Keynote address on Effectively Navigating through the Current Risk Environment by Ingrid van Wees, Vice-President for Finance and Risk Management, at the Ninth Annual and First Virtual RISK ASEAN Conference on 27 October 2020.
Good morning, Ladies and Gentlemen. It’s my pleasure to deliver this keynote speech on behalf of the Asian Development Bank.
External risks are reshaping our risk landscape. As of 26 October, more than 43 million people were infected with COVID-19 worldwide, and more than a million people have died from the pandemic.
Not even the most critical risk managers would have imagined that 2020 would pan out like this.
According to the Global Risk Report by the World Economic Forum, priorities of perceived global risks have been changing over time. 2020 was the first year in which the top 5 global risk likelihood is dominated by one single category: environmental risks. Cyber and data related risks, economic risks, involuntary migration, and terrorist attacks have faded into the background.
This is a strong contrast with the past, when a decade ago, not a single environmental risk made it to the top 5. The top 5 global risks ranked by impact were led by climate action failure, biodiversity loss, extreme weather, and water crisis. In January 2020, both the likelihood and impact of infectious disease was way below that of environmental disasters. In fact, not once in nearly 15 years was pandemic ranked among the top 5 global risks in terms of likelihood; and only twice in terms of impact, in the years 2007 and 2008.
The collective misjudgment is even more alarming when considering that COVID-19 is only the latest in a growing number of zoonotic diseases whose spread from animal hosts into human populations that has been intensified by anthropogenic pressures over the past decade.1 And, in recent years, numerous studies rang the alarm bell alerting governments of an imminent pandemic risk.
Clearly, we must ask ourselves: How good are our estimates and assessment of external risks? Turns out not very accurate, says Harvard Business School.2 Why?
According to its research, we tend to anchor our estimates to readily available evidence despite the known danger of making extrapolations from recent history to a highly uncertain and variable future.
We often are far too narrow in our assessments of the range of outcomes that may occur. We suffer from a confirmation bias. We favor information that supports our positions (typically successes) and suppress information that contradicts them (typically failures).
The human upside bias can lead to treacherous conclusions. People overestimate their ability to influence events that, in fact, are heavily determined by chance. And they are overconfident about the accuracy of both our forecasts and risk assessments.
With this in mind, I will first touch upon the impact of the current pandemic on key aspects of our society. Then, I will turn to the key lessons learned. And finally, I will focus on the management of external risks, which have taken center stage for most of us, in the new normal.
Impact of COVID-19
I will start with the economy.
In our latest Asian Development Outlook Update published in mid-September, ADB forecast that the growth in developing Asia will contract by 0.7%. The IMF last week further downgraded its projections for Asia and the Pacific, concluding that the region is going through the worst recession in living memory after having enjoyed decades of growth. Yet, Asia as a whole is expected to have a relatively strong performance in comparison with global economy, which will contract by 4.4%, according to the IMF.
At the peak of the pandemic in April and May, global trade contracted by 17% year-on-year. Since then trade has recovered, but for the year to August, world trade is still 8% lower than the same period last year. Industrial production in ASEAN-5 countries dropped by more than 20% year-on-year, partly due to weak new export orders, as uncertainty about the duration of the pandemic led to postponement of purchases. ASEAN-5 economies are highly integrated in regional manufacturing supply chains and experienced sharp declines in external trade flows. But trade balances have improved since the first quarter.
International travel came to a near halt in April, and there is little sign of recovery so far. For the 24 developing Asian economies with tourist arrivals data available to August, the year-on-year decline in tourist arrivals ranges from 89% to 100%. For Pacific economies which are heavily reliant on tourism, year-on-year decline in arrivals ranges between 97% and 100%. Ongoing travel restrictions are weighing on tourism-related revenue and export earnings.
Portfolio flows into Asia resumed in May, and most regional currencies have recovered. However, risk sentiment in equity and bond markets has not fully returned to pre-pandemic readings. As of 23 October, major Asian equity markets had rallied, with the NIES gaining 15.8%, and the ASEAN-5 17.6% since April. The average bond yield spread narrowed by 144 basis points. Nevertheless, risk appetite has not fully recovered to pre-pandemic levels; neither in equity nor in bond markets. Asian stock indexes are still down and the average bond yield spread still up compared to pre-COVID levels.
Micro, small, and medium-sized enterprises (MSMEs) particularly felt the brunt of the protracted lockdown. MSME financing, already challenging in regular times, was further squeezed. According to an ADB survey of four ASEAN economies, more than one-third of MSMEs are short of working capital and report having either no cash on hand, or just enough to run the business for only 1 month.
