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What-If Analysis in Commercial Banking To Plan for Uncertainty

April 22, 2021 Marisa Iacobucci  
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Stock market crashes, debt defaults, the collapse of the U.S. housing bubble. Many of the global economic crises in the past 50 years have had financial origins. And while the current economic downturn is an anomaly, brought on by the governmental and societal responses to a global health crisis, the impact on the banking sector has been no less severe. As this McKinsey & Company article said, “the industry has already felt massive effects from the crisis, with more to come.”

With the disruption of global supply chains and the closures of physical places of business the impact on individual, small and medium enterprises as well as large corporations continues. As the threat to economic and market stability persists, financial regulators have responded by offering a wide range of temporary support measures, such as easing restrictions on liquidity and capital, to maintain financial stability. And while these measures have helped banks fulfill this role during the crisis as they sustained the supply of credit, they have still faced enormous pressure on their own capital and liquidity position.

According to this Global Banking Outlook report, “COVID-19 has generated significant instability and high volatility in global capital markets. The financial sector has been one of the most affected, with bank valuations dropping in all countries around the world.” Increased credit risk of corporate and retail clients of the banks was one of the immediate effects of the pandemic. The report went on to say that, “in order to continue financing the real economy and support its recovery, banks are called to distinguish between purely temporary phenomena, destined to be reabsorbed in a short time, and longer lasting impacts which would require actions of management and reclassification.”

More than a year into the health crisis and as commercial banks continue to navigate the financial impacts of COVID-19, how can they turnaround, transform and continue to grow their businesses amidst so much uncertainty and less than favourable economic outlooks? It starts by stress testing and planning for future scenarios and changes with what-if analysis in a complete planning solution for baking and credit unions.

Read on to discover how what-if scenario planning can help banks turn their data into informed narratives, enabling them to navigate any crisis and guiding them to make better business decisions organization wide for alternative futures.

What Is What-if Scenario Planning?

What-if scenario planning, also known as what-if scenario analysis, is a critical foresight tool financial institutions and businesses can use to capture a wide range of possible future outcomes for uncertainties and drivers of change. What-if scenarios can’t predict the future, but they can do is paint a realistic picture of what your future could look like based on certain assumptions.

When it’s business as usual with no major changes in the economy, banks might forecast for three scenarios: stable, downturn and accelerated scenarios. But during the current crisis, a bank stress test might include hypothetical scenarios that focus more on the outcomes of the pandemic, such as the duration of it (when restrictions are enforced/lifted), the economic consequences and the short- and long-term financial impacts on the business. Some of these financial impacts might include the effects on operations, liquidity, high unemployment rates and workforce changes and the potential of a global recession.

Keep in mind that scenario planning doesn’t necessarily change your business plans or goals. What it does do is show you any weaknesses in the banking system and how to adjust your strategic plans and successfully manage your business with any number of unknowns.

Scenario Analysis vs. Sensitivity Analysis

Scenario analysis and sensitivity analysis, two important components of financial modeling, are often used interchangeably, but there is a slight variation between the two.

Sensitivity analysis can be seen as an investigation that is informed by data. It refers to changing one key input or driver in a financial model to see how sensitive the model is to the change in that variable. Banks can use sensitivity analysis to evaluate overall risk, identify critical factors of the business that can be impacted and find alternate solutions for problems.

Scenario analysis, on the other hand, involves listing a series of inputs and then changing the value of each input for each scenario. For instance, a worst-case scenario can include interest rate changes, a decrease in new customers and exchange rate fluctuations, or all of these things happening simultaneously.

How To Use What-If Scenario Analysis

Getting clarity on the business health of commercial banks—for today and tomorrow—and determining the best path forward entails bringing all of the data from every function of the business into a secure, centralized database. From there, using complete planning software with source system integrations and unlimited scenario modeling, it’ll be easier to create stress test scenarios using templates for actuals and forecasts and adjust to any changes with minimal incremental effort.

So for banks, when changes in key drivers happen, such as prime rates, it’ll be easier to move with agility and see the immediate impact on margin and profitability across the organization, achieving a holistic view of interest income within one secure platform.

Take stress scenarios for banks even further with risk sensing and predictive analysis to monitor early indicators. With what-if analysis Power BI capabilities, banks can easily tell a financial story using engaging dashboards, immersive visuals and interactive reports.

You can then centralize collaboration—and avoid spreadsheet mayhem—to get departmental alignment with what-if analysis based on real-time actuals and business drivers for any department or any type of plan. That way, teams can be prepared to carry out countless scenarios against changing variables and always be ready for anything that comes their way.

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