3 Strategic Questions You Should Be Asking as Credit Risk Builds
September 27, 2023
4 minute read – Over the last 18 months, the conversations we’ve had with management teams and board members across the United States have focused on concerns around interest rate risk – rates sat at or near 0% for so long that most people in leadership positions were not in decision-making positions the last time it was relevant to look at up-rate and down-rate environments. We have also been privy to hundreds of conversations around liquidity risk – rare is the institution that hasn’t witnessed material outflows of NMDs. But as we’ve looked at balance sheets over the last several months, we’ve noticed an increase in indicators of credit risk.
We anticipate that credit risk is going to increase for many institutions in the next few months for a number of reasons. Federal student loan payments are scheduled to resume for tens of millions of Americans starting this fall. Coupled with the lasting impacts of inflation, there is reason to anticipate this will increase pressure on many household budgets. Additionally, for many the stimulus money is mostly gone, Americans’ credit card debt has hit a trillion dollars, and the possibility of recession still looms. There is also concern that commercial real estate may not bounce back with work from home becoming the new norm for so many. And we’ve yet to see the ripple effect of the change in credit rating of the U.S. and several larger banks.
While none of us can predict the future, we can ask strategic questions to help prepare for the potential consequences of these and other impacts to consumer expenses, while continuing to cultivate relationships with individuals and the community in which we work. These questions are a place to start the conversation, but just as important as the “what” to discuss is the” who” – who should be part of these conversations. We see it happen again and again, strategic conversations about pressing issues that take place in silos, missing voices and perspectives that can help paint a more nuanced picture of what is happening across the organization. Making sure you are asking the right questions with the right people in the room can help you navigate this unpredictable environment.
The following are questions that can be used to spark discussion around credit risk as environmental factors influence larger economic trends:
- What is the likelihood your strategic target market will be impacted by these economic factors?
- Understanding how your target market may or may not be impacted might color your discussions about raising credit quality standards or taking on more risk to support those who might be in need.
- What data are you leveraging to better understand your target market? There may be benefit in looking beyond the last 3 or 4 years to before the pandemic influenced deposit rates and budgets.
- How might different components of your loan portfolio be impacted differently?
- For example, commercial loans tied to real estate may have elevated losses if they are impacted by lower occupancy rates. Asset values for auto and real estate loans may decline after values jumped significantly after the pandemic.
- How are you linking risk and strategy?
- For example, how are policies, underwriting, risk appetite, etc. synced with your long-term strategy? What-ifs can help you model possible scenarios – trying different variables in your numbers and exploring the potential impact of changing repayment speeds or increased delinquencies and charge-offs – and link today’s decisions with a variety of potential futures. This can also be a tool to help understand how potential risks are connected and where there may be opportunities as you discuss balancing credit risk with other risks like interest rate risk or liquidity risk.
While your institution may not yet be feeling the consequences of continued pressures on household budgets, it is important to engage in discussion on credit risk as part of your strategic conversations. Understanding how your target market is affected and thinking through different scenarios can help you draw connections across your organization and get prepared for future possibilities.