This raises broader concerns about the sustainability of businesses, their debt-servicing capacity, and the ultimate impact on local banks’ performance. Year-to-date, banks in Asia and the Pacific show only small increases in non-performing ratios, despite the severe economic fallout; but this is mainly because of the widespread use of forbearance. Forbearance obscures asset quality pressure stemming from the pandemic. Philippine banks, which recorded rapid loan growth in the decade leading up to the pandemic, are experiencing the highest jump in expected credit loss among ASEAN countries.3
Yet, not all economic sectors suffered. Technology is the clear winner! To accommodate work-from-home arrangements and a less mobile society, many have embraced and accelerated scheduled and unscheduled digitization. We saw connectivity increasing and online shopping, telehealth care, online banking, and government services shooting up. Digital education was mainstreamed in only a few months. Remaining paper-based processes were replaced with digital ones and client interactions have moved online. At the same time, systems were upgraded and cyber security was strengthened to close the gaps created by the work-from-home environment.
As a result of reduced mobility, new technologies are also being adopted for tasks unrelated to communication. For example, banks are now experimenting with the use of drones, alternative data, and AI (artificial intelligence) for their due diligence of new transactions as well as for portfolio management. Resilience was improved by moving new systems directly into the cloud. The quantum leap in digital transformation boosted the share prices of technology companies.
This transition is here to stay.
I will turn now to social aspects.
The pandemic has scarred the social fabric — its unequal impact on the population has increased the wealth gap in many countries. This is the first time in decades that the number of the extreme poor and poor people increased in Asia.
The region is seeing a drastic reversal of its accomplishments in terms of poverty alleviation. As a result of the pandemic, an estimated 78 million people, about 80% of the population of Viet Nam, have been pushed into extreme poverty. Another 162 million people, which is as much as the combined populations of Malaysia, Myanmar, Thailand, and Singapore, are expected to fall below the $3.2-a-day threshold.
More worrisome is that the crisis has affected the vulnerable significantly harder. Children, youth, women, people living with disabilities, and elderly are suffering more. Women and youth, often the less skilled and predominantly engaged in the informal sector, were the first to be laid off. A steep reduction in remittances ranging between 10% and 19% from 2019 levels in ASEAN countries had a disproportional impact on this group.4 Developing Asia accounted for 80% of the global reduction in working hours during the first quarter of 2020, equivalent to nearly 125 million full-time jobs. This almost doubled in the second quarter of 2020.5
In contrast, the global financial crisis resulted in an increase of unemployment in Asia and the Pacific by about 22 million people, about 82% less!
Finally, let me reflect on the impact on the environment:
Terrestrial and aquatic ecosystems initially enjoyed some respite from pollution and environmental destruction as industrial production plummeted and commercial activities came to a near halt.
At the peak of the confinement, greenhouse gas emissions from fossil fuel use dropped by an unprecedented 11% to 25%.6 Many people in Asian megacities saw blue skies for the first time in their lives. These developments spurred civil support for environmental protection.
But this respite for mother nature might not last. With a major ramp-up of economic activities, the annual decrease in greenhouse gas emissions in 2020 will be between 4.2 and 7.5%. This might still seem major, but it is actually only equivalent to the annual reductions needed over the next decades to limit climate change to a 1.5 °C warming and, thus, avoiding a catastrophic climate change,7 while at the same time realizing economic growth and progress on the sustainable development goals.
Lessons learnt from the pandemic and case for action to review risk approach
To make the most of a crisis, we, risk managers, need to draw profound lessons from the current situation and ask ourselves how should we prepare going forward.
What stands out for me is that the cost of prevention is disproportionately smaller than the costs of disaster management and recovery, inertia to act on early warnings, and finally a limited uptake of financial risk sharing instruments that enhance financial resilience as part of disaster management.
I start with the cost of prevention: Comparing ADB’s 2020 GDP growth forecast for developing Asia in December 2019 with that of its Update on 15 September 2020, the economic costs in terms of foregone growth prospects this year is in the magnitude of 5.9 percentage points.8
In contrast, the cost of preventing the next pandemic from a zoonotic disease through annual investments in protecting and monitoring pristine forests and preventing wildlife trade where diseases emerge, by 2030 are estimated to amount to just 2% of the global costs of the COVID-19 pandemic.9 We can see an immediate gain, just counting the economic benefit. In addition, there is the invaluable benefit of avoiding human suffering, stress, and death caused by the pandemic.
Yet, there are many examples where we only react, when disasters strike, despite being forewarned. The focus on the urgent is often standing in the way of the important. It is this very inertia we need to overcome to create a resilient future.
