Even among the biggest banks, significant differences remain in how well credit risk is measured and managed, according to a new study.
Only four of the 64 largest North American banks were ranked as "advanced practitioners" of credit portfolio risk management in a study conducted by Robert Morris Associates and First Manhattan Consulting Group.
Of the banks surveyed, 46% were classified as "active traditionalists" in their approach to managing risk.
"There is a very, very close relationship between creating and maintaining shareholder value and portfolio risk management," said Allen W. Sanborn, president and chief executive officer of RMA, the trade association of lending and credit risk professionals.
The study found that although most banks suffered substantial commercial loan losses in the 1990-93 downturn, banks with lower losses experienced much smaller declines in their stock prices from the cyclical highs of 1989.
Low-loss banks achieved full stock price recovery within six months, versus 30 months for banks with high loan losses, according to the study.
"Eleven of the top 50 banks in 1987 did not survive that downturn, largely as a result of their loan losses," said Ronald Reading, managing vice president of First Manhattan, which conducted the study. He said the survey indicates greater disparity in the size of losses with the next credit downturn.
Other dangers of failing to adopt advanced risk management practices include customer defections, missed business opportunities, adverse loan selection, and poor return on risk.
To head off losses, 25 of the largest banks are each investing between $2 million and $15 million annually to enhance credit portfolio management, according to the study.
Bankers said that although the industry as a whole is improving its management of risk, much work remains to be done. In particular, banks must develop a more sophisticated understanding of the links between loan defaults and eventual loan losses.
"You have to understand what your expected and unexpected losses potentially are, so that you can allocate capital against them and then set your pricing to ensure that you're being appropriately rewarded for the risk that you're taking," said Kevin Blakely, a group executive vice president for credit policy and risk management at KeyCorp.
"I think the industry as a whole has quite a ways to go there," he added.
This study focused on practices at the largest banks in North America, but RMA is conducting a similar study of risk management at community banks.
"Clearly, their world is changing, too," Mr. Sanborn said. "As the biggest competitors change, they have to work to make sure they don't get stuck with the tail end" of the banking business.