As most people are aware these days, one of the most important factors to monitor in the banks performances’ is their credit risk portfolio quality. But how do Banks, namely the UK Banks and regulator(s) control this?
In reality the UK Banks’ performance in this department has been reasonably good even throughout the crisis, remaining at a relatively low level and no significant rise, positioning at a 1.9% its level of non-performing loans (NPL), 5th lowest in Europe, with an overall weight of 8%, approximately 81 billion GBP, of the overall EU 28 (5.1% average). Despite this encouraging figure, it is important to understand that the UK Banks actual coverage ratio for these is just at ca. 30%, which although admissible by the regulator(s) it is still one of the lowest in Europe alongside with Denmark, Finland and Sweden, with 30%, 30% and 29%, respectively.
This would not be a problem if just recently the Bank of England’s – Financial Policy Committee (FPC) hadn’t sounded the alarm on possible “debt bubble risks”, identifying the existence of “pockets of risk” in the current level of lending on loans, overdrafts and credit cards, estimating the potential loss for the UK Banks, in case of a “severe downturn”, of over 30 billion GBP. Just for the purpose of perspective this figure is equivalent to 20% of all of UK’s consumer credit loans…
In this sense, it is very important to constantly monitor, control and upgrade the Banks’ ways to control their credit risk systems and processes not only on the automated side, by the creation of automated reports and systems that unlock an internal chain-reaction, but also and especially on the pro-active side, changes and updates/upgrades in their Early Warning Signals detection as well as in the early stage of credit analysis to their credit personnel. This can only be achieved through constant search for market best practices and knowledge i.e. through Credit Risk Courses, Advanced Credit Risk Courses, Early Warning Signals Courses and other Credit Risk related Courses which will allow credit portfolio managing personnel to better analyze, deal and mitigate risks inherent to their business not only in the initial analysis but also throughout the duration of the loans/credit lines.
Another way in which the regulator finds it appropriate to deal in mitigating this potential risk is more financial, meaning that the banks need to hold more capital and liquidity to deal with these potential losses in the future, however as we all know, these cost money and resources which the markets and especially shareholders tend not to like, because it money just standing there in a figure of speech, not getting properly remunerated or at least to its full potential.
That said, there is still another way to minimize the effect of the regulators demands mentioned in the previous paragraph, which is to improve the coverage ratio which is apparently low in the UK as well as other northern European economies. By doing so, the demands for capital and liquidity will lower by the regulator and therefore implicating less costs, capital and liquidity allocation by the Banks shall be required.
In fact, with just a fraction of the potential cost of boosting liquidity and capital ratios, Banks can actually provide credit risk courses to their credit risk directors, analysts, team leaders, etc. to, whenever and wherever possible, look for alternative and innovative ways to better secure their loans, seeking for extra securities and collaterals and at the same time fully understand the impacts that these day-to-day actions can and do have in the Banks’ balance sheet and cost base.
It is therefore no surprise to anyone that the regulators (FSA/BoE) do value the capital and liquidity ratios to guarantee the stability of the financial system, however they prefer the educational, proactive measures that solve the structural problem of the actual granting process and decision making, which needs to be constantly updated and upgraded by training the relevant people, as well as the monitoring the credit risk quality of the portfolio and early warning signals detection and mitigation as the most effective and sustainable way of managing NPLs and sustaining the business. Preventing and managing the issues is always better than trying to find solutions to the actual problems after they occur.