Trying to ensure safety and soundness is not as easy as it seems given the litany of risks that credit unions face on a daily basis. Regulators have stepped up their assessment of scenarios that can potentially bruise and even kill areas of operations. To help minimize risks, credit unions should consider the following three strategies to not only remain in compliance but to stay ahead of any operational roadblocks.
Monitor and Evaluate
Measuring lending performance is an on-going process, that should be monitored on a monthly basis at a minimum. Once key indicators of risk are identified, be it a high concentration of certain loan types as a percentage of total portfolio value or an increase in time of delinquency aging, tracking areas such as loan risk grades , for example, can help credit unions be on the lookout for signs of increased exposure to their institution. Through monitoring and evaluating loans originated with exceptions by way of static pool analysis, can provide a forward-looking assessment as to how future exceptions using those same policies will affect the company’s risk at the time those exceptions are allowed..
Some of the critical questions credit unions should ask as they monitor their performance include:
- What potential impacts can current delinquency or charge-off trends have on future earnings?
- What impact do current loan quality grading migrations have on reserves?
- Are there any high concentrations of categories, sub-categories, or types of loans that are affecting the overall performance of the loan portfolio?
- Have we properly run stress tests on the loan portfolio on our current data set?
- Have there been any jumps in the data that are not normal? For example, Is the average amount of a charged-off loan consistent? Are lines of credit increasing or decreasing at an abnormal rate.
- Are we seeing a decrease in certain types of loan applications? What about deposits, credit cards, lines of credit?
This list is just a snapshot as there are a number of questions credit unions should ask depending on their strategic plans. The bottom line: Credit unions should spot important lagging and leading risk indicators and monitor them on a regular basis.
Determine the Amount of Risk
By monitoring and therefore understanding the trends in lending data, credit unions can calculate how much risk they can safely take on and whether that risk will help them attain their their strategic goals.
By asking the following questions credit union can self-assess the amount of risk tolerance they have:
- Is our appetite for risk the right loan quality mix? In other words, if we buy deeper can we make more money or will it further expose us?
- Can we prove the risk we are taking produces a higher ROI than if we took less risk? If so can should we take more? If not should we take less?
- Are there underserved markets we could take more risk on?
- Are the reasons for our risk threshold quantifiable or is it based on what we’ve always done?
Knowing the tolerance for risk should be the starting point for a growth strategy and for overall better lending performance. .
The bottom line: Figuring out the risk appetite will help guide credit unions to create realistic and measurable risk guidelines.
Create a Risk Management Structure
From loan and application reviews to compliance, a properly structured risk management system will effectively address a number of key areas. Just as important is ensuring controls are appropriate for the particular business units and policies are living and breathing processes that provide assurance that the risk management strategy is meeting regulators expectations.
Practices must be integrated into a credit union’s day-to-day workflows so that scenarios involving exceptions, for example, can be targeted and corrected well before they become sore spots.
The bottom line: Develop a risk management structure that improves efficiencies, quells or eliminates risks and keeps the examiners happy.