Is Bank Risk Rising or Are Risk Managers Reining It In?
Today the Wall Street Journal is carrying two stories that seem to contradict one another. The headline of the first story says, “After Crisis, Risk Officers Gain More Clout at Banks, U.S. Banking Industry Bends to Pressure to Make Operations Safer and Simpler.” The second story says, “Lenders Are Warned on Risk Regulator, Urges Caution by Banks About Looser Standards in Pursuit of Profits”
The first story features the chief risk officer from Wells Fargo and describes how he nixed a home equity credit product. The article details the rising number of risk officers and bank examiners. The reporter, James Sterngold, mentions the OCC report but doesn’t seem to appreciate the irony of reporting that the clout of risk officers is rising as the OCC reports that bank risk is rising.
The second article is a summary of the Office of the Comptroller of the Currency’s (OCC) semi-annual report, which makes the following assessments among others.
- Intense competition in a slow-growth, low-interest-rate environment is continuing to fuel riskier lending by banks
- Two areas in particular where banks took on more risk in pursuit of profits: high-yielding loans issued to more speculative borrowers and indirect auto loans, in which banks provide financing through a car dealer. Banks also are easing lending standards in commercial loans.
- Lower market volatility may be understating trading risk.
The following chart from the OCC report illustrates one of the risks that has re-emerged since the credit crisis. Covenant-lite loans have blossomed in recent years at substantially higher levels than in the run up to the credit crisis. Typically these are loans made on highly leverage companies. In a normal loan, the borrower is required to meet a series of financial tests (covenants) in order to protect the bank. These tests are disappearing in the drive for banks to capture more business
While I’m not suggesting that we’re on the verge of another credit crisis, I am wondering where the risk managers are when these loans are being made. While the OCC report also concludes that a number of measures of risk have improved, it appears to me that Dodd-Frank and the Fed’s low interest policy may be responsible for these developments.
Every time we have a financial crisis, compliance and risk budgets are increased. In the aftermath, organizational charts are rejiggered to place the naysayers higher up in the bank. Strictly speaking, the two Wall Street Journal articles aren’t contradictory. The visibility of risk managers is rising. Risk is rising. The clout of risk managers, however, is about the same as it always has been. In the end, short-term profit always trumps long-term prudence.