Disciplined Bank Management Can Turn Risk to Its Advantage
Cates, David C., American Banker
Some 20 years ago, bankers abhorred risk. At the same time, they knew nothing about managing risk other than to avoid it!
I well recall the views of William S. Gray, the former chairman of the Hanover Bank 1929-61, who often said, "Bankers never borrow, customers borrow." This negative epigram encapsulates and innocent and obsolete world-view that could never work today: banks as fortresses of soundness amidst an uncertain world, the banker a nay-sayer with no vision of the future, no stake in economic development.
Most contemporary banks, certainly all large banks, have now embraced risk as an inevitable concomitant to the strategies of their enterprises. They have gradually learned to do this over (roughly) two decades, in response to three driving forces:
* first, the people who run banks have an unavoidable responsibility to their shareholders, measured by their attainment of a competitive return on equity. To abdicate this responsibility is, in effect, to adopt a strategy of retrenchment.
* Second, bank policies are in part shaped by public policy: It cannot be denied that since 1961 successive administrations have strongly urged banks to support various domestic and foreign economic development goals.
* Third, there is a widespread excitement that comes to pervade any industry, like banking, that is modernizing and expanding on many facets. this enthusiasm, once established, becomes self-perpetuating, leading to further explorations of opportunity.
In most large banks, these three driving forces to accept risk are disciplined by what is commonly called good management. Still other banks are under-managed, and a few -- a very few -- have been overwhelmed by the magnitude of risks they have knowingly or unwittingly assumed. Map of Bank Risks
Isn't it about time, therefore, that we drew a map of the risk of banking? If risk mismanagement causes banks to fail, and if good management lets them prosper, we should want to analyze what are the risks of banking that all larger banks face! Excessive risks is what causes banks to fail. Let's try to agree, then, on what risk is.
This map should have four attributes:
* First, our catalog of risks should not be so truncated as to blur important differences among types of risk, nor should it be so lengthy as to lose the attention, say, of a board of directors.
* Second, the categories of risk should be immediately understandable to the common sense of senior bankers: If we cannot engage their attention we will accomplish nothing.
* Third, the categories of risk should reflect the analytic concerns of funds-providers and investors as well, so that risk analysis can be shared with outsiders.
* Finally, the headings that make up this list should be, wherever possible, amenable to quantitative, comparative analysis. In this way, risk appraisal can be tested against objective standards. The two key standards, of course, are the performance of peers and the performance criteria of market.
I call my contribution to this dialogue the Seven Deadly Risks of Banking. In the same breath let me reemphasize that risk is a constructive and inevitable companion to the business of banking and that managers of banks should equally think of these risks as challenges and opportunities. Degrees of Severity
My list is ordered according to the speed with which each type of risk can destroy a banking institution. The first two, when sufficiently present together, will bring a market-funded bank down overnight. The next three risks work more slowly, rarely causing sudden failure. The final two determine whether a bank (or bank holding company) will survive under its own charter or be forced to merge in order to survive:
* Funding Risk. Can a bank readily renew its uninsured liabilities?
* Asset Quality Risk. Are its assets collectible at better than 99 cents on the dollar? …