Managing the credit process
Category: Corporate Banking
1. The banks productivity
Benchmarking studies comparing how banks in different countries go about their business, show that there is a wide spread in productivity. In 1991, added value per working hour was 93 USD in America versus 84 USD in Asia and only 52 USD in Europe. The number of people employed by the banking industry rose 24 percent between 1980 and 1992 in West Germany — in the U.S., there was a decline of 4.06 percent. Japanese retail banking is more than twice as productive as German banks, which serve only 170 customers per employee versus 360 in Japan. Branch networks reveal reserves in productivity for European banks: whilst Great Britain has only 31 bank branches per 100,000 inhabitants, the U.S. has 43 and Germany 69. In most countries, branch networks are shrinking due to cost pressure. Sweden’s banking network has been reduced by 3.7 percent in the last five years, from 38 branches per 100,000 inhabitants to 33. If German banks are to follow this path, they still have a long way to go, because their branch networks have only receded by 0.4 percent.
2. Lean banking
Business process analysis in corporate banking; has shown that there is much room for improvement. As a general rule, only 10 to 20 percent of total costs are spent directly serving the customer, this means where the largest proportion of value added is created. The remaining 80 to 90 percent are consumed by internal processes, adding little or no value at all.
Traditionally, work was performed in most banks in a whole array of hierarchical levels, both in the branch system and within individual branches. The segregation of duties between account officers (who call on the customers and add value) and the credit department (which adds value by analyzing risks, but hardly by the many administrative activities it has to do as well) on each level has resulted in long processing times, wasted resources, and tied up staff. In many cases, a single loan request was signed by 15 (fifteen) loan officers or more. Banking law requires only two signatures, internal regulations may demand six to eight signatures. Processing a loan request over two hierarchical branch levels took as much as 30 days on average. And to make matters worse, a considerable proportion of credits could not be finally decided upon in those branches that were responsible for the account, but decisions were passed to higher levels. Studies showed that credit processing time multiplied with each additional hierarchical level. Moreover, additional decision levels did not improve credit quality, instead they » socialize» responsibility and do not add significant value: 70 to 80 percent of the credit analysis done at the branch level is duplicated by a central credit department.
If all this had only wasted time and money, it would have been bad enough. But during a recession, such inefficient credit processes steal the time, that account managers and credit analysts need to better manage the risks in their credit portfolio. And it consumes the funds that otherwise could help make up for loan losses.
As a result, many banks found that they had to re-engineer their credit process The objective was to arrive at a lean credit process that would enhance the banks capacities for risk management, quality control, and relationship management. Lean organizational structures would follow naturally, once the credit process had been re-engineered. Finally, a business process controlling system had to be implemented, providing information on the quality, cost and speed of the new credit process.
3. Structural re-organization
Considerations like these have led many banks to flatten their branch structure and credit decision hierarchies. In some cases, a traditional five-stage-branch system was replaced by a lean two-stage branch structure. Local operational units were empowered to decide up to 90 percent of their business on their own. The credit decision function was de-centralized, which in turn implies that the operational units are held fully accountable for their performance. At the branch level, the traditional segregation of relationship management department and credit department has been abolished. Account managers and credit analysts now work together in one team (the account management unit) and share the joint responsibility for the performance after risk of their loan portfolio. So, the account manager not only has to generate interest revenues by «selling» new loans, but he also has to manage the credit risks. The credit analyst, vice versa, can no longer be content avoiding loans («A denied loan request can never result in a loss»), but he is held accountable for the profit of his unit as well. The job of the banker has become more entrepreneurial. This is reflected in new compensation systems which link yearly bonuses to business performance. So far, results show that this re-engineered credit system has accelerated credit decisions, clarified personal accountability and has led to first measurable steps towards significantly improving the quality of the credit portfolio.
Nevertheless, account management units which are empowered to act on their own need proper controlling. A top-down / bottom-up planning process sets the framework for the overall business results, which are to be achieved. The head office’s central credit department formulates the credit policy which must be followed by each unit. The credit portfolio planning and controlling must be in coherence with credit policy. This is supervised by regular credit reviews and audits. «Management by objectives» makes senior managers and their staff discuss and finally mutually agree upon what should be achieved during the next year. Benchmarking shows which branch does best in which field — and why, so that others can learn from it. And finally, bonuses are tied to a customer satisfaction index, that shows the extent to which the corporate client is satisfied with the banking services received.