Special Edition: Reflections on the WEF Global Risk Outlook Report
(And what it means for financial sector resilience )
Last week the world witnessed the 54th anniversary of the World Economic Forum (WEF) held in Davos, Switzerland. Whilst some support it and others do not, it remains an important event on the annual business calendar and plays an undeniable role in fostering and shaping debate, discussion, ideas, collaboration and cooperation on the most pressing issues facing humanity and the planet. This year was no different with a focus on 4 main themes:
Achieving security and cooperation in a fractured world
Creating growth and jobs in a new era
Artificial intelligence as a driving force of the economy and society
Long term strategies for the climate, nature and energy
I have personally been an ardent follower of the WEF for many years now, having had the privilege of attending it in 2009. There is an abundance of commentary and reviews on the 2024 sessions online and it is not my intention to replicate any of this. Instead I want to focus on the key risk theme emerging from the WEF Global Risk Report, what it means for financial institutions and why it is important that they implement processes and tools to effectively respond to these.
1 Key Risks identified by the WEF Global Risk Report 2024
The Report ranks risks based on their severity and impact to global GDP, human population and natural resources and does so over a 2 year and 10 year period. Some of my observations from the assessment are outlined below (FIGURE C):
AI driven misinformation and disinformation which is ranked number 1 and is a new entrant on the top 10 arises due to the record number of people heading to the electoral polls over the next 2 years, 4 billion in over 50 countries, the largest in the history of mankind. This risk however does not exist in isolation and is closely connected and therefore may be perpetuated by interstate conflict and societal polarization that appear lower down on the list. This risk emphasizes the systemic importance of AI and notwithstanding the great promise it holds, can be equally disruptive in the hands of bad actors.
Climate changes and environmental risks are less prominent in the 2 year time period occupying position number 2 and 10, however considered of significant importance in the 10 year time frame where it occupies 50% of the top 10 risks and ranked most severe occupying the top 4 slots. Could this be a case of too little too late? Climate risks too are deeply interconnected with one another and may perpetuate other risks including chronic health conditions, infectious diseases and human migration patterns (already identified by prudential banking regulators as a top social risk).
Although recession concerns having faded, high inflation and interest rates remain a concern for an economic downturn in the short term, with far greater optimism exhibited over the longer term.
The risk environment is not just characterized by high levels of uncertainty and volatility but also a deeply interconnected nature that produces a compounding effect (FIGURE D). This makes it increasingly complex for financial institutions to pre-empt, prepare and develop the capacity for response thus weakening enterprise resilience and its ability to withstand an existential event if one where to arise. A compelling proof point is the Fortune 500 list of companies – today only 15% of those listed 50 years ago still exist and highlights the inability of organizations to respond to the growing complexity of risks faced. But what do we mean by compounded risks and how does it manifest?
McKinsey and Company recently published definitions for 3 types of compounded risks as follows:
Connected risk – single risks emanating from multiple sources that are connected.
Cumulative risk – minor risk that builds up over time leading to a major shock for the organization.
Novel risk – a new emerging risk arising from an interplay between 2 material risks.
2 What can financial institutions do to manage the complexity of these risks?
There are a number of steps that institutions can implement to improve their risk management capabilities and hence strategic resilience. We share below some perspectives based on our experience with financial sector clients and is not intended to be exhaustive:
Scenario planning – a robust and well-structured scenario planning process is vital and indispensable for strategic resilience in an environment characterized by high levels of uncertainty, volatility and risk interconnectedness. It helps organizations conceive multiple plausible futures and develop the capability to respond to a range of outcomes.
Strengthening risk governance – financial institutions need to increase the rigor of their risk governance processes with a focus on new and emerging risks. Whilst institutions are highly adept at understanding singular risk profiles and developing risk metrics and mitigants in response to these, the same is not true for understanding interconnected risks with compounding profiles. Risk reporting structures to the executive and board needs to include new and emerging risks and the implications and mitigation applied to compounded risks.
Implementing principles of innovation to meet sustainability targets – the recent COP28 meeting and WEF 2024 recognized the enormous climate change challenge facing us all. The UN Intergovernmental Panel on Climate Change scenarios all predict that global warming will exceed the critical 1.5C increase by 2030, triggering systemic level impacts to food, water and human health. Banks have an important role to play as intermediaries in the global economic system, limiting scope 1, 2 and 3 emissions. The world is in a race against time to limit the increases in global warming and to access the funding to support adaptation initiatives. Banks however will need to make paradigm shifts as to how they approach the challenge and consider the adoption of innovative approaches to identifying solutions to mitigate both physical and transitional risks. Strengthening innovation capabilities and implementing robust processes across ideation, innovation sprints and prototyping, solution development and commercialization will enable banks to identify unique solutions to manage not just their own carbon footprint, but importantly help their clients transition sustainably to a lower carbon footprint as well.
This article was written by Avinash Singh, our Risk and Compliance Lead Partner. You can connect with Avinash directly by clicking here.