Confessions of a Credit Risk Manager
At the start of 2007 the financial world looked to be a relatively risk free environment. Credit Risk Managers across the banking sector sat down with their teams and tried to justify their job title by looking for possible chinks in the armour. So what went wrong and what have we learnt?
Confessions of a Credit Risk Manager
The current job descriptions for Credit Risk Managers are varied and ever changing but the essential nature of the work involves managing and developing credit risk monitoring and reporting systems to provide credit financial analysis.
As laid out by the Bank for International Settlements as far back as 2000, “The goal of credit risk management is to maximise a bank's risk-adjusted rate of return by maintaining credit risk exposure within acceptable parameters.” Fairly straightforward stuff and the success of a credit risk management plan will directly impact on the success of the bank, with the Credit Risk Manager obviously at the heart of this.
Have an open mind
It is also their responsibility to work with other risk disciplines across the bank to guarantee an enterprise wide view of risk. These are basic job descriptions that will be on any job advert. But what has been added to these adverts since the financial crisis is the ability to have an open mind and an attitude geared towards problem solving and change.
As one anonymous Credit Risk Manger admitted at the time, in a column with the Economist, they failed to have an open mind and lacked the ability to change their policies when the first murmurs of impending disaster were heard.
“We could only see more liquidity coming into the market – not going out of it. We should of course have paid more attention to the first signs of trouble. No crisis comes completely out of the blue.”
In this instance it was a mishap in the structured-credit market as far back as May 2005 that was the first indicator of what would follow. Bonds of General Motors were marked down by rating agencies and this caused a strong dislocation in the market that Credit Risk Managers failed to analyse properly. They had assumed that liquidity could be taken for granted and in turn had no plans to react to problems.
“We assumed that if the market ran into difficulties, we could easily adjust and liquidate our positions, especially on securities rated AAA and AA. We trusted the rating agencies. It was assumed that the rating agencies simply knew best.” As it transpired, low-risk assets turned out to be high-risk and as the pile of potentially illiquid assets grew, so did the risk.
Lessons for the future have been countless. But one of the most important is that traders often view risk managers as a hindrance to the work they do, getting in their way and telling them how to operate.
Credit Risk Managers don’t directly make money for a bank and they can often be brushed away as a small part of proposal presentations. As a result the focus was on getting a transaction approved quickly rather than analysing and assessing the risks involved. Positioning risk management in the correct way is therefore vitally important.
Give them more prominence
Getting traders to become risk managers is one way to do this and such a change could help to improve the industry. As the secret Credit Risk Manager said, “It was difficult to come up with hard and fast arguments for why you should decline a transaction, when you were sitting opposite a team that had worked for weeks on a proposal.”
By having more traders on the other side it would give them a far better idea of the risks that their actions involve.
Find out more on the future of Credit Managers