Ideas & Debate

Balancing bank credit risk and profit an extreme sport

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A Kenya Bankers Association conference in Nairobi in the past. FILE PHOTO | NMG

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Summary

  • There is always a healthy (and in many cases fractious) tension between the business development team and the risk team in all financial institutions because each has a role to play in achieving that balance. They often meet each other on the two-sided escalator of driving profits up while keeping lending losses constantly sliding down.

Many years ago when I worked as a corporate relationship manager at a bank, I dabbled in the thought of moving to the credit risk department as I had got bored of the mundane sales and extremely aggressive numbers-targeted business development role.

I spoke to the head of credit risk at the bank, asking him if there was an opportunity to make a horizontal career move into what I thought would be a challenging and intellectually stimulating role of assessing borrower risk from a purely analytical, rather than profit-motivated perspective. The head of credit risk cocked his head to one side and gave me a baleful stare.

“Why would you want to leave a glamorous, bonus-guaranteed position to come to the most reviled section of the bank?” he asked. “I’m bored,” was my only reply.

He then proceeded to school me on what credit risk entailed, summarising, “This is the part of the bank that has no glory, and only comes to everyone’s attention when a big transaction goes wrong. And when that happens, the bullets that will come flying leave nothing but dead bodies and broken careers.”

Well, that brought my temporary boredom-infused, career-limiting insanity to a screeching halt. I was reminded of this interaction when someone forwarded to me a Financial Times (FT) article published on April 25, 2021 reporting how shareholders of the Swiss banking giant Credit Suisse were seeking to remove the board director chairing the risk committee, Andreas Gottschling.

This was following what the FT reported as twin scandals of transactions that had gone pear-shaped and led to the loss of $4.7 billion from the collapse of family office Archegos Capital and another potential insolvency of their client Lex Greensill that could cost the bank’s clients as much as $3 billion.

Consequently, according to the FT article, the bank has been forced to raise $1.9 billion to shore up its capital. Apart from the fact that these are eye-watering numbers to be discussing at the bank’s emergency board meeting that had to have been called, the FT in a typical tongue-in-cheek print media manner reminds readers that the 53-year-old Gottschling earned a $1 million annual fee as the chair of the bank’s risk committee, a position he has held since 2018.

But why would shareholders be baying for his blood? From the piqued perspective of the shareholders, Gottschling and his committee dropped the ball in determining the amount of risk that the bank was bearing on these transactions and should have raised the red flag, if not entirely stopped the transactions from happening.

Gottschling apparently sat on several conference calls discussing the Greensill transaction and according to the FT article, “Ultimately, Gottschling sided with those who thought Greensill was a valuable entrepreneurial client with whom it was worth continuing business, according to people with direct knowledge of the matter.”

Essentially shareholders are saying: there are $1 million annual reasons in your wallet why we expect you to have known better. It is noteworthy that Lara Warner, the chief risk and compliance officer of Credit Suisse, was asked to leave in April 2021 following the twin scandals.

Balancing risk versus profit within a banking environment is an extreme sport, treacherous at best but monumentally lucrative if that balance is well achieved.

There is always a healthy (and in many cases fractious) tension between the business development team and the risk team in all financial institutions because each has a role to play in achieving that balance. They often meet each other on the two-sided escalator of driving profits up while keeping lending losses constantly sliding down.

Sitting not so pretty on the sidelines is the board through its risk committees that have to ensure the right people are on the job and have the backbone to say no to everyone, including the chief executive officer when certain risks outweigh the benefits of doing business.

In this jurisdiction where finger-pointing is largely left to the banking regulator when a bank gets into trouble, there is merit in observing and learning from what the shareholders of Credit Suisse are doing.

Under our Kenyan Capital Markets Authority (CMA) governance code, members of the audit committee are required to be elected at every annual general meeting of a listed company. In doing this, shareholders are taking ownership of ensuring that the members of the audit committee are qualified to do the job.

But for banks, perhaps a higher standard should be held by the CMA that requires the same level of shareholder rigour is applied to members of the credit risk and risk committees. In so doing, listed bank boards will become even more careful selecting watchful directors who can watch the watchers of the business.

[email protected] Twitter: @carolmusyoka