BankersHub.com February, 2017 Newsletter Page - 1

CREDIT CULTURE: DON’T MAKE LOANS WITHOUT IT (PART 1 OF 8)

By Dev Strischek

ABOUT THE AUTHOR(S)

Dev Strischek is a leading expert in Credit Risk

Management, with 18 years as SVP – Sr Credit

Policy at SunTrust, 20+ years as Boardmember of

Risk Management Association, and Advisory

Boardmember of the ABA School of Commercial

Lending.

Email: dev.strischek@gmail.com

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BankersHub was founded in 2012 by Michael Beirdand Erin Handel, 2 Financial Services professionals dedicated to educating and informing banks, credit

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Newsletter Article

February, 2017

How We Do Things Around Here

As banks are created, merged, acquired, or dissolved, their unique

ways of doing things are eliminated, modified, revised, or converted

into new approaches to banking. One much compared element of

financial institutions is their credit cultures, especially as two banks

begin to contemplate what their combined organizations should be. As

they evaluate each organization’s philosophy toward risk, they are

really trying to decide what credit culture will emerge.

A bank’s credit culture reflects its unique combination of policies,

practices, experience, and management attitudes that defines and

determines the lending environment and lending behavior acceptable

to the bank.1 It is the system of behavior, beliefs, philosophy, thought,

style, and expression that sums up the bank’s credit risk management.

A strong credit culture radiates through the organization from top to

bottom; it is felt rather than dictated. It is more “how we do things

around here” than what is written in policy and procedure.

For obvious reasons, the regulatory community favors institutions with

a well-developed culture that takes a long view, has clear policies that

delineate its risk tolerance, practices risk discipline, and has committed

resources to support sound risk management.2 In fact, Citicorp’s

legendary chief lending officer Henry Mueller argued that a credit

culture builds the right risk foundation for good banking:3

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“A credit culture is made up of principles that need to be communicated. A credit

culture is rooted in corporate attitudes, philosophies, traditions, and standards that

require administrative underpinnings. The role of a credit culture is to create a risk

management climate that will foster . . . good banking . . . “

The recession of the early 1990’s saw many troubled banks merged into their surviving partners, and thus,

much of the introspective, groundbreaking observations on credit culture were written during this period.

Their observations are still relevant to this decade’s continuing bank consolidation and the recurring credit

culture clashes between buyers and sellers.

The impact of culture on corporate goals is substantial. If a culture is not supportive of an organization’s

objectives, the organization’s ultimate success is at risk. The interplay between credit culture and bank

strategies will be explored in detail--the identification of the existing credit culture, determining which culture

works best with management’s goals, and

insuring that the appropriate tools are in place to implement and maintain the desired credit culture. The key

to successful KPO is to build the skill it takes to perform the function into the process itself, so that the

process is not impacted by employee attrition or workforce expansion. Instead, in many financial

institutions, we find the skill is “built into” the person performing the job. They’ve been performing it skillfully

for years on end and using individual training methods to bring new workers up to speed. Job

documentation tends to be cursory and technical, useful only if accompanied by extensive on-the-job

training in the company of experienced workers.

Groundhog Day: Yesterday Is Here Again4

As the banking industry recovered from the recession of the early 1980’s, it tumbled into a worse recession

by the early 1990’s, yet the problems twenty years ago don’t seem so very different from today’s issues:

Management overconfidence

Aggressive underwriting and lending to marginal borrowers in risky lines of business

Loan concentrations in borrowers, geographies, lines of business, maturities or types of loans

Inadequate pricing for risk

Lack of credit discipline evidenced by lending outside of areas of competence

Inadequate policies, procedures, systems, and controls

Erosion of core earnings

Wider bands of volatility in earnings and asset quality

Poor transaction management caused by aggressive underwriting, overlending, ill-defined sources of

repayment, incomplete credit information, and poor documentation

Big banks are not immune to these problems; in fact, these problems seem to have afflicted some of the

largest institutions thought to have the best policies, procedures, internal controls, lenders, and credit

approvers. What happened? Blame the poor economy and distressed borrowers for some of it, but the

remaining problems point to a breakdown in credit discipline. The best-written policies have no value if they

are neither read nor enforced, especially during periods of stress when senior management aggressively

pursues loan growth to boost current year earnings and expand market share while ignoring its own

underwriting policies and overriding turndown decisions.

Imagine the confusion in a bank when the credit approval officer initially declines a loan request because of

negative cash flow repayment ability, insufficient collateral, and lack of adequate guarantors only to discover

that senior management has overridden the turndown. The lender senses either a suspension of or

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breakdown in the rules, and the credit officer perceives a loss of decision-making power and competence.

None of these consequences is healthy for the organization; the bank’s credit culture has been

compromised.

Risk Management’s Job Is to Grow Shareholder Value

As a bank sets its performance goals, its primary goal is to enhance shareholder value. Today’s markets

reward organizations that generate predictable, stable earnings and punish institutions that perform

erratically and uncontrollably. The winning combination of rising revenues and declining expenses offers two

paths to success, and as a bank weighs the possible options, its lenders typically assume responsibility for

the revenue’s path and its credit risk managers are generally held accountable for minimizing risk expenses.

Tension between line and credit increases as management pressures the lenders for more loan volume and

higher earnings, and of course, higher profits are the reward for taking more risks. To keep the profits

coming, the bank’s management must decide how much risk it can afford to tolerate.

A high return on equity depends on revenue generation at a reasonable cost and at an acceptable risk. The

senior lender and the chief credit officer must share the same goal of high-volume, high-quality loans and

act as a team to support their CEO’s goal of enhancing shareholder value by means of predictable, rising

earnings because shareholder value is ultimately the present value of future profits, while the current stock

price reflects the market’s opinion of the team’s progress toward building shareholder value.

Shifts in business conditions happen, but the market still expects shareholder value to be stable and

predictable, steadily growing throughout the business cycle by means of earnings growth during expansion

and earnings stability and quality during recession. Therefore, the credit risk strategy must be flexible

enough to adjust to the cycle while shifting between growth and stability. Although the philosopher Bertrand

Russell argued that all movements go too far, nevertheless, your bank must respond to the ebb and flow of

credit cycles, and your credit culture must maintain the discipline to move the bank out of harm’s way.

1Ann Barr Taylor and R.P. McWhorter, “Understanding and Strengthening Bank Credit Culture,” The Journal of Commercial Lending, April 1992, pp. 6-11.

2Kathleen M. Bean, “Effective Risk Management Is Sought by Regulators, Bondholders, and Shareholders,” The RMA Journal, September 2001, pp. 54-56.

3P. Henry Mueller, “Risk Management and the Credit Culture—a Necessary Interaction,” Credit Risk Management, Robert Morris Associates: Philadelphia, 1995, p. 77.

4John McKinley and John Barrickman, Strategic Credit Risk Management, Robert Morris Associates: Philadelphia, 1994, p. 2.

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