Positioning the Balance Sheet for Profitability as High Interest Rates Persist
Rising rates over the last year and a half has posed challenges for financial institutions – from higher deposit costs to reduced loan demand. At the same time, lenders are also having to reassess the credit quality of their loan portfolios, given higher rates and a weaker economy have caused strain for many borrowers, especially businesses and commercial enterprises.
While it seems that rates may have peaked for the time being, it doesn’t look like rates will fall anytime soon. The question is: what does this mean for financial institutions’ balance sheets?
Institutions looking to protect their balance sheet through the continued volatility can turn to a few foundational tactics to weather through the uncertainties of our current economy.
Create a Framework to Identify Emerging Risks & Opportunities Sooner
First and foremost, banks must remain vigilant in monitoring changes in borrower creditworthiness, adjusting their lending strategies accordingly. To do this well involves closely observing market trends, economic indicators, and individual borrower circumstances. It also requires consistent alignment between the bank’s credit policies and its lending processes.
Credit policies should be reviewed and updated periodically to reflect changing economic conditions. Certain policies that made sense in a low interest rate environment may not be as applicable in today’s high interest rate environment. If rates drop as expected later next year, your current policies may no longer reflect the best strategy. In fact, some experts predict the Fed will cut interest rates at least six times next year, starting in the second quarter.
However, even if interest rates remain very stable for a longer period of time, it is good to review policies on a quarterly basis to ensure that they are working as expected and there are no underlying issues such as large customers reducing their activity. Reviews are also warranted when a financial institution adds, eliminates or changes a credit product and when the institution itself adds a branch or goes through a merger, an acquisition or divestiture. This is key, as many banking leaders anticipate a wave of mergers and acquisitions in 2024, after bank consolidation saw a freeze in 2023.
Inform Strategic Decisions & Streamline Loan Structuring
A bank’s credit policies serve as the foundation for all credit decisions and the lending processes should help enforce those policies. Technology can make the process of lending -- from origination to underwriting to loan reviews -- as efficient and accurate as possible to ensure credit policies are consistently adhered to and enforced. Technology is the great enabler of this equation.
Today’s technology can also give banks and lenders a complete view of the credit and operational risk associated with a credit relationship or a portfolio segment, enabling them to make better decisions (including pricing decisions) and help foster successful outcomes for their clients.
For example, advanced analytics enables financial institutions to identify trends and patterns within their loan portfolios, allowing them to anticipate potential risks and take preventive action. The technology also enables financial institutions to set alerts so they can react quickly to any changes in a client’s financial situations. For instance, if account overdrafts have increased for a customer, the bank may be able to restructure the terms of a loan to make it easier for the customer manage monthly payments.
Proactive intervention helps both the customer and the financial institution quickly address any challenges. The customer will appreciate active intervention occurring before a small problem becomes a much larger one – one that a small restructuring of loan terms will no longer correct. Early intervention helps keep an account current and helps avoid it moving down the slippery slope of collections.
By going back to the basics of portfolio monitoring and using technology to your advantage, financial institutions can set themselves up for success, no matter what the economic outlook holds for the year ahead.
Posted on Monday, December 11, 2023 at 2:45 PM
by Baker Hill