In addition to the constant, growing and fierce competition for customers and market share Community Banks and Credit Unions constantly face, the unpredictability and impact of the current Covid-19 pandemic is testing these institutions’ resilience and robustness of their risk management strategies to face, manage and survive this crisis.
The strain and financial repercussions of the current pandemic have clearly demonstrated the importance and criticality for these institutions to have in place effective and responsive risk-adjusted strategies to assist them achieve earnings stability, improve their liquidity and reduce losses.
The deployment of risk-adjusted strategies is a fundamental requirement to enable financial institutions to identify, quantify and manage risks that either directly or indirectly impact the performance of Net Interest Income (NII) or Net Interest Margins (NIM) under unexpected adverse market, credit operational and economic conditions as the economy is currently experiencing.
Recognizing the potential impact of unplanned and adverse financial or economic events is a first step in the formulation of a risk-adjusted economic capital management framework designed to protect these institutions against the effect of unplanned tail-risk events, as the current on-going pandemic has caused.
A risk-adjusted strategy provides Community Banks and Credit Unions the analytical framework and foundation to identify, quantify and manage their capital requirements with data and metrics that capture and integrate the performance of their assets and liabilities across time and ensure these institutions have the required level of capital to prevent liquidity short-falls in the markets they operate.
By focusing on the interdependence and correlation of factors that impact capital levels, liquidity, NII and NIM across time, a risk-adjusted strategy enables institutions to be better prepared by having the required capital levels to enable them to face and withstand the impact of adverse economic and unplanned financial events. A risk-adjusted strategy adds strength and improves the profitability and survival of financial institutions by integrating the cross-benefits and interdependence of the traditional risk management functions in their organizations:
Credit Risk Management: To ensure that institutions have in place the required processes to assist in the proper identification, quantification and management of risks (credit, market, operational).
Capital Management: To ensure that an institution’s capital reserve levels are correlated with the risk levels in an institution’s balance sheet.
Operational Risk: To proactively identify, manage and prevent financial damage due to operational management lapses.
Regulatory Risk: To ensure institutions follow and adhere to established regulatory requirements and mandates.
By providing an integrated assessment of risk and profitability across business lines and the incorporation of the interdependence of strategy, asset quality and operational controls, a risk-adjusted strategy provides an accurate and dependable assessment and quantification of the economic capital levels financial institutions need to protect NII, NIM and the required liquidity in their balance sheets needed to meet capital demands brought about by unplanned economic, financial or global economic crises.