Bank directors and management teams must prepare themselves and their institution for the potential for an economic crisis due to the COVID-19 outbreak.
This preparation process is different than how they would manage credit issues in more traditional economic downturns; traditional credit risk management tools and techniques may not apply or be as effective. Directors and others in bank management may need to consider new alternatives and act quickly and deliberately if they are going to be successful during this very difficult time.
The traditional three lines of defense against quickly elevating credit risk may not work to prevent the credit impact of the new coronavirus and its consequences. The “horse is out of the barn” and no existing, normal risk management system can prevent some level of losses. This pandemic is the proverbial black swan.
The real questions now are how can banks prepare to deal with the related issues and problems?
Some institutions are likely to be better prepared, including those with:
- A strong capital base.
- Good, conservative allowance reserve levels.
- Realistic credit risk assessments and portfolio ratings prior to the pandemic.
- Are poised to take part in a potential acquisition.
- A good strategic approach that is not materially swayed by quarterly earning pressures.
- A management and board that “tells it like it is” and is realistic.
- Good relationship with regulators, CPA firms, professionals and investors.
What are a bank’s options when trying to assess and manage the pandemic’s impact?
- Deny the problem and kick the can down the road.
- Wait for the government and regulators to provide solutions or a playbook for the problems.
- Sell the bank — most likely at a big discount if at all.
- Liquidate the bank, likely only after expending capital, with assistance from the Federal Deposit Insurance Corp.
- Be proactive and put in place processes to deal with the problem and consequences.
There are some steps a bank can take to be proactive:
- Identify emerging and potential problems and the options to handle them, and then create a plan that is strategic, operational and provides the best financial result.
- Commit to doing what’s right for the bank, its employees, customers and community.
- Enhance or replace the current credit risk management system with a robust identification, measurement, monitoring, control and reporting program.
- Adopt an “all hands-on deck” to improve focus and deal with material issues in a priority order, deferring things that do not move the needle.
- Assess internal resources and consider moving qualified personnel into areas that require more focus.
- Seek outside professional assistance, if needed, such as loan workout or portfolio analysis and planning.
- Perform targeted reviews of portfolio segments that are or may become challenged because of the pandemic and potential fallout, along with others may have had weaker risk profiles before the pandemic.
- Communicate the issues such as the magnitude of the financial challenge to employees, the market, regulators, CPAs and other professionals who provide risk management services to your bank.
- Deal with problems head-on and decisively to maintain credibility and respect from various constituencies while achieving a superior result.
It is best for everyone in the bank to work together and act quickly, thoughtfully, honestly and strategically. There will, of course, be some expected and understood need in the short term for increases in allowance provisioning. If planning and actions are executed well, the long-term results will improve the bank’s performance and enhance its credibility with the market, regulators and all other professionals. Just as valuable as an outcome is that your bank’s reputation will be enhanced with your employees, who will be proud to have been part of the effort during these difficult times.