirect losses result from disruptions in service delivery and from the direct and indirect effects of the disaster on clients. For banks clients, disasters might increase the normal risks intrinsic to borrowing and running a small business or enterprise. Loans that are useful under normal circumstances will pose additional challenges after a disaster. Under conditions of unmanaged risk, the consequent risks attached to borrowing include the possibility of greater indebtedness to cover disaster losses, and of accelerated asset depletion and reduction in consumption levels to meet payments. If a major disaster occurs, however, livelihoods may be so badly disrupted that many microfinance clients may eventually be unable to repay their loans. Many clients may actually have to move temporarily or to migrate permanently after losing some or all their household and productive assets.
At the institutional level, disaster risk exposure – and eventually disaster impact – is related to the size, age and level of financial and operational sustainability of the organization. In respect of clients’ profile, institutions reaching very low income clients tend to be more vulnerable to disasters. Disaster effects trigger or interact with some of the normal risks faced by banks, including institutional and strategic, operational, financial management and external risks. These effects also make evident organizational vulnerabilities related to poor governance and/or poor governance structures. As all these risks materialize, the effects of the disaster on a banking institution intensify. It is thus relevant to understand the interaction between disaster effects and these risks.