A bank’s credit lifecycle, or ecosystem, is a multi-dimensional view of the credit management process. Traditional risk assessments at most community banks are historic in the sense that they are focused on the past. Instead, the banking industry needs to adopt a more holistic, more dynamic approach to managing its credit risk—one that anticipates the future and focuses on what’s about to happen, not what just did. Effective credit management is far more than underwriting good loans—which can be characterized as transactional risk—and is where the process begins. It now includes its counterpart, aggregated portfolio profiling—which can be defined as macro risk—and includes performance measuring, modeling and forecasting. These two critical, but disparate, disciplines must now include other key points of input, and working in concert, form a credible feedback loop, says David Ruffin, co-founder of Credit Risk Management in Raleigh, North Carolina.

Why it’s important to focus on both transactional and macro risk.
Worshiping exclusively on either end of the risk spectrum is problematic. Understanding individual loan risks only is losing sight of the forest for the trees. And the other end, well, we all know models are only as good as the integrity of what informs them. The optimum sweet spot is that the two complement, not compete, for attention. In the end there must be an enumeration, a sum of the parts to accurately project a bank’s risk profile, both present and future. All stakeholders, including investors, management and regulators, now demand that. 

Additionally, since the financial crisis, a new metric has emerged in lending: the need to compute and apply the credit cost to loans being booked. The credit cost is your bank’s most intellectually honest reflection of what performance patterns exist in your loan portfolios, and is a critical input into future pricing. 

The critical activities that comprise a bank’s credit lifecycle.
Even before you underwrite a loan, you should begin by determining the credit policy and guidelines for each offered product—and how they fit your bank’s risk appetite. As we move to individual loans, any underwriting and decisioning tool should capture the factors that lay the foundation for the credit lifecycle.

We now shift from transactional underwriting to macro performance monitoring—the crux of the feedback loop. In addition to a credit decision and risk grade, your underwriting should compute a credit cost, an estimated loss projection at origination—and a key assumption to test over time. Other deviations on a myriad of discrete data points at the loan, product and vintage level can refine your tolerances and/or pricing. Of course, it’s critical to have a loan review function to monitor key aspects of credit quality, as well.

Using all of these performance data points, you should consider stress testing to quantify the impact to losses, earnings, liquidity and capital under stressed hypothetical scenarios. Stress testing should be seen as more war game than forecast, helping to form the boundaries around which strategic and capital plans can be grounded and defended. After all, most banks effectively stress their commercial borrowers through projections. The same logic applies to the bank itself! 

And finally, with the combination of macro performance monitoring and stress test analysis, along with inputs from compliance, audit and other enterprise risks, your bank can then holistically consider these risks—and opportunities—in light of its risk appetite, growth and capital plans. You can then close the loop and act on this new knowledge, allowing your bank to calibrate product-level credit risk, origination volume and even margin and profitability.

Managing the credit lifecycle requires a disparate set of skills.
Perhaps the greatest challenge is to orchestrate the disparate skills needed along the credit lifecycle. Traditional credit analysis is different from calculating probabilities of default, risk grade migration and statistical probabilistic modeling. Oh, and not to mention the highly quantitative proposed current expected credit loss approach, about to replace the loan loss reserves as we know it! Suspicions—and even territorial jealousies—may develop internally along the credit risk spectrum. But going forward, the transaction and macro disciplines must be synced and conversant with—and embracing of—the other.

Focusing on the credit lifecycle is an important discipline for all banks.
Some community bankers may question the need for new approaches such as the credit lifecycle. Understanding your credit ecosystem makes good business sense and is part of a growing regulatory expectation. The approach is rational, well documented, and defensible and is being used by an increasing number of banks. There’s a darned good chance that it can make a positive difference at your community bank.


David Ruffin


David Ruffin is a principal at IntelliCredit, A Division of QwickRate. His extensive experience in the financial industry includes an emphasis on credit risk in a variety of roles that range from bank lender and senior credit officer to co-founder of the successful Credit Risk Management, LLC consultancy and professor at several banking schools. A prolific publisher of credit-focused articles, he is a frequent speaker at trade association forums, where he shares insights gained helping lending institutions evaluate credit risk—in both its transactional form as well as the risk associated with portfolios based on a more emergent macro strategy. Over the course of decades, Mr. Ruffin has led teams providing thousands of loan reviews and performed hundreds of due diligence engagements focused on M&A and capital raising.