We need to fulfill our leadership role by answering fundamental questions and acting upon them. The main questions are
How much should we invest in proactive risk management measures? how do we value these investments? Turning those proactive investments into assets would allow us to bank and finance them. Natural resource accounting would allow for inclusion of natural assets and could be a first step for governments to value natural treasures.
How can we together ensure that more investments are channeled towards investments that strengthen mitigation and resilience, avoiding those that harm our ecosystems? This is an area where the financial sector, public, and regulators can work together to identify and label investments according to ESG (environmental, social and corporate governance) standards in order to enhance transparency and allow for targeted investment.
How well prepared is our business and how resilient is it when several external risks materialize at the same time? Are we using available instruments to diversify and share the risk with other capital market players?
This brings me to financial resilience.
We commend governments that reacted swiftly to the crisis with massive fiscal and financial support packages, which significantly reduced the economic fallout. The value of declared support packages in developing Asia as of the end of August amounted to $3.6 trillion, about 15% of combined GDP.10 And it was only with these emergency packages, that the worst was averted.
When combined with a reduction in income as a result of reduced economic growth and additional ongoing expenses to manage the pandemic, cash is becoming tight for businesses as well as governments. With severely tightened fiscal space and pressures on domestic resource mobilization, governments have little buffer left to counteract the next disaster.
Most of the costs for addressing disasters have historically been borne by governments, rendering them financially vulnerable especially since the timing of many probable disasters is uncorrelated. There are a range of financial instruments and structures that can be used to prepare for and share the costs of a disaster. Examples are the development of a national disaster fund to save and prepare funds for a disaster, and use of risk-specific insurances and catastrophe bonds to share the cost of recovery post-disaster.
What does this imply for the management of the top 5 risks in the Global Risk Report? Undoubtedly, climate change, water stress, and failure of the oceanic ecosystems are some of the great disruptors hanging above our head like a Damocles sword.
Proactive risk managers need to think further. They need to consider whether current business models and environmental management practices comply with the imperative of sustainability. Whether they could, in the future, be subject to intensified, stricter regulations. Can bonds be subject to rating downgrades when ESG factors are considered? Whether businesses may even be at risk of litigation because of unmitigated pollution?
So how to move forward in the new normal?
From my point of view, we should widen our view in risk management by consistent and broader inclusion of external risks such as climate risk, in our investment choices and pricing and risk managements to address both imminent and long-term risks.
Improve analysis, transparency, and reporting on beneficial and harmful investments, and to allow for targeted channeling of funds towards sustainable investments. The latter will be less affected by stricter regulations.
Address fragmentation of responsibility and accountability for interrelated risks and impacts when discussing the risks and mitigation. An enterprise-wide risk management framework might reduce this risk.
Promote broad use of technology and science to identify and quantify the risk, to build early warning systems, enhance understanding of impact by modelling the interlinkages, improve valuation of the natural assets by modeling their positive impact on resilience, and create multidimensional scenario analyses.
Amend regulatory frameworks and policies to support sustainable, inclusive economies. Funds need to be channeled toward these investments, some of which are viable and some are not. I encourage all of you to consider a change in strategic direction to partake in the new opportunities these developments are creating.
COVID-19 should be a trigger for a fundamental reset. The disease has taught us that our planet and the prosperity of our societies are even more vulnerable to such risks than we thought.
Today and the next few days are a good opportunity for further reflection, exchanges, and sharpening of your plans to contribute to an inclusive and sustainable recovery and future.
Let’s get to work and accelerate the transition.
1 According to the United Nation’s Environment Program, every year, some two million people, mostly in low- and middle-income countries, die from neglected zoonoses. In the last two decades alone, zoonotic diseases have caused economic losses of more than $100 billion https://www.unenvironment.org/resources/report/preventing-future-zoonoti... 2 Harvard Business Review article from 2017.
3 Fitch Rating. Credit Costs to Remain Elevated for APAC Banks in 2021. Winding Back of Relief Measures to Expose Impact of Pandemic Shock
4 ERCD Survey on Remittances reductions in ASEAN.
5 ADB. 2020. Social Sector Group Presentation to the President.
6 Data is from Corrinne le Quere et al. 2020. “Temporary reduction in daily global CO2 emissions during the COVID-19 forced confinement” in Nature Climate Change. Volume 10. July 2020. pp 647-653.
8 Source: Based on ADB. Key Indicators. and ADB. 2020. ADO Update. Manila
10 This compares with $15.3 trillion, or about 32% of GDP, in the advanced economies. See ADB. 2020. ADO Update Sept 2020. Manila