Banks Should Create A Risk Culture To Succeed
Macroeconomic developments, heightened regulation, and pressure on margins and profitability are drastically changing the banking sector. According to a Mckinsey report, in such a fiercely competitive scenario, bank decision makers, especially in the emerging markets should rethink moving risk management to the top of the agenda for CEOs and their boards.
Traditionally, banks in emerging markets have paid little attention to cultivating a risk culture, where employees feel encouraged to speak up when they observe new risks. The report explains that fostering such an atmosphere not only requires the involvement of a multitude of stakeholders but also takes time. Yet in the current economic and banking environment—where banks must respond decisively to existing and emerging risks—it’s critical to develop a strong risk culture.
“Many banks have begun to take the initiative by setting up dedicated sessions with business, risk, and control functions to evaluate risk-response scenarios; explicitly defining what’s expected of all stakeholders; and engaging in tests to reinforce a strong risk culture. In addition, many emerging-market banks plan to introduce or upgrade institutional frameworks on risk to promote prudent decision making—an action strongly encouraged by regulators concerned about strengthening banks’ risk management and governance,” says the report.
Improving the collections process
There is significant room for improving credit collections. For example, the report highlights loan-loss impairments for emerging-market banks nearly tripled to €34 billion between 2007 and 2012.
The report notes that addressing this issue requires two steps: identifying actions on nonperforming loans that can have an immediate positive impact on bank performance, and supporting improvements to credit management related to a defined recovery strategy, organizational structures and processes, and systems. We’ve found that programs of this sort can have a huge impact: in Eastern Europe, for instance, banks have been able to reduce their stock of nonperforming loans by as much as 20 percent.
Developing innovative risk models
Emerging-market banks need to make better-informed credit decisions. There is simply not enough information on creditworthiness, whether in the form of reliable financial data about customers (especially for small and midsize enterprises), credit-bureau information, or historical performance data. Given these gaps, banks have strong incentives to develop their own innovative risk models that incorporate both qualitative and quantitative factors.
The report observes that where credit bureaus are active, they are having an impact. In one emerging market that adopted such models, loan defaults by micro, small, and medium-size enterprises fell by 79 percent at small banks, while large banks’ default rates fell by 41 percent. At the same time, the probability of a loan being granted to a smaller company rose 43 percent.
Rethinking capital allocation
Bank capital will be increasingly scarce in most markets. Yet banks can support business growth and unlock profit potential by understanding where current capital is consumed and optimizing its absorption. We have seen some banks establish a capital-based threshold at which they retain a client’s business.
Others seek more collateral or push for more favorable collateral from a risk-weighted-asset standpoint and add covenants to mitigate “rating drift.” Emerging-market banks can also optimize their product portfolio for capital consumption, steering customers toward receivables-based financing rather than working-capital financing.
The report states that tackling these strategic and operational imperatives requires focus and effort, but the emerging-market banks that succeed will have important competitive benefits. “Aside from stronger financial performance and improved strategic management, many will realize true competitive advantage as stronger capabilities lead to superior risk selection, risk pricing, and active risk management,” it says.
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