MAXIMIZING
RESULTS
MINIMIZING
RISKS
The Economic Value of Balance
THE CHALLENGE:
How to Balance
Risk with Growth
It’s no mystery why they’re called balance
sheets. A bank’s scorecard reflects how well
it can balance risk and income. Whether
central, commercial, investment, retail,
or online, banks make money by lending
money. But to grow, banks need to get that
money back.
Since the origin of banking in the 13th
century, a bank’s main source of income
has always been interest—the difference
between interest paid on deposits and
interest received on loans.
No matter how complicated the interest
equation, the principle is simple:
• Loans repaid?
Net income.
• Loans defaulted?
Net loss.
• How should we structure our
sales and credit functions?
• How many prospects should we
have in the pipeline?
In other words, how do we minimize risk,
yet regain and sustain profitable growth?
• Too many loan defaults?
Bank failure—the unfortunate plight of
nearly 200 U.S. banks since 2008.
Following this principle, banks successfully
maintained the intricate balance of
maximizing results and minimizing risks for
years. In the early part of the 21st century,
however, a growing global economy tipped
the scale. The balance of power shifted
to sales, forcing risk assessment to the
wayside. Syndication and securitization of
loans allowed the loan originators to sell
them to another bank or financial institution,
which further diminished a bank’s need to
assess and minimize risk.
This set of circumstances ultimately led to
the financial crisis of 2007, when everything
changed. The U.S. economy collapsed,
the stock market crashed, businesses
failed, consumers filed bankruptcy, banks
foreclosed mortgages, and money stopped
moving. The crisis wasn’t limited to the
U.S. The economies of Iceland, Ireland, and
Greece imploded, while the U.K., Germany,
and France encountered severe difficulties.
Even the formerly rapid growth of Asian
economies stuttered.
These economic setbacks and the subsequent
slowdown have altered the mindsets of
banking executives—and consumers—
around the globe. As a result, financial
institution leaders ponder critical questions:
• What’s the right approach to lending?
• What’s a qualified prospect?
• What kind of risk assessment criteria
should we employ?
TO MINIMIZE RISK, you must fill the pipeline with lots of highly qualified prospects.
To maximize results, you must fill the pipeline with lots of highly qualified prospects.
The purpose of this paper is to:
• Explore recent and ongoing marketplace elements that impact sales and
credit in financial institutions from a
global perspective.
• Illustrate how assertive sales cultures
provide value to risk management,
and how aggressive risk management
practices support growth initiatives.
• Explore the outlook of the global
economic conditions that will likely
impact sales and credit functions.
• Provide practical strategies for
achieving the balance between minimizing risk and maximizing results.
A QUICK
LOOK BACK
Today, savvy leaders recognize the
competitive advantage of collaboration
between the traditionally divergent
disciplines of sales and credit. In fact, the
highest-performing institutions are not just
strong in both functions; they strategically
align them.
But it wasn’t always this way.
From the 1970s until fairly recently,
commercial lending institutions treated
sales and credit as independent and
opposing operations. Credit decisionmaking was exclusively focused on
uncovering and minimizing risks in loan
deals. Sales decisions were focused on
account acquisition, expansion, and
growth. This separation fueled dissension
between the groups, sometimes to the
point that, at the extreme, credit officers
criticized origination staff as undisciplined
risk-takers, and originators perceived
those in the credit role as conservative
deal killers.
This conflict between sales and risk
management was one of the major
contributing factors to the 2007 financial
crisis. A push to generate a growing loan
book spawned perilous trends in banking:
under-pricing of risk, lower liquidity
holdings, and an accelerated growth in
lending. A view that the world economy
would continue to grow indefinitely
created years of widespread bliss during
which conventional rules of banking were
abandoned. Sales indeed grew, but on
shaky ground.
This trend was further enhanced by creditrisk shifting instruments that changed
the relationship between borrowers and
lenders. Banks no longer had to absorb
the credit risk, and no longer needed
to hold capital against risks. In short,
banks no longer needed to act like banks.
