While the industry ails, some commercial real-estate lenders thrive.
March 2015 | by Mr. John Olivier, Chief Investment Officer
With capital scarce and lending hazardous, corporate banks will need to improve both the efficiency of their risk-weighted assets (RWAs), especially loans, and of their pricing. Moving to a lean capital business model (including such steps as expanding into better collateralized, RWA-efficient products such as factoring) will help ensure that banks are fully exploiting the power of their balance sheets. Incentives for lending should measure contribution after risk costs, rather than volume. Shifting incentives for frontline bankers from lending products to deposits and fee-generating products will help avoid lending for lending’s sake.
To reflect the higher cost of funding and the risk their clients face, banks must adopt a new pricing discipline, both for new business and as they renew or extend credits to top-tier clients. Many have already begun efforts to improve pricing but are stumbling because they lack capabilities. Specifically, they need flexible internal transfer-pricing mechanisms to react quickly to market changes in funding costs. They will need the ability to calculate, in real time, a target credit margin for each customer, taking into account the up-to-the-minute cost of financing, the client’s business climate (its size, macroeconomic conditions prevalent in its geography and industry, and so on), and its risk exposure.
Also crucial is a set of reference prices to set expectations for the target credit margin on loans and for other products and services. If the reference prices are to have meaning, then banks will also need a strict discounting policy that includes a clear statement of decision-making authority. RMs will need a pricing tool that provides them with a full understanding of the profitability achieved with each client. Standardized templates in the tool will help them document their agreements. A clear set of pricing key performance indicators (for example, average level of discounts expressed as a percentage of base price; average return on equity) will guide their pricing discussions and credit proposals, helping them to monitor customer profitability. Regular reports from the tool will help banks track margin developments.
Eastern Europe: Improve Restructuring and Risk-Mitigation
To no one’s surprise, financial institutions—like those in virtually every part of the globe—have seen their risk management strategies come up short. In Eastern Europe, the problems are, if anything, worse. Not since the fall of Communism—a time when many of today’s bankers were still in school—has the region seen such complex problems, requiring skilled use of early- and late-stage credit workout and loan-loss mitigation. Many banks are unprepared; their workout groups consist mainly of lawyers that can dispose of corporate remains. But before that, banks must work quickly to develop the programs needed to do fifty or one-hundred workouts a year.