The Need for Risk Management in Financial Institutions

Scenes of the Season: Run on the Bank

When consumer confidence drops, financial institutions face the heightened prospect of clients pulling their deposits or investments.

Generations of movie audiences have learned the basics of how banks manage deposits and make loans from watching the bank run scene in the holiday movie classic It’s a Wonderful Life.

As George Bailey tells the worried customers storming Bailey Building and Loan, their money isn’t sitting in a vault. It’s in their neighbors’ homes, financed by mortgages held by George’s small bank.

The emotions driving the people of Bedford Falls to demand George return their money are universal and can be shared by the customers of financial institutions, says Argo Pro’s Mary Henderson, senior vice president, head of financial institutions. 

“The minute they catch wind of something negative, such as interest rates going up, the markets tend to react immediately,” she says.

Such scenarios highlight the need for risk management in financial institutions.

“If you are managing a client’s investment portfolio  and there is a negative stock market impact, you may see redemptions and people wanting their money back,” she says. “You tend to get lawsuits then. You will get people who will sue because they feel you weren’t managing their retirement money the way you should have.”

Source: Crisis and Response: An FDIC History, 2008–2013.

Risk management in financial institutions

It’s important for public and private financial institutions to have appropriate coverage in place in the event that plunging consumer confidence leads to lawsuits.

Relevant coverages include:

  • Professional liability for asset managers and private equity
  • D&O coverage, which protects directors and officers in the event of lawsuits such as those brought by shareholders following negative stock market activity
  • Errors and omissions coverage

“You do have runs on the bank,” Henderson says, referring to the financial crisis of 2008. Luckily the Federal Deposit Insurance Corporation (FDIC) guarantees insureds deposits for up to $250,000.  While this helps to contain some of the uncertainty and can help to curtail a run on a bank, the banks can and do still fail as was evidenced in the crisis.

Learn more about Argo Pro’s diversified financial institutions offerings.