CHICAGO — Risk may be a four-letter word, but it's not somethingthat is necessarily or should be feared.

That's the message Tara Heuse Skinner conveyed to attendees ofher break-out session, “Enterprise Risk Management: What CreditUnions Need to Know” at NAFCU's conference last week.

Skinner, a risk solutions architect with SAS, noted that riskcomes from the Latin word “risicum,” which is the word for barrierreef and refers to moving through the challenge to theopportunities beyond. The three major risk threats to creditunions, and other financial institutions, are credit risk, marketrisk and operation risk. The goal of enterprise risk management isto create and enhance value by managing uncertainties, sheadded.

It is not that organizations shouldn't take risks, but theyshould compensate for them with careful planning and setting upintricate systems that aggregate risks and allow employees toreport risks without fearing reprisals.

She said the financial crisis was made worse because financialinstitutions didn't handle risks-including those involved insubprime lending-effectively.

“Banks were compensated for having a high volume of transactionsbut didn't take into account the risks that were involved whenthose loans went bad,” she explained.

She recommended that credit unions go beyond the minimumregulatory requirements -which she said should be a floor not aceiling-when determining what risks they should take. Requirements,such as those for an adequate capital to risk ratio, force creditunions to identify and measure their risks.

To make up for the costs of certain risks-such as members maynot be able to pay what they owe the credit unions-Skinner said sheadvises credit unions to create pricing systems that createcompetitive inequality.

This kind of pricing structure includes the right price-but notnecessarily the same price-for all members. That can result inlower fees for the less risky members and higher ones for thosewhose financial situations could cause damage to the credit union'sbottom line.

Skinner conceded that effective risk management can be expensiveand burdensome, the rewards are substantial. Regulators are likelyto give the credit union higher CAMEL ratings; rating agencies willgive higher scores and this will lower the cost of funds andincrease their availability; and insurance companies are likely tolower the cost of premiums.

During a separate session, John Kutchey, the NCUA's deputydirector of the Office of Examination and Insurance, said that manyof the recent credit union failures have been caused by anincreased risk concentration. He noted, for example, that a the endof 2000, real estate loans were 38.7% of all credit union loanswhile at the end of last year that figure had risen to 54%.

He said the agency's examiners look carefully at thethoroughness of a credit union's policies for identifying,measuring monitoring and controlling risk. They also take care todetermine the acceptable risk limits for each product on both anindividual and aggregate basis. The agency also wants to be surethat credit unions thoroughly identify and consider risks fromcertain events. These can include natural disasters and shifts inthe economy.

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