When it comes to the risk management process, there is no one-size-fits-all approach. Financial institutions have a wide variety of approaches, as calculations and analyses differ between lenders.
“It is as much an art as a science,” says Tim McPeak, risk management consultant at Abrigo. “Everyone’s going to have their own ways, and from bank to bank they will have different underwriting guidelines and standards. At a high level, that’s fine. That’s what creates good banks and bad banks; some banks are better at those things than others.”
But these inconsistencies pose significant challenges to managing credit risk at financial institutions. Here are some common areas where inconsistencies exist at banks and credit unions:
• Data entry: Putting a number in the wrong field can have a cascading effect and negate the accuracy of the entire project. Other common manual errors include double counting income and debt-service and excluding necessary tax forms.
• Spreading: “Three analysts at the same institution may spread three tax returns into financial statements three different ways,” notes McPeak. For example, if a business sells an asset and makes a gain, some would count that gain as income, while others would choose to exclude it because it is not recurring.
• Applying regulatory guidance: Standards are often not applied consistently across the portfolio, e.g. risk rating score. Financial institutions also need a systematic and consistent process for determining the provision for the ALLL.
• Data tracking and documentation: Many financial institutions do not have adequate documentation of key financial ratios and how risk ratings are derived for regulators and auditors. You not only have to have the answers, but also have to show how you got to those answers.
There are many ways to improve consistency at financial institutions, but here are two ways to address these challenges:
1. Establish a credit culture
2. Utilize technology