CHICAGO -- Risk may be a four-letter word, but it's not something that is necessarily or should be feared.
That's the message Tara Heuse Skinner conveyed to attendees of her break-out session, "Enterprise Risk Management: What Credit Unions Need to Know" at NAFCU's conference last week.
Skinner, a risk solutions architect with SAS, noted that risk comes from the Latin word "risicum," which is the word for barrier reef and refers to moving through the challenge to the opportunities beyond. The three major risk threats to credit unions, and other financial institutions, are credit risk, market risk and operation risk. The goal of enterprise risk management is to create and enhance value by managing uncertainties, she added.
It is not that organizations shouldn't take risks, but they should compensate for them with careful planning and setting up intricate systems that aggregate risks and allow employees to report risks without fearing reprisals.
She said the financial crisis was made worse because financial institutions didn't handle risks-including those involved in subprime lending-effectively.
"Banks were compensated for having a high volume of transactions but didn't take into account the risks that were involved when those loans went bad," she explained.
She recommended that credit unions go beyond the minimum regulatory requirements -which she said should be a floor not a ceiling-when determining what risks they should take. Requirements, such as those for an adequate capital to risk ratio, force credit unions to identify and measure their risks.
To make up for the costs of certain risks-such as members may not be able to pay what they owe the credit unions-Skinner said she advises credit unions to create pricing systems that create competitive inequality.
This kind of pricing structure includes the right price-but not necessarily the same price-for all members. That can result in lower fees for the less risky members and higher ones for those whose financial situations could cause damage to the credit union's bottom line.
Skinner conceded that effective risk management can be expensive and burdensome, the rewards are substantial. Regulators are likely to give the credit union higher CAMEL ratings; rating agencies will give higher scores and this will lower the cost of funds and increase their availability; and insurance companies are likely to lower the cost of premiums.
During a separate session, John Kutchey, the NCUA's deputy director of the Office of Examination and Insurance, said that many of the recent credit union failures have been caused by an increased risk concentration. He noted, for example, that a the end of 2000, real estate loans were 38.7% of all credit union loans while at the end of last year that figure had risen to 54%.
He said the agency's examiners look carefully at the thoroughness of a credit union's policies for identifying, measuring monitoring and controlling risk. They also take care to determine the acceptable risk limits for each product on both an individual and aggregate basis. The agency also wants to be sure that credit unions thoroughly identify and consider risks from certain events. These can include natural disasters and shifts in the economy.