KNOWLEDGE The Most Valuable Intangible~

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KNOWLEDGE The Most Valuable Intangible
RMA Journal, The, June, 2001 by Anju P. Bhargava

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While employed by a large bank, the author oversaw a study of loan losses with the intent to prevent such problems in the future. The results are as useful to banks today as they were to the institution conducting the analysis in the early 1990s.

One of the many challenges facing bankers is also one of the most important: internalizing lessons learned from past losses. Although each economic cycle has its unique characteristics, given vary ing underlying forces at work, banking veterans can attest that the fundamental lessons remain unchanged. They also can attest that sharing this message with younger professionals can be a frustrating exercise.

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Lending, Opus 101. Whatever the circumstances surrounding it, the basic credit transaction remains the same. Fundamentally, a loan results from the interaction between the relationship manager and the customer. The instruments through which the relationship manager orchestrates the transaction are knowledge, the micro culture within the business unit, the quality of the portfolio, bank policies, and the corporate strategic vision. Just as the success of a concert depends on weather, audience, acoustics, and other factors, the RM's symphony can go out of tune from myriad external factors affecting the industry as well as repercussions from regional and global economic shifts. Loan losses result from a disconnect of one or more of these internal or external factors.

One Bank's Story
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In the 1990s, a $30 billion regional bank (the U.S. subsidiary of a major global bank) recognized the need to capture and integrate its collective learning into the organization's awareness system. The bank management acknowledged a simple truth: you have to know where you have been to know where you are going. It set to work changing the credit culture environment and putting a management decision audit tool in place.

In 1994, the bank's office of the chairman authorized an in-depth study--an autopsy, actually--of more than $1 billion in charge-offs from 1989 through 1993. The purpose was to ensure that history would not repeat itself. Quantifying the crisis provided a way for the staff to understand the past and accept the transformation of the bank's credit culture through key corrective initiatives. (According to the Office of the Comptroller of Currency, this was the only financial institution to undertake such an extensive and critical introspective analysis, though many others had a similar loss experience).

The study began by forming a small (1.5 person) task force in the risk management unit. This independent area had not been involved in decision-making during the crisis period. Separation from the line, including the workout areas, allowed for objectivity in research.

A multi-pronged approach to leverage learning integrated credit analysis, audit, and reengineering techniques with technology. As the bank's MIS was geared more towards data capture than analysis, a data base was developed to capture the qualitative information and take different snapshots of the quantified loan loss portfolio. Through an in-depth review of the credit files supplemented by interviews, each credit was dissected to record the facts and the understanding behind the numbers. The objective was to turn the data in the files along with the experience and the wisdom of the people into a usable tool.

Staff cooperation was at a high level as they were eager to learn from past errors. From the beginning, the staff was assured this was not a witch-hunt but a learning exercise. In fact, no names were recorded in the analysis. This made the people comfortable and willing to provide the necessary details.

The sample. The sampled credits represented a cross-section of industries where loan losses were experienced from 1989 through 1993. Greater emphasis was placed on understanding issues related to the large dollar charge-offs. The study discussed below is a composite of 11 primary industries affected. It should be noted that not all industries and divisions in the bank experienced loan losses. And the findings are no doubt representative of the experience at other regional U.S. banks.

Industry sources [1] indicate that more than 30% of the large banks (with assets over $2 billion) went through a crisis in the 1980s. The crisis was caused by changes that started in the 1960s--deregulation leading to disintermediation, banks' commitment to growth in terms of earnings per share and leveraged, industry-wide trendy pursuits (LDC loans, commercial real estate funding, and leveraged buyouts), and increased competition from nonbanks.

In examining the loan losses, a trend in thought patterns and business cycles was discovered. A study of loan losses is akin to dissecting the heart of a bank. Loan losses do not occur in isolation; rather, they reflect the health of all functional disciplines. The key findings include:

1. Credit analysis. In the sample, major factors in charge offs related to inadequate credit evaluation. The analysis categorized the causal factors as internal to the organization and external relating to the borrower and over all economic environment (see Appendix 1).




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