So, you have finally hired a company to provide an outside review of your credit department and all is wonderful! Right? Nothing now to worry about? You can set back and coast as yet, another item is checked off the list in preparation of your upcoming exam!
Perhaps. But there are several possible pitfalls that an outsourced credit risk assessment can hit which derail the possible usefulness of such a study. Avoidance of these can make the returns you will see on the outside review more effective. After all, who wants to waste money?
The first assumption is not defining the value you want to receive. If you desire to spend tens of thousands of dollars to receive a report that is tossed in the cabinet and only pulled out when the regulators show up, then you do not need to read the rest of this blog. An outside credit review gives you a different prospective on how your shop operates which often can help you see strengths and weaknesses more clearly. A good definition of the take-a-ways you want to receive from the process and final report is essential. Some of these to consider are: clear definition of risk deficiencies; actionable plan to correct problems and/or improve on strengths; opinions on staffing, technologies and other tools used every day in the department; and either education on sound credit or issues that your team should be educated on to make you better.
The objectives should be defined clearly in a contract that defines the scope of services, cost, time frame, and deliverables. This is the second pitfall, when the engagement contract is lacking. I know of one bank who hired a credit risk review (CRR) company based on a contract that only stated the number of files they would review, the date, and the costs. There was no clarity of what else would be reviewed, how opinions would be formed, or the ending deliverables. Ultimately, you want this to be a tool which you can use to make your institution better.
Just because you hire someone, does not mean you will receive value. Good vendors are moving away from a focus on file coverage numbers to a risk-based approach. The latter focuses over depth of analysis to form sound opinions as opposed to checking off a review of 5-10 files per day per reviewer. The approach should not be a one-sized-fits-all approach. I once visited folks in a bank who specialized in tractor-trailer financing. They built much of their portfolio around properly assessing and managing the credits in this area. An examiner who does not dive deep into their management practices may just conclude that they lend to a risky segment of the economy with a high concentration in that area. Yet, they consistently had delinquency and charge offs at levels below other peers in the area.
The actual report you receive can be a pitfall. If the report is generic in nature and does not have properly supported systemic conclusions or if there is not a thorough analysis on items like appraisal management, documentation processes, credit analysis, underwriting, officer supervision, file documentation, and risk migration, then it lacks usefulness for use as a tool to grow on. Some reviewers spend all their time transposing data like financial statements or loan data into vendor software, charge you for this, and then present this back to you as the meat of the report without any other actionable items.
Another pitfall can come when there is weak audit committee oversight into the process. Now in many smaller credit unions and community banks, the competency of the audit committee is limited and is often below that of the credit department. In a perfect world, there would be strong board, strong audit committee, and strong credit management. But no matter, the vendor cannot fully drive the bus on the review. Nor can this be left to unqualified internal staff who may be shuttled over to the credit review function just to allow them to complete their 40 hours each week.
The wheels can come off with a review which is too easy and does not ask the hard questions of “why”. Sometimes this must be asked several layers deep in order to come to the root issues. A reviewer who only swims on the surface will often miss the root issues that the institution needs to understand. There is no value in that.
A final pitfall is to have a review completed and have not one actionable item for improvement that you can implement. Each review we have had I find at least five and maybe ten or more items which are then loaded into a Gantt Chart and set to be reviewed with the lending team. These changes not only helped up to be better at credit, but they also changed some of the fundamental ways we transact business to improve profitability.
The CRR can be so much more than something in a file cabinet. Good ones are tools that actually make you better. If you have questions on your current external or internal auditing process and want a fresh set of eyes to review, contact us. If you need a third-party review, we offer those services in our Credit Risk Advisory Department.