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HOW TO PREPARE YOUR INSTITUTION FOR THE NEXT

DOWNTURN

By the RMA Credit Risk Council

Culture Plan

Assess

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“The time to repair the roof is when the sun is shining.”

– John F. Kennedy

Source: JFK’s State of the Union address, January 11, 1962. Said in the context of

preparing the country for the next economic downturn.

TIMELY ADVICE FROM JFK

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THE BEST TIME TO PLAN

The benign credit environment is the best

opportunity to start preparing for the next

downturn.

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THE BEST TIME TO PLAN (CONT.)

Planning now allows time to make adjustments to

portfolios in order to be able to weather the next

financial crisis.

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ASSESS YOUR PORTFOLIOS

Portfolios with excessive concentrations of credit are more challenged to withstand a downturn.

Assess the portfolio to determine whether significant concentrations*

exist in:

Specific industries. Geographies. Asset

classes.

Where these exist, implement strategies to manage concentration

risk such as:

Limiting growth in

those areas.

Balancing the portfolio with

loan growth in other areas with less “correlation

risk.”*Obligations exceeding 25% of the bank’s capital structure. http://www.occ.gov/publications/publications-by-type/comptrollers-handbook/Concentration-HB-Final.pdf

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REDUCE THE AMOUNT OF RISK PORTFOLIOS MAY PRESENT DURING THE NEXT DOWNTURNIdentify exposure to weaker borrowers within the portfolio.

Work with the customer to provide a solution that mitigates risk in a way that leads to a continued beneficial relationship.

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DEVELOP EXIT STRATEGIES FOR HIGH RISK RELATIONSHIPS THAT CANNOT BE REMEDIED

For consumer and small

business loan portfolios:

• Develop more responsible loan structures.

• Consider making product design changes. 

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DEVELOP EXIT STRATEGIES FOR HIGH RISK RELATIONSHIPS THAT CANNOT BE REMEDIED

(CONT.)

For revolving products:

• This may mean a provision to require the borrower to amortize a portion of the debt.

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“LINES OF DEFENSE” FRAMEWORK

Recent regulatory guidance on the multiple “lines of defense” provides a

useful framework to ensure that independent risk management can effectively influence change once

risks, either potential or actual, have been identified. 

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INCENTIVE COMPENSATION

Similarly, guidance on incentive compensation provides tangible

suggestions to ensure that a flawed incentive structure does not lead to inappropriate risk-

taking behavior.

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CAUSES OF DOWNTURNS

Most downturns can be traced to a few enduring weaknesses of human behavior:

A failure to step back and see the complete picture.

Overconfidence (particularly about asset prices).

Or a belief that past performance will continue indefinitely.

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CAVEAT

Lessons learned from previous experiences are valuable…

however, the next downturn

may not look the same.

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KEY INGREDIENT FOR SUCCESS: RISK CULTURE

Ultimately, the key ingredient for success in preparing for the next

downturn is a risk culture that encourages proactive identification of

emerging risks and effective resolution once they are identified.

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The Credit Risk Council supports professionals who are responsible for establishing, maintaining, or carrying out credit risk management policies.

The Council focuses on funded and off-balance sheet risk management, including capital markets activity, and other forms of credit intermediation and risk mitigation.

ABOUT RMA’S CREDIT RISK COUNCIL

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Visit http://www.rmahq.org for information on risk management

RMA is a member-driven professional association whose sole purpose is to advance sound risk principles in the financial services industry. 

RMA helps its members use sound risk principles to improve institutional performance and financial stability, and enhance the risk competency of individuals through information, education, peer sharing, and networking.

Become a member today.