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5 Risk Predictions for 2023

In the coming year, we can expect a slowdown in worldwide economies, an increased emphasis on operational resilience, a shift toward simpler and more flexible models, a stronger demand for qualified risk professionals, and new risks and opportunities fueled by shifting demographics.

Friday, January 6, 2023

By Cristian deRitis

As global economies confront multiple threats, ranging from inflation and rising energy prices to armed conflict and natural disasters, 2023 is shaping up to be a challenging year. 

While accurately predicting the path of future events is impossible, there are several trends we can identify with confidence. By paying attention to these broad tendencies, risk professionals can better prepare themselves and their organizations for whatever risks and opportunities may arise.

Here are five risk predictions for the coming year:

1. An economic slowdown in 2023 will expose risks – both financial and nonfinancial

Whether or not the global economy falls into an “official” recession in 2023 is debatable, given the number of positive and negative crosscurrents. However, there is universal consensus among economists, analysts and investors that economies worldwide will slow considerably, as households and businesses pull back on spending and investment and as populations continue to adjust to the post-pandemic world.

Slowing growth combined with rising interest rates will pressure profit margins. Businesses that have depended on cheap financing to turn a profit will face challenges to grow their revenues sufficiently to keep up with rising costs. Some will inevitably fail or be acquired.

Cristian deRitisCristian deRitis

This real-life stress test will also expose weaknesses in new business models. An obvious example is the cryptocurrency industry, which is undergoing its first true test, as higher interest rates flush out the businesses that were too good to be true. If that industry is to survive in any form, it will need to adapt and evolve. Ultimately, crypto businesses may need to focus more on applications for blockchain technology and less on the development of new currencies.

While the collapse of the crypto industry has been severe, spillover effects to other financial markets and the broader economy have been limited. Safeguards implemented after the Great Recession dissuaded traditional financial institutions with strong risk management policies and procedures from investing in these and other speculative financial products.

Other weaknesses in the economy have yet to be revealed and could prove much more debilitating, particularly as interest rates march higher. For example, the reduced value of many commercial real estate properties, especially office buildings, has yet to be fully recognized, as investors and businesses try to ascertain how much demand may be permanently lost to remote and hybrid work arrangements. While the current assumption is that losses in property values will be recognized over time in an orderly fashion, there is a risk that values could fall sharply as financing for commercial mortgages dries up or becomes prohibitively expensive.

While we cannot perfectly predict which industries or sectors will be hit hardest in the next down cycle, the financial law of gravity has yet to be proven wrong. If growth in an individual business or industry can’t be sustained, it won’t be.

2. Risk managers will prioritize resiliency

Given the impossible task of predicting how the economy will unfold with a high degree of accuracy, the next best thing firms can do is to develop systems and processes that allow them to react quickly to any situation that arises. 

Rather than attempting to construct the perfect model or forecast, firms will prefer to build simpler models that can be easily adjusted and refined as conditions change. Businesses and lenders will, moreover, expand the number of upside and downside scenarios they consider when setting their strategic plans or when forecasting revenues and losses. This approach will empower them to describe a distribution of possible outcomes, instead of relying on point estimates or single scenarios.

The value of flexibility and resilience is so high that risk professionals will be willing to trade off some forecast accuracy in exchange for models and risk management systems that are agile, flexible and fast.

3. Shifting demographics will present challenges …

Businesses and governments will become increasingly sensitive to the obstacles presented by aging and shrinking populations.

Companies were already coping with labor shortages prior to the pandemic. While a cyclical economic slowdown may mask underlying trends temporarily, firms will continue to face a shrinking labor force in many parts of the world. Indeed, in the wake of the resolution of many of the supply-chain bottlenecks that manifested during the pandemic, labor availability will become the new supply-chain constraint – with the potential to impact both the production of goods and the quality of services.

Although population declines will take place over the course of decades, business decisions in 2023 will already take these trends into account. Automation will become a regular topic of conversation, as companies explore a range of tools to compensate for worker shortages. Productivity statistics that lagged during the pandemic will start to grow, as businesses overcome the transition costs involved with adopting new technologies.

While the use of labor-saving technologies will inevitably lead to job losses in some industries and occupations, the level of demand for workers is so high that mass unemployment is unlikely.

4. … as well as opportunities

While an aging population may challenge established business practices that rely on large workforces, it will also create opportunities. In fact, for workers willing to be flexible and employers willing to provide training, favorable chances will abound. By partnering with private industry, government job training programs will step up to fill the skills gap keeping unemployment low.

Older workers offer an untapped resource for businesses that are able to leverage their talents and experience. Employers may need to accommodate workers with more flexible schedules and to complement their skills with training (especially in new technologies), but firms that can bridge these needs will be richly rewarded with a broader talent pool than their competitors.

An aging population also presents opportunities in the form of demand for goods and services. This will be more wide-ranging than the traditional demand for increased medical care and home-care services.

For example, retiring baby boomers may be wealthier than their parents, with a longer life expectancy. Companies in industries as diverse as travel, finance, consumer electronics and construction will need to pivot their business models to target this older demographic – or risk being left behind.

5. Risk professionals will be in high demand

Considering all the cyclical uncertainty and structural shifts in the world today, companies will continue to seek the counsel of risk professionals who can not only identify risks and opportunities but also execute on plans to increase value.

The pandemic experience clearly demonstrated the value of a risk culture. Banks, credit unions and other businesses with well-established risk policies navigated the crisis with greater ease and higher quality decisions than organizations without any crisis management plans.

The value of risk principals is also being recognizing outside of their traditional, narrow domain. For example, a simple tool like a risk matrix approach can benefit every department and individual, via providing a framework to organize and prioritize competing tasks.

Rather than being viewed as the enforcers of compliance rules and regulations or obstacles to growth, risk teams need to continue preaching a message of empowerment. Educating a wider audience on risk practices can enable more informed decision-making and deeper discussions at all levels.

Parting Thoughts

As we gear up toward the future, one thing is certain: risk management is no longer solely a backend operation focused on minimizing losses.

Aside from the aforementioned trends, cybersecurity, supply-chain resilience, model risk management and climate risk will continue to be top of mind for regulators and risk managers alike in 2023. I look forward to covering these and other topics in future columns in the year ahead.

Best wishes for a productive 2023, and may all your decisions be optimal!

Cristian deRitis is the Deputy Chief Economist at Moody's Analytics. As the head of model research and development, he specializes in the analysis of current and future economic conditions, consumer credit markets and housing. Before joining Moody's Analytics, he worked for Fannie Mae. In addition to his published research, Cristian is named on two U.S. patents for credit modeling techniques. He can be reached at cristian.deritis@moodys.com.




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