How European financial firms can better manage volatility risk

Adding to the urgency is that all elements are impacted by cost, affordability and inflation. Given continued uncertainty, there are four key areas that FIs should be reviewing and updating:
 

1. Strategy: e.g., if valuation multiples fall and/or potential targets become distressed, where would we look to acquire scale or capabilities?
2. Propositions: e.g., should we launch new products and services to cater for recession-specific demands?
3. Operating model: e.g., are we getting an adequate return on all current investments and projects?
4. People: e.g., how will our workforce support customers though a recession? How do we provide an empathetic front-line experience?

2. Prepare for the next: a future geopolitical framework
 

The geopolitical orthodoxy is likely to change dramatically. Institutions need to plan for the impact on their business and operating environment, such as on supply chains. To help plan for this, EY teams have developed four potential scenarios:
 

1. Globalization lite: akin to the pre-COVID-19 pandemic status quo, a reduction in international tensions, dynamic GDP and low inflation.
2. Friends first: supply chains, trade, and investment favoring “friendly” countries, including a gradual divergence of “the West” and China, coupled with still positive GDP growth and higher but bearable inflation.
3. Cold War II scenario: a sharp economic and financial decoupling between China and the West, with intensified confrontation. Economic growth is low and inflation is high.
4. Self-reliance reigns: similar to the 1930s, a retreat from globalization and international cooperation, major economies turning inward, accompanied by weak economic conditions and high inflation.

Each scenario impacts economic growth potential and inflation, and leads to different levels of access to markets, investors and clients. It could also undermine the viability of some cross-border businesses. Ultimately, it could make current business footprints and operating models significantly more costly to sustain.
 

In response to these risks, management teams and boards need to act to ensure:
 

• Resilience by de-risking their current business and operating model.
• Agility by ensuring they will have the flexibility to adapt in a timely manner and can continue enhancing their capabilities.
• Growth by adapting business portfolios to focus on areas where they have the greatest advantage, and seizing opportunities to scale or specialize.

3. Imagine the beyond: Megatrends
 

In the longer term, technological advancements will be the single key driver of change. That is why it’s critical that FIs imagine the future beyond the immediate and even medium-term. The Megatrends framework helps to do just that, by highlighting some potential topics that will shape the future.
 

Primary forces (technology, globalization, demographics and environment) drive the Megatrends (pdf) that may significantly impact the next three to 10 years. While such a timeframe makes projections less certain, financial services companies need to examine how these megatrends might impact societies, economies and the wider global order. For example, a future behavioral economy, which uses data to influence decisions, could impact how FIs use AI and risk moling, and the ethics involved.
 

Leaders need to fully understand the impact across a range of megatrends to ensure their planning is based on the future environment.
 

Managing volatility well — a competitive advantage
 

You can’t always predict the future. But you can be better prepared for it. It’s not enough to know about the various forces of change; decision-makers need to understand how different phenomena affect each other in an interconnected, interdependent world.
 

For example, what impact does the future hold on current plans around transformation to better serve customers and cut costs? What actions are needed to ensure prudential strength scenario under different possible scenarios? With so much effort going into the drive to net zero, what planning has been done around the impact of geopolitical change?
 

In adapting to current and future volatility, FS institutions need to constantly consider what changes are required to their strategy, financial management, propositions, people and operating models. Only then can they formulate strategies and contingencies that will enable their organization to thrive — whatever the scenario.
 

This article is co-authored by Saleem Malik, EY UK Financial Services Restructuring Leader; Shalini Shan, EY UK Financial Services Strategy Leader; and Nomit Kalidhar, Partner, Banking & Capital Markets, Ernst & Young LLP.