Too Many Bankers Keep Ignoring History

Before the Great Recession, when profits were soaring, banks grew faster than their customers and the economy. Lending was excessive. Despite the unsustainability, lenders were generally heedless. In the aftermath, and with the world overleveraged, banks are struggling to adjust and reinvent themselves. Selling too hard has always been the industry's curse, inviting unnecessary and uneconomic borrowing and unsound credit practice.

Banks are up against contrary pressures. Despite slimming profit margins, new regulations and the erosion of their business by nonbanks, they need to be profitable enough to attract capital in support of economic growth. With little room to maneuver, the extension and control of credit must be near-perfect. Aggravating this, retirements, cost-cutting, staff reductions from mergers and the proliferation into new activities with new risks have diluted talent at every level.

The likely answer is a culture set by directors based on realistic credit policy commensurate with resources and professional competence. Policy is culture's mainspring and guardian and bears directly on the bank's liquidity, since money put out is unavailable until repaid. The starting point is to know banks' proper lending turf.

Everyone now realizes the world will never return to where it was. This redefines bank directors' responsibilities and qualifications. It means they are expected to think strategically and be alert to what is happening around them, as well as within their own banks. For example:

• Are board members sufficiently conversant about banking to challenge management's assumptions?
• Do the directors understand the risks the bank is taking?
• What are the banks' strengths, weaknesses, opportunities and threats?
• What are the portfolio's overall risks, concentrations and trends?
• Does the bank have geographic diversification?
• Are computer models based on valid assumptions?
• Developments often move ahead of the market's ability to reflect on risk. They may stem from unintended consequences or other forms of financial distortion. Previously well-defined rules of the business fail when markets are seriously out of balance because critical relationships between factors in the market differ from before and are not understood. Does the board have a committee that periodically delves into overall bank risk and unexpected happenings which could upend financial systems and cause the bank to lose control? What might these be and how likely are they to occur?
• Off-balance-sheet obligations sometimes have a way of coming home to roost. Where are they?
• What balls are being dropped in banking and why?
• Why are banks failing?
• What effect on the bank will new competition have and what makes it tick?
• How well do lending officers know and understand borrowers?
• What about the shortage of bank and director talent? How will the bank plan and cope with succession?
• Do the bank's computers fit its real needs? Are they economic, and what ability do the suppliers have to provide new technology when it is introduced?

Policy, process and audit dominate culture. While a bank's credit apparatus may be decentralized, credit policy is centralized because each bank needs a credit conscience. Process includes the delegation of lending authority and is based on an unambiguous administrative structure with checks and balances. It is the arm of risk-taking strategy, beginning with environmental scans leading to market strategies, business plans, business administration and repayment of principal. While policy must be part of the process when strategies are being developed, it is too late if credit policy is relegated to merely loan review. An audit is a comprehensive review mechanism used to evaluate performance and loan quality. It examines conformance with policy, practice and procedures, market threats, adherence to target markets, business plans, training gaps, administration and repayment.