This series considers the new role to be played by the Financial Services risk function during the COVID-19 pandemic.

The effects of the COVID-19 pandemic have been severe and continue to evolve and grow every day. In addition to the direct health effects globally, there are broader impacts to the economy, healthcare system, infrastructure and society that significantly affect financial services firms.

The immediate economic downswing across many industries is leading to an increased need for debt offerings from financial services firms. In addition, government mandates encourage banks to support the broader economy, which means they are expected to ramp up operationally to maintain remediation efforts. Much uncertainty remains, but the worldwide economic downturn is now expected to be deep and prolonged.

The sudden shift from prosperity to crisis, and the impact of regulation, should trigger an immediate recalibration of policies, standards and thresholds.

In this context, the risk function has a key role to play within banking organizations. The function should think about and address near-term and longer-term challenges across credit risk, liquidity risk and enterprise risk functions. 

As a direct impact of the economic crisis, the credit risk function should make changes to adequately manage credit risk and act quickly to adjust to new and dynamic market situations. Banks should evaluate their credit policies, procedures and governance processes, revisit their portfolio management and reporting capabilities, and think about how they can operationally support changes in both volumes and workflows within their underwriting, collections and default management functions. 

Near-term response

Many banks have rapidly transitioned from triage to a “special situation” response model to integrate decisions across the offices of the Chief Financial Officer, Chief Information Officer, Chief Risk Officer, Chief Credit Officer, Chief Information Security Office and lines of business. The new function aims at setting and operationalizing the enterprise strategy in response to crisis-driven events.

Credit policies, procedures and governance

The sudden shift from prosperity to crisis, and the impact of regulation, should trigger an immediate recalibration of policies, standards and thresholds.

Financial institutions are strongly encouraged to rapidly understand all new and upcoming government programs, rules and regulations implemented in response to this crisis. Having a strong understanding of new rules and the associated impacts can provide key insights into updating and refining credit policy and procedures as needed.

Firms can consider implementing interim credit policies to best serve in a crisis environment, providing alignment with guidance from regulators. They may also want to select key industries, countries and clients to focus on for their target loan customers and reevaluate credit thresholds and risk ratings for changing customer profiles. In this environment, deferments and forbearance policies should be reevaluated.

Due to the increase in “virtually credit risk-free” loans (such as Small Business Administration loans, which are fully guaranteed by the government), banks should reconsider processes and authority for granting credit exceptions and approvals. It may be beneficial to empower Credit Risk Officers by allowing for additional authority to make credit decisions for specific credit risk-free loans with reduced bureaucratic oversight, versus other noncredit risk-free loans (for example, Main Street Lending Program loans for which banks must retain five percent of the notional value in their books) that require traditional credit review and approval processes.

Firms should also assess their models and enhance their scenario analyses for accuracy in predicting credit risk potential and assess if any existing models can be leveraged for new product types. In instances where existing models cannot effectively risk rate new credit segments and/or products, banks should decide whether and how much to invest in new models.

Portfolio management and reporting

The urgent demand for new credit is expected to challenge strategic portfolio construction and highlight deficiencies in on-demand and integrated portfolio views as well as limit processes.

In the near term, banks may want to identify the full scope of data available in systems and/or documentation and perform proper classification (such as by industry segments, geography, product, asset class, risk rating or digital capabilities). Based on these data categories, firms can review their limits by industry, concentration or other criteria, along with risk appetites to monitor overexposure. The use of advanced analytics with alternative data can help create new signals indicating portfolio concentration and help measure risk and recommend portfolio allocations. Any change in limits and associated rebalancing of the portfolio should be aligned to the redefinition of credit policies and the customer due diligence process.

Increased customer demand for credit products and changing customer profiles may lead to a need for potential adjustments in portfolio management processes, as well. Banks can implement interim manual early warning triggers to recognize portfolio trends and identify at-risk portfolio segments that require more active investigation, monitoring and mitigation. They can also build interim manual reports to provide more immediate visibility to regulators and key management stakeholders, helping to inform short-term credit and portfolio management strategies.

Finally, banks can look at their current portfolio resiliency and target portfolio objectives. They can then look to re-forecast affected assets, reassess their overall early warning frameworks and monitor credit reserve balances in anticipation of higher credit default events. By gaining a strong understanding of new lending scenarios, firms can also begin to balance short-term loan approvals with longer-term portfolio construction. Looking ahead, it is important for banks to align their revised credit strategy to their overall strategy and brand tone.

In the second blog in this series, we will look at the operational support capabilities banks need, as well as some of the longer-term response initiatives for the post-crisis environment.

To help our clients navigate both the human and business impact of COVID-19, we’ve created a hub of our latest thinking on a variety of topics. You can visit our hub here. 

To find out more on this topic and how we can help, please contact Fred or Jeff or our colleague Hortense Viard

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