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Community Bank Risk Management Study

The Journal of Lending & Credit Risk Management, March 2000 | Go to article overview

Community Bank Risk Management Study

The 1999 Community Bank Risk Management Study supplements a more extensive study RMA conducted in 1997. The results of that study were released in Beating the Odds.... A Community Banker's Guide to Risk Management.

The objective of this much briefer survey is to track changes over the two years in order to identify emerging trends in community banks' risk management practices. Respondents were asked 17 questions, representing a handful from the original 1997 survey and covering each of the following areas:

* Risk Grading

* Portfolio Risk Management

* Credit Approval & Credit Scoring

* Market Risk

* Credit Risk Pricing & Profitability

* Reputation & Strategic Risk

* Workout/Distressed Asset Management

A notable trend in community banks' risk-rating practices is an increase in the number of pass grades used, from 3.6 to 4.4. Another trend is the increased confidence community bankers have in their rating systems.

Respondents were asked to compare the level of portfolio risk across several different credit product lines with the level of risk from the prior two years. In both 1997 and 1999, the majority of respondents rated all categories at the same level of risk as the prior two years. The difference between the survey results is that, in 1997, more respondents rated consumer overall, credit card, first mortgage, and auto products at a higher level of risk compared to two years prior than did respondents in 1999. In fact, more respondents in 1999 cited credit card and auto portfolios as having a less risky profile than two years prior.

Interestingly, when asked the same question about perceived levels of risk in their C&I and CRE portfolios, respondents indicated the reverse trend. In 1997, more respondents considered C&I and CRE to be less risky than they do today. This is evidenced by a marked decrease in the number of participants expressing a "lower risk" perception.

Today, all respondents are tracking some type of portfolio concentrations, versus the 92% who stated that they did so in 1997. However, when respondents were surveyed regarding their credit risk pricing, 23% claimed they do not include a risk/return assessment in their institution s strategies.

Overall, community bankers have been diligent about improving their risk management strategies, but our findings indicate that some areas still need higher levels of adoption. Stress testing must become more prevalent, not just in C&I and CRE but in consumer portfolios as well.

Community banks have the advantage of being members of the communities they serve. By increasing their use of risk management techniques, they will not only prepare themselves to withstand the next economic downturn, but have a chance to positively affect their community's economic vitality as well. It is our hope that these results will motivate all survey respondents to revisit their risk management strategies.


Risk grading. Risk grading is viewed by many as the fundamental building block of prudent credit risk measurement. This section focuses on how community banks establish and use risk grades.

Two years ago, when asked to rate the relative influence of certain elements on the assignment of loan risk ratings, respondents indicated that the most influential factor was earnings/operating cash flow. This was followed by debt capacity (or leverage), collateral quality and control, and character of management. High-performing banks had similar results; however, they placed a greater emphasis on financial reporting than banks overall.

Our 1999 results show little change in community bank's rank of these influences. Earnings/ operating cash flow retains the top spot, but character of management moves from fourth to second place, and financial asset/liability values takes third place. This new category, formed for purposes of the 1999 survey, combines the second most important influence, debt capacity, with the fifth ranked, balance sheet relationships, from the 1997 survey.

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