Risk Assessments at Small Community Banks

The enterprise wide risk assessment has become an important tool at large complex banks.  Every year risk managers are tasked with developing a wide ranging assessment of the overall risk at the bank and the mitigation in place to address this risk. They us sophisticated modeling tools and expensive software to help with the development of these behemoths.   But what about a small bank?  Isn’t the overall level of risk evident? Why should a small $300 million bank take the time?  In our opinion, no Bank is too small to need a complete risk assessment  

What is a Bank Risk Assessment? 

In large part, the question of whether or not to perform a risk assessment becomes more pressing depending on how one defines a risk assessment.  A risk assessment is defined in Investopedia as “ 

“The process of identification, analysis and either acceptance or mitigation of uncertainty in investment decision-making. Essentially, risk management occurs anytime an investor or fund manager analyzes and attempts to quantify the potential for losses in an investment and then takes the appropriate action (or inaction) given their investment objectives and risk tolerance. Inadequate risk management can result in severe consequences for companies as well as individuals. For example, the recession that began in 2008 was largely caused by the loose credit risk management of financial firms.”  

We believe that this definition means that risk assessments should be performed by all financial institutions.  The risk assessment is the Bank’s opportunity to establish the level of appetite for risk.  In doing so the Board establishes the limits of how must risk it is willing to take to reach its overall strategic goals.   Put another way a risk assessment at a small bank is an excellent opportunity for the bank to take stock of what it is doing and where it is going! In completing an effective risk assessment the Bank has the opportunity to look at the skill and experience level of staff, the training available, the current IT systems in place and to weigh all these against the lending opportunities at the Bank.   

 Risk Assessment versus Strategic Planning

A risk assessment is different from a strategic plan in that the strategic plan looks to find opportunities available to a financial institution and how best to exploit those opportunities.  The risk assessments looks at the opportunities juxtaposed the inherent risk at the financial institution.  Put another way, there may a great number of opportunities available in auto lending, but these opportunities can only result in profits, if the Bank has the proper infrastructure to exploit the opportunity.   The risk assessment allows the bank to take complete and honest stock of its abilities, capabilities and limitations.  Does the bank have the software, the knowledge and the staff that are capable of making all of the required disclosures?  Without these, the opportunity that seemed like such a good idea can become nightmare of regulatory enforcement actions!  

Finding Hidden Risk

For smaller banks, the greatest areas of risk are often unrecognized.  With smaller levels of capital and limited assets, the smaller bank has a thin margin for error.  One or two big loans that become nonperforming can create capital and other operating concerns.   There have been myriad changes in the regulations that apply to banks in the areas of consumer lending, BSA/AML and Fair Lending to name a few.  For those banks that consider themselves business lenders, the fact that many of these regulations blend over into commercial lending can come as quite a shock.  By performing a risk assessment that considers which regulations apply to the Bank and the staff’s overall familiarity with necessary steps for compliance can save  the institution a great deal of embarrassment and money!  

The risk assessment gives the Bank an opportunity to research the ways to disburse risk, take full advantage of opportunities that exist in the assessment area and to establish a framework to make the strategic plan, one that will help the Bank grow safely and within its own capabilities.  

Each Risk Assessment is Unique.

Jon Danielsson, the director of the Systemic Risk Centre at the London School of Economics notes that: 

“If the authorities pick one modeling approach over another, they may just as easily be backing the wrong horse, a model that is less accurate, affording financial institutions and the financial system less protection in the future. For this reason, it is generally better for financial institutions to develop their own models internally”

Source:  Inconsistent Risk Assessment by Banks Isn't That Bad- John Carney CNBC

Each Bank has its own characteristics that make it unique.  Everything from the make-up of the Board, the experience and skill of the staff, the relationship with the local community must be consider in its proper place as part of a complete and effective risk assessment.    We believe that in considering all aspects of a Bank’s operation, the Bank can truly “know itself”.