A common credit culture in uncommon circumstances

RMA Journal, The, Sept, 2004 by Betsy Cadwallader

While a news anchor with NBC, Bryant Gumbel remarked, "Time changes every man. Unusual circumstances change them in unusual ways." By extension, a company experiences can affect its culture. This article offers tips on keeping credit culture strong amid change.

Asset quality of major U.S. commercial banks continues to improve with the economic recovery. Loan demand remains relatively tepid and the supply of capital seemingly unlimited. The recent emergence of newly capitalized public BDCs (business development companies) and the continued growth of hedge funds and other non-regulated financial entities will only exacerbate the demand/supply imbalance. Such an environment should encourage an institution to reexamine its risk culture.

Creating and maintaining a well-defined institutional risk culture consistent through inevitable economic cycles present a daunting challenge in today's environment. Acquisitions increasing scale and geographic dispersion, the resulting acquisition-related management changes, information gaps limiting a holistic ability to analyze risk, and ineffective or inconsistent training and education will all negatively affect cultural consistency. The following will address each of these hurdles and provide some guidance and strategies for combating the challenges.

Change through Acquisition

The most obvious hurdle to cultural consistency is industry consolidation. Acquisitions, particularly today's mega-mergers, are combining very large, geographically diverse, established institutions, each having its own distinct and embedded culture. Managers of the respective organizations feel that theirs is the most effective risk management practice and should be the surviving culture. Cultural differences quickly reveal themselves in how risk functions are organized, in respective risk identification and assessment methodologies, in hold limits and capital allocation, in specific industry aversions, exceptions, and problem loan management, and in risk policies and procedures. Even geographies can embed disparate practices, deemed "market" for the specific geography. Fortunately, credit quality statistics will generally quantify and force-rank risk management effectiveness across institutions or geographies within institutions.

Effective merger integration requires quick identification of these differences during the information-sharing premerger planning period. Detailed attention to policies and procedures, as well as the harder-to-define "the way we do things around here," should be articulated, shared, and compared. Establishing consistent risk management practices and values--the institution's culture--should be an early priority of the combined organization. It is only with the passage of time that the new combined organization will begin to believe and, with consistent reinforcement, embrace the new culture. Those institutions that either don't address or choose to ignore inherent institutional differences will face ambiguous practices post merger that potentially threaten future asset quality and delay effective merger integration.

Management Changes and Lack of Goal Alignment

Senior management is responsible for creating and driving the institution's risk culture.

Inevitably, culture flounders when management fails to articulate a clear message. Again, acquisitions and the loss of institutional memory associated with management change can be the direct cause of cultural confusion. Just as often, however, unclear culture results from management's failure to embrace its responsibility. Further, acceptable credit statistics and risk performance (as long as the credit/business cycle allows) can result in complacency--an "if it ain't broke, don't fix it" attitude. Finally, developing and maintaining a definitive risk culture is the shared responsibility of line origination and risk management. Without aligned interests and shared commitment to risk management, culture cannot survive and thrive. Today's aggressive competitive environment is creating new opportunities to quickly forget lessons learned only a couple of years ago. Absent an allied front, the cycle will repeat and renewed credit quality deterioration is likely.

Information Challenges Limiting Effective Data Analysis

Again, rapid consolidation has affected management's understanding of the true risk within the organization. As institutions merge, understanding the risk profile of the combined organization becomes increasingly complex and relies more on management information. The process of slicing and dicing details regarding portfolio structure, pricing, tenor, industry exposure relative to established limits, and other risk concentration and assessment measures can become extremely manual; poor data quality can create unreliable results. The effectiveness of policies and procedures is possible only when tested against the actual portfolio. For example, credit policy exceptions should be tracked and measured in sufficient detail and frequency to check the policy's efficacy and relevance and to identify management's attention to nonconformity. Information technology and data integration is often a real limitation to this important data mining and analysis. Managements that recognize the importance of good information will prioritize and demand quality information systems that permit an accurate view of both the forest and the trees.