As banks contend with a challenging economic environment, new research shows that preparing for downside risks comes at a cost.
In the decade following the Great Recession, banks that reduced hazardous lending and paid more for skilled risk management professionals were also more likely to report lower profits, according to a study conducted by Thomas Schneider at Old Dominion University, Philip Strahan at Boston College and the National Bureau of Economic Research, and Jun Yang at the University of Notre Dame.
Between 2010 and 2019, demand for risk management jobs increased nearly 600% as regulators set new requirements for emergency capital buffers. Headcount growth for such professionals was more likely to occur at banks that took heavy losses during the recession, or in anticipation of a regulatory stress test and following a poor performance.
During the same period, researchers found that the probability of a 20-basis-point reduction in return on assets correlated to a bank's investment in highly skilled risk management labor. Risk consulting expenses also increased, rising from $10 billion globally in 2007 to $29 billion in 2015.
"We found that wages have risen at these banks and that net income fell, and it's possible that it's falling proportional to risk," Schneider, one of the report's authors, said in an interview. "Banks are reducing their systematic risk through these jobs. But it's not free for them; there's a cost to it."
The study highlights how lenders have attempted to prepare for the next financial crisis by comparing risk management hiring trends at 197 large banks required to undergo Federal Reserve stress-test examinations.
Starting in 2011, banks with more than $50 billion of assets were required to undergo the regulatory Comprehensive Capital Analysis and Review, which the Fed based on both banks' internal analysis and third-party examinations. The primary incentive for good performance was the Fed's approval of banks' dividend increases and share repurchases.
But amid an economic downturn and low stock valuations, the report's authors argue, a new risk accounting model adopted in 2020, one that weakened the requirements for banks to pay out dividend increases and share repurchases, might lead a "gradual decline" of investment in risk management professionals.
"It's possible that, by not having as much scrutiny, banks may pay less attention to risk management or potentially take on model risks that otherwise could have been avoided," Schneider said.
Overall, stress-tested banks account for over 80% of demand for such positions, with risk management job postings at banks increasing from 12,000 in 2010 to over 70,000 in 2019. Job postings tripled in this category during the same period, increasing from 4% to 12% and outpacing an 8% rise for non-stress-tested banks, according to the report.
As a result, risk management jobs now make up a much higher portion of the banking labor market. The fraction of job posts requiring risk management skills has increased from less than 10% in 2010 to more than 40% last year, the study found.
However, increasing labor demand has fostered stiffer hiring competition for a limited pool of talent. Only 14% of job postings at banks are considered "high skilled" positions, according to the report, while 29% of risk management jobs and 53% of stress test jobs require additional levels of training and experience.
The balance banks have attempted to maintain since the financial crisis between meeting stress-test requirements and pursuing growth opportunities is apparent from the significant increase in demand for risk management professionals, according to Brian Hart, a principal at KPMG's financial risk, regulatory and compliance group.
"Stress testing is a safety and soundness tool," Hart said. "It's all about setting the right strike zone in terms of being well capitalized, but not overly so."
The full study is available
