Top 3 Strategies for Commercial Banks to navigate risk
Staying on top of your portfolio and an ever-changing market is critical to successOakNorth
September 11, 2023
In the dynamic landscape of the financial industry, commercial banks are no strangers to risk. Ensuring the health and stability of their commercial portfolios is of paramount importance. With the advent of technology, commercial banks now have access to targeted alerts and early warning indicators that can play a pivotal role in identifying and mitigating risks within their commercial portfolios. In this article, we delve into the strategies that banks can employ to harness these tools effectively.
Leveraging targeted alerts
Targeted alerts are real-time notifications that provide banks with critical information related to their commercial portfolios. These alerts can encompass a variety of factors, such as changes in market conditions, industry trends, or shifts in borrower behavior. To maximize the potential of targeted alerts, commercial banks should:
- Customize alerts: Tailor alerts to match the bank's specific risk profile and exposure. This customization ensures that only the most relevant information is received.
- Automate processes: Automate the alert distribution process to ensure timely delivery and rapid response. This reduces the risk of missing crucial updates.
- Conduct multi-dimensional analysis: Combine different types of alerts to gain a comprehensive understanding of potential risks. This could include financial metrics, market sentiment, and geopolitical factors.
Early Warning Indicators (EWIs)
EWIs are metrics that signal the emergence of potential risks well before they manifest fully. Commercial banks can capitalize on these indicators by leveraging:
- Data-driven insights: Utilize historical data and predictive analytics to identify patterns and anomalies. EWIs may include deteriorating financial ratios, reduced liquidity, or sudden shifts in customer payment behavior.
- Threshold setting: Define clear thresholds for each early warning indicator. This empowers banks to take swift action once a specific threshold is breached.
- Scenario analysis: Simulate various scenarios to assess the potential impact of different risks on the portfolio. This allows banks to develop contingency plans and assess their risk exposure accurately.
Identifying risks is only half the battle. Banks must also develop robust strategies to mitigate these risks effectively:
- Proactive communication: Establish open lines of communication with borrowers. Regularly engage in conversations about their business health and potential challenges they may face. This helps banks anticipate issues before they escalate.
- Diversification: Promote diversification within the portfolio. By lending to a variety of industries and businesses, banks can reduce the impact of sector-specific downturns.
- Risk rating systems: Implement a risk rating system that assesses the creditworthiness of borrowers. Continuously update these ratings based on the information gathered from targeted alerts and early warning indicators.
- Stress testing: Conduct regular stress tests to evaluate how the portfolio would perform under adverse scenarios. This proactive measure assists in identifying vulnerabilities and formulating risk-mitigation strategies.
Targeted alerts and EWIs offer commercial banks a powerful arsenal to identify and mitigate risks within their portfolios. By leveraging these tools effectively, banks can proactively manage risks, safeguard their financial health, and strengthen their position in an ever-evolving financial ecosystem.
ON Monitoring helps banks identify risk (borrower financial hardship or industry-related risk) early through targeted alerts. These alerts are based on the bank’s credit policy with respect to the borrower’s historical trends, point-in-time performance, performance relative to peer benchmarks (based on industry), and forward-looking/forecast performance. Alerts are configurable based on banks’ risk appetite and credit policy standards (for example the DSCR floor or a change in revenue). Commercial banks are able to analyze the financial data that powers the alert to pinpoint the drivers of risk and get detailed information about flagged borrowers. This is very different from other monitoring solutions in the market as it enables the bank to get incredibly granular in terms of accessing the data behind the alert. This glass box approach as opposed to a black box approach means banks understand the data behind the alert so are better equipped to defend the analysis in front of their board, shareholders, and regulators.