Lending Policies & Processes that Mitigate Risk in Any Economy

Lending Policies & Processes that Mitigate Risk in Any Economy

Managing risk is a core component of banking, but the financial landscape today and over the last few years has been especially fraught with risks. Between ongoing competition for deposits, a struggling CRE space as office vacancies surge, and an increase in consumer loan delinquencies – there are many risks for bank leaders to navigate in the year ahead.

According to the Risk Management Association’s annual Chief Risk Officer Outlook survey, three of the most common top risks reported by respondents were financial, which include: treasury/asset-liability management risks (cited as a top risk by half of respondents), wholesale (C&I and CRE) credit risks (42%), and a possible recessionary environment (42%).

At the same time, a deluge of new and updated regulations, along with enhanced pressures from bank supervisors has more bank directors and executives worried about regulatory compliance.

Financial institutions that effectively navigate this risk environment and set themselves up to make smart, consistent lending decisions on the front-end that control the build up of risk, sets their institution up for success no matter what the second half of 2024 holds. 

Consistency, Accuracy, Automation All Critical

Three foundational elements of controlling risk are consistency, accuracy, and automation. Technology takes all those elements and aligns them with a bank’s risk tolerance and credit policies.

Today, many community banks manually assess loan applicants, collateral, loan terms and more using manual processes, often rooted in spreadsheets and separate documents. They must assess these factors against a range of compliance requirements and credit policies unique to the bank and loan type. Understandably, this increases the risk of inconsistencies, errors, and oversights when decisioning a loan request.

On the other hand, automated loan origination technology ensures consistent inputs, credit analysis, compliance, accurate pricing and more. All of this ensures sound, predictable credit decisions with greater efficiency for both the bank and the borrower.

Today’s technology can also streamline activities like collateral management and exception tracking. Automated alerts can be triggered when an account or customer needs attention. For example, if collateral values dropped for a certain account, a relationship manager can be notified to address and if needed, workout an updated arrangement with the borrower. 

Proof of Process Improves Compliance

Another advantage of automation that clearly aligns with a bank’s risk tolerance and loan policies is that it goes a long way toward demonstrating compliance. By using technology to automate certain lending processes based on an institution’s risk profile and credit policies, banks inherently establish a proof of process, which shows how loan decisions and outcomes are reached. This proof of process is important from a governance, risk, and compliance standpoint because it helps demonstrate that the financial institution’s credit decisions were based on consistent, objective parameters. 

Stronger Stress Testing

Banks that prioritize consistency, accuracy and automation in their risk management activities are also set up for more meaningful stress testing. When financial and borrower data is captured, analyzed, and organized consistently, it’s much easier to accurately simulate prospective economic scenarios and see the potential impact on capital and financial performance.

This will help answer important questions, such as: Based on current portfolio concentrations, where is there potential for added risk? What will happen to credit risk exposures if the economy slows or interest rates increase?

While no one can predict the future – not even the best economist – there are tools and tactics that financial institution executives can implement to set their bank up for success no matter how the economy performs in the second half of 2024. Whether interest rates rise or fall, the banks equipped to make informed, consistent decisions that align with their institution’s unique credit policies and risk framework will be positioned for profitable long-term growth.