Risk managers get in trouble when they start measuring risk based on the expectation of loss or exposure. Expected loss is just part of the risk story. Be it credit risk, liquidity risk, interest rate risk or operational risk, exposure for a bank must include the unexpected exposure, not solely the expected loss. Expected losses are priced into a contract and banks are typically compensated upfront for these risks. It is the unexpected loss that must be protected by capital and causes the most amount of damage and bank failure.
Tag: risk management
It was at Balad Air Base, Iraq, in March of 2008 – I had been sitting in the dusty little shack for the last five hours and the boredom was REALLY starting to set in.
There is an interesting separation between the recent drop in equity prices and credit products. Traditionally, a huge sell-off in equities reverberates through credit hitting corporate bonds first and then bank loan pricing. This time, it is barely happening. Back in late 2007, we saw this “sympathetic coordination” between equities and credit before there started to be legitimate credit concerns beginning with housing and capital markets liquidity. So what is different now?
As we have discussed before, your bank is a manufacture of credit, liabilities and fee services. Whether you know it or not, you have a certain production capacity of each. In today’s current environment, some banks are running at full and even over capacity while some banks are operating at the 50% utilization level. The question that comes up is what is the right capacity and how much should you be pushing on the gas to increase production?
Lots of banks have a limited number of credit grades. For the most part, the average bank has eight different categories, the first four of which are pass grades. If this is your bank, you are ripe to get hurt both in risk management and in loan marketing. Larger banks that use an infinite number of grades in their pricing model or at least use a two-tier system composed of probability of default and loss given default are at a material advantage when competing against a community bank that has a limited number of credit grades.
According to the latest data from Moody’s/RCA CPPI, the value of commercial real estate rose by 0.5% in March bringing the total appreciation rate for 2017 to 0.8%. This has been in-line with most bank’s projections that forecasted an average of 3% for the year, or 0.75% for the quarter. Most of this growth was a result of demand in major metro markets, as smaller markets saw a decline in value of 0.2%.
New data out from FICO shows that physical debit card fraud in the US jumped 70% in 2016. That is because there is not only more debit card usage, but that usage has driven criminals to use more fake card readers to nefariously skim debit card information. Last year, hacked card reader crimes rose 30%. Most of the card fraud comes from ATMs, of which over 66% are owned by non-banks. Over the last several years, that puts card fraud at ATMs up an astonishing 546% according to FICO.
In banking, we tend to think of risk as transactional in form. We contemplate what would happen if a loan defaulted if a cyber-attack occurred, if a new product caused a liability or if interest rates spiked. This is to say that we think of risk in the context of a particular event – if X happens, then Y risk will occur. The problem is that this event-driven mentality limits our thinking on risk. Risk is present no matter if it is monetized or not. Rising interest rates does not create risk; it just monetizes it.
Most bankers are familiar with the concept of a risk-return trade-off. This is the principle that potential return rises with an increase in risk. Low levels of risk pays low potential returns, whereas high levels of risk pay high potential returns.
Commercial loan competition is intense and we recently witnessed a long-term customer of a community bank refinance with a competitor bank for just a 15bps lower loan rate, zero closing costs and no loan fees. This is an extreme example, but the point is germane – competition is intense and community banks need to be creative to manage profitability. We would like to share one particular tactic that we use at CenterState Bank to increase commercial loan profitability. We are certain that your bank can benefit from this same approach and poss