(Interestingly enough, two countries
escaped the crisis largely unscathed:
Canada and South Africa. Why? Because
banks in these countries acted like banks.)
THE QUEST
FOR BALANCE
RE-EMERGES
STRONGER
THAN EVER
In the last few years, executives of financial
institutions around the world have returned
to their roots: integrating, balancing, and
creating synergy between growth and
risk management. What accounts for this
restored discipline? Certainly, the impact
of the 2007 financial crisis played a role,
causing multiple bank failures and tighter
loan restrictions. Institutions now realize
they need to get back to the business of
lending, yet they also need to strengthen
their balance sheets. The challenge comes in
trying to do both at the same time.
Not only are shareholders demanding a
more prudent approach to risk management,
but governments around the world are
introducing new legislation that requires banks
to hold more reserve capital to ensure that
nations never again have to bail them out. For
example, present-day Australian government
policy aims to reduce the country’s reliance
on mining. In Singapore, the government is
taking steps to cool the housing market. And
in China, while banking systems have always
been heavily regulated, the current endeavor
to control inflation and curb the price bubble
in the housing market is a hurdle for smalland medium-sized businesses needing loans.
Increased regulations have bank executives
considering how to respond proactively. The
solution for many is to create a culture where
everyone, regardless of role, understands
the need to drive revenue growth while
also minimizing risk. To enable this synergy,
financial institutions must assess the
components of their institutional cultures,
including training, communication, decision
making, and compensation.
For example, communication
between credit and sales needs to
be candid and two-way. Compensation
and rewards need to be balanced
between loan volume and risk
considerations. Reward systems based
on short-term profits and front-loaded
payoffs promote a bias toward excessive
risk taking, and reward systems based on
loan tightening limit growth.
Finally, to rebuild their balance sheets, banks
have been lending to companies that they
perceive as likely to repay. Presently, this
means large rather than small companies.
Favoring large, lower-risk companies while
depriving small- and medium-sized firms
of the credit they need to grow, however,
impacts not only revenue opportunity for
banks but also the global economy. These
small- and medium-sized companies generate
the most employment and economic growth
in nearly every country.
As a result, bank leaders see no other
option: assertive selling and aggressive risk
management must coexist.
WHAT IS THE
OUTLOOK?
The good news. The outlook is much brighter
than it was two years ago. Despite the
sluggish economy, loan growth is beginning
to pick up in certain areas, reflecting both a
greater willingness to lend and an increased
desire to borrow. According to an August
2011 report by The Fiscal Times, bank loans
rose each month in the second quarter
of 2011, after falling every month for the
past two years. And despite the continued
weakness of the U.S. economy, banks have
progressively eased lending standards, at
least for those firms surpassing $500 million
in annual sales—a trend repeated around
the world. Australian banks, for example, are
lending to the big mining companies, but not
yet to small- and medium-sized businesses.
Similarly, Chinese banks are lending to larger
infrastructure projects rather than to the smalland medium-sized companies that employ the
majority of the Chinese workforce.
The not-so-good news. The case is quite
different for smaller businesses. The lending
story for this market is almost exactly the
opposite. Viable yet small companies have
found themselves struggling to obtain
financing. In the U.K., for example, there are
reports that small firms don’t think it’s worth
even asking their banks for lines of credit or
new lending. To small businesses, it still feels
very much like 2008. Because there is no
useful credit risk transfer option for smaller
loans, lending institutions know that they
can’t trade out of them and instead must bear
the entire risk, creating a temptation to steer
clear of multiple, harder-to-understand smalland middle-market loans in favor of fewer
larger but safer credits.
HOW DO
FINANCIAL
INSTITUTIONS
GROW THEIR
BUSINESS
POST-CRISIS?
Simply stated, it’s back
to the basics:
Sell assertively, lend
prudently: make money.
Sell without focus, lend
recklessly: lose money.
Without a doubt, banks around the world
need to get back into the business of
lending. Those who are willing to step up
and take on a little more risk will likely fare
better in the long term. In this shifting global
marketplace, the challenge for banks will be
to avoid the errors of the past. To ward off
another crisis, banks need to reinstate the
time-tested principle: manage risk with a
focus on sales to drive growth.
