A prudent banker and the risk appetite
The road signs read “maximum speed limit”, “no overtaking” but the driver ignored all of them. Alas! Accident here! “Bloody day”, the front pages of the newspapers screamed for attention in reporting awful experiences of accidents on our roads. Hmm! A deep breathing after reading the news brings the word prudence to the fore. Prudence is care, caution, and good judgment, as well as wisdom in looking ahead. Douglas Mcmanaman, a teacher of Philosophy says that “one may be brilliant and learned without being morally good, but it is not possible to be prudent and not morally good. The prudent man is one who does the good, as opposed to one who merely knows the good.”
Do you for once think through the fact that a banker in his three-piece suit and sitting behind his desk could also “overtake” or “drive” beyond the “speed limits” of his authority into “accident”? This peculiar accident could be dire and unimaginable. Big banks could die! This write-up gives you a sneak view of a banker and his risk limits.
Financial Institutions by their service culture and commitment to ensure customer experience and loyalty design a bouquet of products and services for different segments of the banking public. A bank by its strategies and product offerings may have a number of units. While Personal Banking unit by its generic name enables individuals to have normal bank accounts for their needs, Corporate Banking and International Banking units provide services to companies and other persons who do business across national boundaries. Customers in Institutional Banking Segment, for instance, may need foreign currency accounts and other trade services including guarantees, import and export loans, personal banking customers on the other hand, may apply for car and mortgage loans to improve their status and well-being.
In a banker-customer relationship, any decision of the banker to meet the needs of his customers must been done within the banks’ internal policy considerations. The banker is also required to respect legislations and other relevant laws and conventions in force which provide a benchmark aim at protecting the interest of each party. A prudent banker must always keep his eyes on the rules and not compromise on the ethics of his profession. One of the ethical tests that a banker faces in his line of duty is the discipline and the fortitude he requires to observe his company’s risk appetite, the signpost!
A bank’s risk appetite has three attributes which are money (deposits and investments) in its care, risks it faces and corporate strategic objectives. There is a measure of risk in a market segment for a bank to deal with, and this informs the amount of money it may be willing to make available in respect of products and services it offers to all category of customers in a bid to achieve its corporate strategic objectives. A bank’s risk appetite influences its credit exposure limits. Credit exposure limit is simply a total amount of loan or financial support that your banker is willing to give you as a single borrower, a group, industry or an entity. The amount of loan or financial commitments that a bank gives to any of its customers shows the extent to which it wants to be exposed to the risk of loss in the event of the borrower's default. Credit Exposure limit is a matter of internal policy for all market segments in a bank’s strategy and could be formulated based on its risk appetite, industry experience and regulations among others. The responsibilities to prevent or manage the risks of loss that may arise as a result of a borrower’s default which directly affects depositors’ savings and investments as well as shareholder value require teamwork and diligence.
Chain of Command
Bankers supposedly work in a team from junior officers at the button of the ladder to top management who report to the Board of Directors. While Board of Directors reports to shareholders depending on the issues at stake, the day to day affairs in a well-structured bank with clear lines of authority, are, however, in the hands of management. The internal set-up of a bank would lay out how power and responsibilities are assigned, controlled, and coordinated, and how information flows between different levels of management. Indeed, instructions flow downward along the chain of command and accountability flows upward. The clearer the lines of authority in a bank, the more effective the decision-making process and greater the efficiency. Some of the key authorities who have a voice of influence on a bank’s financial exposure limits have been identified in this article.
Management and Board of Directors
A well-crafted internal policy on credit administration of a bank is explicit on the chain of command regarding credit exposure limits. The policy creates a ladder of authority for senior management and other line managers in a credit team and then indicates on each step of the ladder, amounts of loan or advances they should approve. Level of expertise or experience of staff and the risk appetite of the bank inform the exposure limits to managers. Managers are so expected to adhere strictly to these limits unless and until otherwise decided by a higher authority in the decision-making chain or the policy is revised. A robust internal policy framework of a bank would also mandate a Board with rich depth of skills and knowledge to provide direction and control over its activities so that there is transparency and accountability.
Bank of Ghana
The Central Bank is the prime supervisor of all the banks, savings and loans companies, microfinance companies and the money lenders in the country. In order to ensure depositors’ savings and investments are safe, it ensures these financial institutions do not exceed a threshold of their credit exposure limits in respect of their net own funds. Apart from legislations, the Bank of Ghana(BoG) also uses notices and directives to shape the conduct of these lenders and sanctions any of them that violates its orders provided it is able to get wind of a breach. It is worth noting that while regulatory and supervisory duties of the BoG are very necessary, compliance on the part of management and the Board is very relevant to respecting exposure limits. There are, however, a number of issues which can lead to abuse of the limits. Some of these are:
- Make it big syndrome and inability to control taste buds for high incomes within a short period attitude of managers. Some bank managers and persons with controlling shares in the non-bank financial institutions breach credit exposure limits to satisfy their intrinsic desires.
- Weak Internal Controls (the bank office “Police”) duties. A bank’s internal controls coordinate its policies and procedures, detect deviations and encourage adherence to policies. Weak or inefficient internal controls lead to breaches of the limits.
- Deficient management information systems and irregular audit reports.
- Weak oversight and poor supervision of management by Board of Directors.
- Internal policies which do not state in clear terms the chain of command and counter-signatories to transactions could encourage overbearing senior managers to use their discretionary authority to override the limits.
- Conflict of interest tendencies and clear intent of some bank managers to exploit lax systems to their benefits serve as fertile ground to ignore the limits.
- Inadequate training programs for staff and senior management of a bank could lead to breach of the limits.
Invariably, actions and inactions of bank managers who without respect to due process in their efforts to meet the expectations of customers, expose banks to legal risk with its associated consequences on the banks’ operations. To note, two basic principles of law; “ultra vires” and “ratification” find themselves in the scope of authority for credit exposure limits on financial commitments and guarantees to customers and other connected parties. Ultra Vires is a Latin word for “acting without authority or beyond powers”. Ultra vires decisions take many forms and may be binding on a bank or if is ratified (confirmed after the decision) by a higher authority. The proviso here is that any decision to ratify ultra vires transactions is discretionary to the higher authority due to inherent risks associated with some transactions. The risks provide avenues to higher authorities especially Board of Directors to escape liabilities which may result after the transactions.
In the practice of Banking, there is always a lingering cloud of skepticism when procedures are not followed in respect of transactions to customers and other associated parties which otherwise would have received the approval or rejection of higher authorities in the chain of command. Final decisions are as good as the procedures used in arriving at them. Procedures keep everyone in check and help to avoid or reduce risks. It is in this vein that a prudent banker is expected to be mindful of the risk appetite of his company and should not engage in business dealings with unforeseeable burden of risks. As bankers, we should make prudence our middle name and let it connect our heads, hearts and minds at all times in the performance of our duties. Bankers! Control the taste buds of your risk appetite, and keep your eyes on the signposts to the credit exposure limits!
The writer is a Chartered Banker