Magazine article The Journal of Lending & Credit Risk Management

Getting a Grip: Year 2000 Credit Risk

Magazine article The Journal of Lending & Credit Risk Management

Getting a Grip: Year 2000 Credit Risk

Article excerpt

Bankers worldwide are working to ensure their systems are ready for Year 2000. Equally important are the banking community's efforts to address Year 2000 credit risk. In this article, a Bank of America senior vice president shares the bank's Year 2000 credit risk assessment worksheet. In February, an in-house attorney at Bank of America looks at Year 2000 loan documentation protections.

Nothing excites a credit officer more than a challenge. After all, credit is the profession of those who thrive on learning second-hand everything there is to know about somebody else's business and then structuring a deal that will not put the depositors' and shareholders' nest eggs at undue risk. If that's not challenging, I don't know what is.

However, a new challenge on the horizon is threatening to take all the fun out of being a lender. It potentially affects all commercial borrowers equally and virtually simultaneously. Bankers worldwide are trying to get a grip on Year 2000 credit risk. And while its origin is technical, Year 2000's financial results may be devastating to individual businesses and the economy at large.

What is Year 2000 credit risk? It's the risk of borrower default caused by a Year 2000-related reduction in cash available for repayment. This may occur before, during, or after Year 2000 because of:

* The expense of Year 2000 remediation, whether or not the remediation is successful.

* Lack of(or unsuccessful) Year 2000 remediation.

* Business interruption caused by a Year 2000-related problem in a key vendor, supplier, or customer.

* Litigation caused by Year 2000-related problems (product liability, failure to fulfill contracts, financial misrepresentation, and many other possible scenarios).

The credit challenge of this unique risk is twofold. First, the problem is huge. Year 2000 risk potentially affects any and all business borrowers regardless of geographic location, industry, or business acumen. And second, we do not have the benefit of time: The problem affects any and all businesses today, tomorrow, and next year and only becomes more urgent as the clock ticks toward the millennium. As we have been reminded by computer system pundits, this is one systems' deadline that is immutable. Unfortunately, the same applies to credit.

On top of having to simultaneously assess the individual borrower risk inherent in entire commercial portfolios, bankers must overcome a second unique challenge: Year 2000 is a one-time event. Because bankers haven't experienced anything quite like it before, understanding Year 2000 credit risk is as new to the most experienced banker as it is to the latest recruit. There are no tried and true formulas, methods of analysis, or risk assessment tools on hand. Thus, new methods and tools are needed to help decipher this new risk.

The good news is that once a borrower's Year 2000 credit risk is understood, any actions needed to mitigate and manage resulting repayment risk will be part of the standard skill set and repertoire of the banker.

This article introduces a worksheet currently in use at Bank of America. It was developed to help commercial credit officers consistently assess the Year 2000 credit risk of business borrowers. The worksheet guides an officer to a high, medium, or low Year 2000 credit risk conclusion for an individual business borrower. …

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