The rest of our series:
As COVID-19 spreads across the U.S., finance and credit departments at financial institutions are facing a new world of risk. Projections created in the fourth quarter of 2019, or even in the early months of 2020, are suddenly out of touch with reality as interest rates drop, unemployment soars, and borrowers experience financial distress.
FIs that haven’t considered the economic consequences of a pandemic are now struggling to understand the full impact of this unprecedented event.
In this fifth blog in Ncontracts’ series breaking down key operational risk considerations of COVID-19 department-by-department, we’re looking at pandemic business continuity planning and risk management in two departments: finance and lending.
The finance department is the expert when it comes to modeling financial risk, but the many unknowns of COVID-19 and its short-term and long-term economic impacts create a particularly challenging environment.
When assessing risk, finance should start with expectations based on current information. What does it know about the present-day situation and what does that mean for financials?
Once that’s done, finance can dedicate itself to a second scenario: Modeling a situation that continues to get worse. If there’s time, finance should model a worst-case scenario. This gives the FI the time to think through a plan so it knows what adjustments to make as more data becomes available.
Questions to address include:
- Where will revenue drop most?
- What is the expected loss from staff shortages limiting product and service offerings?
- What level of loss is acceptable and within risk tolerances?
- Are there options to increase non-interest income?
- Is it necessary to cut expenses? If so, where is it legally acceptable (reducing staff/branch hours, termination penalties from vendors, etc.)?
- What financial losses do we expect associated with a decrease in business? Are they within risk tolerances?
- Will customers stop spending if they fear the economy will go into recession or lose their jobs?
- What’s the impact of customer financial losses, including ability to repay loans?
- Will liquidity levels change? What if we go into recession?
- What’s the impact of changes to capital reserve requirements?
- What’s the impact of compressed margins due to dropping rates?
- How does the government spending stimulus impact things?
- Are loan loss reserves sufficient?
Lending needs to look at data to understand both opportunities and challenges going forward. Paying close attention to datapoints and demand, consider potential risk by asking questions like:
- What types of loans will increase/decrease in demand?
- Will borrowers seeking funds for operating expenses be creditworthy?
- Will there be decreased lending demand in the long-term if small businesses contract?
- Do we have the capacity to take advantage of increased refinance and mortgage loan volume due to low rates?
- Will customers stop repaying their loans due to financial distress? How long can they continue to make payments? Will the government require forbearance?
- Are new government lending programs a good match for the FI?
- Is there a way to safely and soundly offer “responsible small-dollar loans to both consumers and small businesses” like regulators ask?
- Will changes to the portfolio impact Fair Lending?
- How can we help borrowers with workout strategies (deferrals, restructures, etc.) that work for the borrower and the FI? What is the best method?
- How will regulators respond to our efforts?
As always, finance and lending should share the results of their risk assessments with other departments. When making risk determinations, the more data an FI has, the more informed the final decision will be.
Risk management can’t work in a vacuum. We may be self-quarantining or sheltering in place, but when it comes to risk management, we all need to come together.
For more insights into how COVID-19 is impacting operational risk and resiliency, join us for our webinar Unprecedented: COVID-19, Vendor Management and Managing the New Normal, on Wednesday, April 8, 2020 @ 2:00 PM CT.