In support of this principle, many banks
are implementing longer-term incentives
by encouraging assertive selling based on
the development of strong, long-lasting
customer relationships. At the same time,
they take a consultative approach to carefully
manage existing credit relationships and
examine new loan opportunities with due
diligence and impartiality.
THE
ENCOURAGING
IRONY:
Assertive Selling
Enhances Risk
Management and
Aggressive Risk
Management
Cultivates Sales.
When an organization’s performance
systems are structured to embrace
consultative selling behaviors, there are
a number of benefits that are synergistic
with strong risk management practices.
On the flip side, yet equally as symbiotic,
aggressive risk management provides
benefits to new business origination.
Benefits of Strong Risk Management
Practices:
• Improved deal flow. Increased selling
equals increased opportunity to select
and build quality deals.
• Favorable pricing. When more deals
are in the pipeline, an institution can be
more selective in pricing deals profitably.
• Increased use of non-credit products.
With an assertive sales force examining
the customer’s total business needs,
there is greater penetration of non-credit
solutions in the account. Non-credit
products increase profitability without
increasing risk.
Benefits of Aggressive Risk Management to
New Business:
• No distractions from poor portfolio
performance. When the portfolio is
sound, sales resources are not redirected
to, or burdened with, the task of
managing a poorly performing portfolio.
• Strong portfolio. In an aggressive risk
management environment, the quality of
the portfolio is better, and it’s made up of
customers who can repay their loans and
bring profit.
• Fair treatment of customers. An
aggressive risk management policy
ensures that prospective customers are
treated fairly. If a deal does not fit the
institution’s model of risk, the sales team
is better able to position the denial in a
customer-focused way and may be able
to direct the customer toward a more
amenable solution.
• Strengthened communication. A
strong risk management culture
demands a thorough understanding
of borrowers, which in turn can
strengthen customer relationships by
showing that the relationship manager
knows and cares about each borrower’s
unique needs.
STRATEGIES THAT
SUPPORT THE
BALANCE
Despite the uncertain global economy and
changing industry conditions, financial
institution leaders can implement concrete
strategies to balance the need to minimize risk
with the need to sustain profitable growth.
Strategies to consider based on an organization’s size, culture, and unique objectives:
• Ensure that the relationship manager
understands the intricacies of the
customer’s business—the long- and
short-term needs, risks, challenges, and
opportunities.
• Consider creating a single role
that embodies both sales and
risk management functions to
eliminate duplication of efforts
and adversarial points of view.
• Engage in an assertive and consultative
relationship-building process.
• Implement a team approach, comprised of individuals from sales and
credit who collaborate on decisions.
• Can they negotiate on behalf of the
customer to internal departments,
committees, or managers?
• Can they articulate the reason why
a deal should proceed?
• Do they commit to a thorough
understanding of a borrower’s
unique needs?
• Ensure compensation plans are
balanced and consider both the quality
and quantity of deals.
• Reinforce teamwork, communication, and
mutual understanding of sales and credit
functions through management practices
and performance incentive plans.
• Implement cross-training so that sales
and credit have a mutual understanding
of and respect for each others’ roles
and responsibilities.
• Apply consistent risk management
practices to reduce the roller coaster
ride that institutions often face when
required to put on the brakes due to
credit quality concerns.
Regardless of the country, economic
setting, regulatory policies, or the
structures and strategies employed, highperforming institutions align the purpose
and objectives of sales and credit in a
way that drives income growth based on
balancing aggressive sales with minimizing
risk. Forward-thinking leaders now
recognize that this balance is not a paradox
but an example of combined efforts being
greater than the parts.
ABOUT OMEGA
PERFORMANCE
www.omega-performance.com
2300-X00083
Whether you are an account manager,
relationship manager, or lender, Omega
Performance can equip you with the skills
to source sound lending opportunities and
structure high-quality, profitable loans to
help grow a more profitable, lower-risk loan
portfolio. Omega Performance combines
more than three decades of experience with
leading technology to provide proven results
you can count on.