Magazine article Journal of Commercial Lending

Think Risk

Magazine article Journal of Commercial Lending

Think Risk

Article excerpt

With strong balance sheets and restored earnings streams, many bankers feel ready to take on increased risk. Some are doing so at a dramatic rate, both in traditional lending and in a stepped-up pace of new products.

All to the good. Banking is a business of risk. Properly priced, controlled, diversified, and monitored, increased risk can improve shareholder value. But the lesson of the past decade in banking is that failing to manage risk correctly destroys a bank. Furthermore, as the industry takes on more risk, there are more demands that risk be managed better. Regulators, shareholders, analysts, and communities all are holding banks to higher standards of risk management.

By and large, banks are organized to minimize credit and interest rate risk, although the controls can fail, as too many banks discovered a few years ago. However, banks are typically not organized to manage effectively their total exposure across a broad range of risks. At most institutions, risk is the responsibility of a department head: Operational risk belongs to the chief operating officer, risk from fraud falls to the chief auditor, and senior management and the board are supposed to keep the bank from making strategic decisions that are too risky.

In larger institutions, there will be trading, foreign exchange, and derivative products that involve risk, which will be the responsibility of, say, the managing director of global markets. But in most banking companies, no one person is empowered to look at any and all activities going on and say, "Hey, wait a minute. Do we know what would happen if. . .?"

In the current environment, this is a very dangerous position. And many banks are considering making a senior officer responsible for comprehensive risk management. This decision raises some thorny questions. Should companywide risk management be vested in a "czar" with extraordinary powers to evaluate and decide on risk? Who, other than the CEO, can truly determine what "risk bets" the bank should take? Is risk better managed by requiring line managers and department heads to "think risk" in all their activities, combined with central coordination and monitoring? In other words, installing effective, comprehensiv bankwide risk management is as much a matter of style as it is of procedures an organization.

A bankwide, total risk management approach must encompass any event that has th potential to affect any bank resource adversely, including capital, earnings stability, customer franchise, and shareholder and regulatory relations. The types of risk, in addition to credit and interest rate risk, are operations, fraud, strategic, capital markets, and regulatory.

Two basic functions must be filled if total risk management is to be achieved and the bank is to be protected against expected and unexpected risks. First, someone must be empowered to look at everything the bank is doing and planning to do, solely for the purpose of evaluating risk. Second, every department's controls, practices, and procedures that are intended to spot and minimize risk must be evaluated continuously.

A comprehensive risk management system should include:

* Sponsorship by executive management and the board.

* A culture in which every manager is expected to think risk--to identify, measure, and report on risk exposure.

* A member of executive management responsible for overseeing all risk management with authority to act on risk problems and ensure risk control. …

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