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How can senior management lead a successful credit risk management strategy?

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Credit risk is the possibility of losing money or reputation due to the failure of a borrower or counterparty to meet their contractual obligations. It is one of the most significant and complex risks that financial institutions and corporations face. Therefore, senior management needs to lead a successful credit risk management strategy that aligns with the business objectives, regulatory requirements, and stakeholder expectations. Here are some key aspects of such a strategy.

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Liz Martin

Partner at Energex Partners
Alwyn Lally

Reinsurance Consultant (Technical & Medical)
Ali Abdellaoui

1 Define risk appetite

Risk appetite is the amount and type of risk that an organization is willing and able to take in pursuit of its goals. It reflects the trade-off between risk and reward, and the balance between growth and stability. Senior management should define the risk appetite clearly and communicate it to all levels of the organization. It should also review and update it regularly to reflect the changing market conditions, business performance, and strategic priorities.

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Ali Abdellaoui
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L'appétit pour le risque d'une organisation représente la quantité et le type de risque qu'elle est prête à accepter pour atteindre ses objectifs, équilibrant ainsi risque et rendement ainsi que croissance et stabilité. La haute direction doit le définir clairement, le communiquer à tous les niveaux de l'organisation, le réviser régulièrement en fonction des conditions du marché et des priorités stratégiques, et s'assurer qu'il reste aligné sur les objectifs globaux de l'entreprise.

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2 Establish risk governance

Risk governance is the framework of policies, processes, roles, and responsibilities that guide and oversee the identification, measurement, management, and reporting of credit risk. Senior management should establish a robust and effective risk governance structure that ensures accountability, transparency, and consistency. It should also assign clear risk limits and controls, and monitor and enforce them regularly. Moreover, it should foster a risk culture that promotes awareness, communication, and collaboration among all stakeholders.

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Ali Abdellaoui
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Risk governance is a framework of policies and processes that guides the identification, measurement, management, and communication of credit risks. It must ensure accountability, transparency, and consistency, set clear limits and controls, and promote a risk-aware culture fostering awareness and collaboration among all stakeholders.

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3 Implement risk models and tools

Risk models and tools are the methods and systems that help quantify, analyze, and manage credit risk. They include credit scoring, rating, pricing, provisioning, stress testing, and portfolio management. Senior management should implement reliable and robust risk models and tools that are fit for purpose, data-driven, and validated. It should also ensure that they are integrated with the business processes, systems, and platforms, and that they are updated and reviewed periodically.

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Alwyn Lally

Reinsurance Consultant (Technical & Medical)
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Model?implementation risk is the risk that a model, as it is implemented, strays from what is specified in the design document. Inputs may differ: perhaps historical data for a key factor is obtained from a source other than that specified in the design document. Mathematical formulas may differ: this can arise from simple typing errors, or a programmer may implement a formula in a manner that inadvertently alters it.

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Ali Abdellaoui
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Risk models and tools are essential for quantifying, analyzing, and managing credit risk. They include credit scoring, pricing, provisioning, stress testing, and portfolio management. Senior management must implement reliable models and tools tailored to objectives, data-driven, and integrated into operational processes. They should be regularly updated and reviewed to remain relevant in an evolving environment.

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4 Enhance risk reporting and disclosure

Risk reporting and disclosure are the ways of communicating credit risk information to internal and external stakeholders. They include risk dashboards, reports, statements, and indicators. Senior management should enhance the quality, timeliness, and relevance of risk reporting and disclosure. It should also ensure that they are aligned with the regulatory standards, industry best practices, and stakeholder expectations. Furthermore, it should use the risk information to support decision making, strategy formulation, and performance evaluation.

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5 Invest in risk education and training

Risk education and training are the activities that help develop and maintain the skills and knowledge of the staff involved in credit risk management. They include courses, workshops, seminars, webinars, and certifications. Senior management should invest in continuous and comprehensive risk education and training for all staff, especially those who have direct or indirect exposure to credit risk. It should also encourage and reward learning, innovation, and improvement in credit risk management.

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6 Adapt to risk environment

Risk environment is the external and internal factors that influence the level and nature of credit risk. They include economic conditions, market trends, customer behavior, competitor actions, regulatory changes, and technological developments. Senior management should adapt to the changing and uncertain risk environment by being proactive, flexible, and resilient. It should also anticipate and respond to the emerging and evolving credit risk challenges and opportunities.

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7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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Liz Martin

Partner at Energex Partners
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Often, despite clear DOAs, policies and systems there are errors and gaps. It is vital to have the right staff with the time to really understand what is going on. Traders can sometimes dismiss risk controllers questions if they are allowed to or the risk controllers are too inexperienced. The two need to collaborate to catch errors, see gaps and foresee issues.

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How can senior management lead a successful credit risk management strategy?

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1 Define risk appetite

2 Establish risk governance

3 Implement risk models and tools

4 Enhance risk reporting and disclosure

5 Invest in risk education and training

6 Adapt to risk environment

7 Here’s what else to consider

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