Page 2 The Banker’s Advocate
STRESS Continued from Page 1
cline in this sector. In some cases, the
growth was funded with volatile or more costly sources of funds, which compounded the problem and in the worst cases re- sulted in bank failures. This has prompted some regulatory concerns about other areas of concentra- tions that may exhibit emerging risk or require increased risk management procedures. These con- cerns are not limited to asset concentrations be- cause funding sources also give some indications of emerging risk and regula- tory concern.
As a result, the regulatory focus in the future may be sharpened to identify assets and liabilities that could be vulnerable to weak eco- nomic conditions or other types of stress before the issue becomes problematic. This proactive regulatory approach likely would af- fect the examination proc- ess, depending on a bank’s risk-profile trend and ade- quacy of the institution’s risk management proce- dures and limits. A high concentration in
an asset category or indus- try may not be a problem but may generate more regulatory scrutiny since the previous examination. One example of this would be the growth on the bal- ance sheet of a particular type of investment due to low loan demand. In these cases, bank management
About the author Gary Bush is a Certified Examinations Manager at the Arkansas State Bank Department, where he supervises one of two groups of commercial examiners assigned to Little Rock. Bush has been at the Department for more than 18 years.
land prices in an economic downturn may be necessary if cash flows are expected to decline within the agri- cultural loan portfolio. This potential risk supports the need to maintain realis- tic and current values of all underlying collateral. There are some factors
As a result, the regulatory focus in the future may be
sharpened to identify assets and liabilities that could be vulnerable to weak economic conditions or other types of stress before the issue becomes problematic.
may experience expanded examination procedures to ascertain the quality of these investments beyond the typical bond rating sys- tem.
Strong policies and pro- cedures should be estab- lished and ongoing finan- cial analysis – similar to a loan review process – for some investments may be required if emerging risk becomes an issue. Ade- quate stress testing should be in place and, depending on the degree of interest rate risk, funding structure or a declining trend in asset quality, some institutions may be asked by regulatory authorities to retain higher capital levels. Another example would
be banks that are primarily centered in row-crop agri- cultural communities. These institutions generally have an industry concentra- tion because of limited lending opportunities in areas other than agriculture.
These institutions gener- ally have loans in three ar- eas: ▪ Crop production ▪ Equipment financing ▪ Farmland real estate These banks may receive some expanded examina- tion procedures because of the industry concentration and if there is an expecta- tion of emerging risk – for example, if commodity prices are falling or if weather conditions are ad- verse.
In these cases, senior management may be ex- pected to shock current crop production loans for yields and changing com- modity prices. This could give some indication of dependence on secondary collateral to repay the debt. It may also indicate if the producer’s ability to service related term debts for equipment and land has been impeded.
Stressing equipment val- ues assuming liquidation or
September 30, 2011
that may reduce risk for this industry concentration that bank management may measure and examiners should consider: ▪ High level of crop pro- duction loans on irrigated and precision-leveled land ▪ High percentage of crop loans on good soil types ▪ Crop insurance to re- duce the risk of natural disasters such as flood and drought ▪ Marketing/pre-selling of growing crops
These factors may limit
the level of exposure to the institution’s capital but po- tential risk to liquidity may result if the repayments of the seasonal debts extend beyond seasonal funding source maturities. Manage- ment’s actions for scenar- ios such as this may be de- scribed within a well- defined contingency fund- ing plan.
There are some financial institutions that are well diversified on the asset side of the balance sheet but have limited sources of funding. These organiza- tions generally have a small degree of geographic dis- persion and a minimal branching network, and
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