Credit risk management – the big picture

16 November 2010



Mikael Krohn,
vice-president,
EDB Business Partner

According to a recent survey by Royal Bank of Scotland, managing risk is more important than growth for nearly half of UK firms – and these companies are not alone. Over the last two years, risk management has become a primary concern for both banks and lenders, both in terms of regulatory compliance and ensuring the future survival and profitability of financial institutions in the event of future economic turbulence. It is now all too apparent that risk management cannot be sidelined as a support function, as it has traditionally been. It needs to instead be integrated into all departments and viewed as crucial to the lending business.

However, it is not as simple as being able to increase investment into risk management in order to comply with shifting regulatory requirements. In today’s climate of ever tightening budgets, financial institutions must be able to clearly demonstrate Return on Investment in order to justify spend on risk management. In light of this, a huge challenge that faces lenders is the need to achieve a balance between risk management, compliance and profitability. Mikael Krohn, vice-president at EDB Business Partner, discusses the challenges that risk managers are still facing in achieving this balance, and whether all three elements can be successfully aligned.

The regulatory flood

Risk management is an ongoing focus for banks and lenders, particularly in light of ever more stringent regulatory updates and supervision. For instance, the ‘Basel III’ agreement will require lenders to more than double their capital requirements. However, according to Paul Tucker, the deputy governor of the Bank of England, “regulators must go above and beyond new international rules to keep banks in line” (1. Daily Telegraph, 2 November 2010).

As banks prepare for these compliance challenges, they are simultaneously working towards improving customer service and rebuilding trust in the industry’s ability to effectively manage risk. In addition, we can expect that existing regulations around data quality and processes will be more strictly enforced. This reflects the fact that a major factor in the successful management of risk in lending is the ability to document the risk profile of the portfolio, which requires the availability of quality data, risk models and ongoing expertise. According to research commissioned by Oracle, 86 per cent of IT professionals and financial services staff expect to see some changes in the regulatory load on their organisation or in the financial services market. Compounding this problem is the fact that 40 per cent believe that increasing compliance coupled with tougher deadlines will continue to hinder data accuracy (2. Oracle Financial Services, 19 Oct 2010).

However, risk managers are not only focused on compliance but also on demonstrating the additional business value that effective risk management processes can offer. Delivering increased efficiency and profitability remains at the forefront of risk managers’ minds.

Delivering profitability and return on investment

In order to achieve a balance between risk and profitability, banks must begin to look at ways to integrate IT investments in risk management to improve overall business processes. In the light of the recession and the low activity in the lending sector, financial institutions are operating under tighter profit margins, which have led to many banks cutting costs and slimming down their organisations. Whilst many banks have focused on cost-cutting actions that have an immediate impact on the bottom line, it is crucial not to lose sight of the underlying challenge to improve efficiency, quality and control of processes. Many financial institutions are working with legacy systems for risk management that could have a history of up to 40 years. Moreover, mergers and acquisitions within the industry have led to additional technology integration challenges for lenders.

For the banks to catch up and adapt to IT changes in the market often requires a transformation of their platforms that involve great risk, large investments and new competence. However, ultimately having efficient risk management processes in place will have a beneficial impact on the whole organisation. In addition, it is also important not to forget to build scalability into lending processes in advance of an economic recovery, or improvements on the bottom line could be short-lived.

Moving towards automation

As banks look to build scalability and efficiency into their processes, the decision to automate more elements of the lending process is becoming an increasingly popular one. Several financial institutions, particularly in Scandinavia, have begun to move towards efficient web-based services for processing applications, self-service for customers and credit analysis tools for decision making. For more efficient customer acquisition and work processes, banks must look to automate data capture, objective decision making criteria and support for automated pricing and credit approval.

As banks’ budgets continue to be constrained, the benefits of taking a more automated approach are clear. Banks can deliver a higher level of efficiency, in part by moving the approval and production process into self-service channels, and in part by integrating the bank’s credit policy into the tools used by its offices through workflow management.

An additional benefit of this approach is that staff can focus on making business critical decisions or on more complicated referrals, rather than on manually processing all loan applications so their time is used more wisely and cost-efficiently. Self-service loan application solutions also enable innovation and help banks to expand their distribution and customer service channels from being purely branch-focussed to making more use of the online channel.

Looking ahead

Whilst compliance issues will continue to be a focus for banks’ risk management teams, profitability and ROI will ultimately be priorities for most risk management investment projects. In order that this is sustainable, it is vital that preparing for economic recovery and building efficiency into processes does not drop off banks’ radar. Automation and self-service in lending is likely to grow in popularity in order to meet these aims, but it will also have the added benefit of meeting customer demand for more online services. Looking ahead, the banks that get the balance right will be the ones that successfully ride the regulatory wave to a profitable 2011 and beyond.


1. 'More to be done to make banks safer says Bank of England deputy Paul Tucker' Telegraph article (Nov 2nd 2010)
2. Oracle Financial Services Releases “European Confidence Report” Research (Oct 19th 2010)

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