The gravity of disaster risk and redefining risk management in banking

We are aware that disasters cause both direct damages by partially or completely destroying assets, and indirect losses by affecting the flow of goods and services. Moreover, disasters can affect a country's social and economic infrastructure and production capacity. 

Similarly, one of the most significant risks associated with disasters is that originating from external sources which wreak havoc onto the banks, their clients and consequently, the whole banking and financial industry.

Additionally, unaddressed disaster risks create huge losses not only for the clients, their enterprises, income streams and ability to repay loans, but also the bank's portfolio, service delivery capacity, and sustainability of their operations. 

However, it cannot be denied that disaster risk has not been on the priority list of the risk management processes of the banking and financing industry. The Covid-19 pandemic is driving key stakeholders of the financial sector to redefine the importance of disaster risk and reassess institutional risk management priorities. 

The environment, development and disasters are all interconnected. It is evident that environmental degradation and our development efforts contribute to higher disaster risk, which in turn, adversely affects human development and contributes to further environmental degradation. 

Disasters pose serious development challenges and undermine hard-earned progress on political, social and economic fronts. While it is often recognised that ecosystems are affected by disasters, it is hardly realised that protecting ecosystem services can both save lives and protect livelihoods. 

Many recent studies, especially in the context of Covid-19, highlighted the fact that investments in development are in jeopardy unless precautionary action is taken toward reducing disaster risk. Specifically, the Sustainable Development Goals (SDGs) also rightly recognised the risk to development stemming from disasters and called upon the global community to strengthen our collective efforts to handle natural and man-made disasters. 

Several natural disasters have occurred at regular intervals even though they were considered low-probability events two decades ago; however, experiences from the last two decades and the ongoing devastation are pushing us hard to understand the consequences and necessity of natural disasters and their management. 

The Covid-19 pandemic is driving key stakeholders of the financial sector to redefine the importance of disaster risk and reassess institutional risk management priorities.

From the perspective of the financial sector, when a country's production and its future growth can significantly be impacted by disasters, the financial institutions and their regulators/supervisors should ask themselves if they and the financial system at large are resilient enough to withstand sizable disasters.

The low-income communities are the most vulnerable to disasters because they often have the least access to prevention and preparedness. In addition, the poorest are the least resilient in recovering from disasters because they lack support networks, insurance, and alternative livelihood options. 

These facts have become more significant due to the global increase in the frequency of disaster occurrences and the magnitude of losses in recent decades. Even during the pandemic, news related to floods, hurricanes, storms, etc. is common. 

Many countries across the globe are experiencing the worst wildfires in years of recorded history. Experiences indicate that banks cannot avoid disaster risk, let alone ignore it, and with the growing visibility of the impact of climate change, addressing disaster risk has become essential.

Like many other nations, Bangladesh has been facing more and more natural disasters over time due to climate change. In fact, we are also listed as one of the most vulnerable countries to climate disasters in the world. Bangladesh has been experiencing several manmade disasters, fires, and other incidents that have caused huge business, economic, and reputation loss over the years. 

As a policy response, Bangladesh Bank became quite active in addressing disaster and disaster-related risks in recent years, though there were instances of scattered initiatives to help the disaster-affected people following some deadly natural disasters. 

The existing administrative setup of Bangladesh Bank delegates the key responsibilities associated with natural disaster risk to its Sustainable Finance Department. Several green banking interventions, environmental risk management initiatives, and corporate social responsibility ventures have also been associated with the disaster risk management efforts in the country's banking industry. 

However, unlike other banking/financial industries of the world, disaster risk is yet to be adequately recognised as a separate and critical risk element in the risk management processes of our banks and financial institutions. 

According to the existing relevant risk profile in banking, there is no scope to consider disaster risk as a tail-risk. The weak insurance market and the reluctance of using insurance or risk management tools are adding to the existing risk exposures. The situation demands a more deliberate approach on the part of the banks to address disaster risks. 

The pandemic has fast-tracked remarkable changes in this context. With the growing integration of technology in banking activities, the necessity of addressing disaster risk (both natural and manmade) has even gone up sharply as a part of IT security risk management.  

To understand the true extent of disaster risks and losses, banks are required to capture and maintain databases under separate and specific heads as the initial step of disaster risk management in banks

To respond to the situation comprehensively, policymakers and market participants must realise the necessity of having a healthy ecosystem as a natural line of defence.

Most importantly, we need to realise that the causes of seemingly natural disasters are practically manmade. Moreover, the economic policy responses to the Covid-19 pandemic and disaster risk management would be incomplete without recognising that environmental degradation is in itself a hazard - a man-made threat. 

The ongoing pandemic compels us to perceive all disasters as manmade and renders the term 'natural disaster' as barely meaningful. Consequently, the banking industry must also redefine its risk management approach accordingly.        

The author is a Professor at the Bangladesh Institute of Bank Management (finbislesh.com).