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Options and Opportunities: Economic Recovery and Model Risk

Henry Umney |

The scale of economic disruption caused by COVID in 2020 is unparalleled in recent economic history. It is both global and local, as different countries apply different health and economic policy remedies to help them move forward.

Uncertainties remain. Some countries are having second spikes, while others seem to be moving – slowly – back toward normality. Others are still dealing with a very persistent first wave.

Economically, governments are playing a balancing act – return too soon, and spikes can re-emerge. Wait too long, and much unnecessary harm will result.

This kaleidoscope of dynamics is driving very different expectations of how the situation may develop in the coming months.  The UK’s central bank believes that it the UK, at least, is on course for a rapid V-shaped recovery.  However, in the US, the President of the St Louis Federal Reserve believes that the outcome may be less optimistic.

Differing expectations are driving very different responses by governments. The UK’s Chancellor of the Exchequer has proposed a host of measures to stimulate the housing market support consumer spending, and provide employment subsidies. Other governments, such as Canada and China, are looking more toward infrastructure investment to speed their recovery.

How are business leaders navigating this uncertainty?

We should not ignore the long-term implications either. Governments have run up historic deficits to fund healthcare, unemployment support, furloughs, business loans, and much else. Central banks have cut interest rates to near-zero (again), with the US Federal Reserve buying junk bonds, for the first time, to maintain market liquidity. These will have an enormous impact on fiscal and monetary policy for years to come.

So how are chief executives and their senior management teams navigating this complexity, which seems to change daily?

For some, sadly, they are ‘rightsizing’ their business, recognizing that the reduced tempo of economic activity will mean their cash flow and profitability will be subdued for some time.

Others are seeing it as an opportunity for growth and development, with business tapping into the debt and equity markets to enhance their balance sheet and build ‘war chests’ to fund acquisitions and product R&D.

How are business leaders navigating this uncertainty?

In Mitratech’s experience, one striking development is a significant increase in investment in business and economic modeling by large corporates, banks, asset managers, and insurers. Senior management seeks a better “crystalball” that offers insight and options in navigating this extraordinary landscape of change, risk, and opportunity.

The febrile economic environment is driving the need for constantly changing and updated models that capture new dynamics. Investment in modeling systems, software, and staff has increased markedly this year, so management can better simulate scenarios to identify risks, opportunities and outcomes. They want to make better-informed decisions.

These models – and the decisions they inform – are only as good as the data, policies, and controls that support them. An experienced provider (like Mitratech) is capable of objectively helping organizations to better manage their model risk, and reduce the chance of issues in the modeling process that can compromise the final results. For some institutions, this is about addressing compliance issues like SR 11 7 (in the US), or SS3/18 (in the UK). For all organizations, it is about visibility, audibility, and the assurance that their ‘crystal ball’ is working as designed.

Learn more about some of the tools and approaches we offer to help address model risk management (MRM).

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