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HOW TO PREPARE YOUR INSTITUTION FOR THE NEXT
DOWNTURN
By the RMA Credit Risk Council
Culture Plan
Assess
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“The time to repair the roof is when the sun is shining.”
– John F. Kennedy
Source: JFK’s State of the Union address, January 11, 1962. Said in the context of
preparing the country for the next economic downturn.
TIMELY ADVICE FROM JFK
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THE BEST TIME TO PLAN
The benign credit environment is the best
opportunity to start preparing for the next
downturn.
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THE BEST TIME TO PLAN (CONT.)
Planning now allows time to make adjustments to
portfolios in order to be able to weather the next
financial crisis.
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ASSESS YOUR PORTFOLIOS
Portfolios with excessive concentrations of credit are more challenged to withstand a downturn.
Assess the portfolio to determine whether significant concentrations*
exist in:
Specific industries. Geographies. Asset
classes.
Where these exist, implement strategies to manage concentration
risk such as:
Limiting growth in
those areas.
Balancing the portfolio with
loan growth in other areas with less “correlation
risk.”*Obligations exceeding 25% of the bank’s capital structure. http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/Concentration-HB-Final.pdf
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REDUCE THE AMOUNT OF RISK PORTFOLIOS MAY PRESENT DURING THE NEXT DOWNTURNIdentify exposure to weaker borrowers within the portfolio.
Work with the customer to provide a solution that mitigates risk in a way that leads to a continued beneficial relationship.
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DEVELOP EXIT STRATEGIES FOR HIGH RISK RELATIONSHIPS THAT CANNOT BE REMEDIED
For consumer and small
business loan portfolios:
• Develop more responsible loan structures.
• Consider making product design changes.
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DEVELOP EXIT STRATEGIES FOR HIGH RISK RELATIONSHIPS THAT CANNOT BE REMEDIED
(CONT.)
For revolving products:
• This may mean a provision to require the borrower to amortize a portion of the debt.
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“LINES OF DEFENSE” FRAMEWORK
Recent regulatory guidance on the multiple “lines of defense” provides a
useful framework to ensure that independent risk management can effectively influence change once
risks, either potential or actual, have been identified.
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INCENTIVE COMPENSATION
Similarly, guidance on incentive compensation provides tangible
suggestions to ensure that a flawed incentive structure does not lead to inappropriate risk-
taking behavior.
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CAUSES OF DOWNTURNS
Most downturns can be traced to a few enduring weaknesses of human behavior:
A failure to step back and see the complete picture.
Overconfidence (particularly about asset prices).
Or a belief that past performance will continue indefinitely.
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CAVEAT
Lessons learned from previous experiences are valuable…
however, the next downturn
may not look the same.
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KEY INGREDIENT FOR SUCCESS: RISK CULTURE
Ultimately, the key ingredient for success in preparing for the next
downturn is a risk culture that encourages proactive identification of
emerging risks and effective resolution once they are identified.
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The Credit Risk Council supports professionals who are responsible for establishing, maintaining, or carrying out credit risk management policies.
The Council focuses on funded and off-balance sheet risk management, including capital markets activity, and other forms of credit intermediation and risk mitigation.
ABOUT RMA’S CREDIT RISK COUNCIL
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