Creating a Highly Effective Credit Risk Review Function in 2023 and Beyond

by Kelly Jenkins

Global economic growth slowed considerably last year as many central banks continued hiking interest rates to close out the year. In 2023, persistent inflation in advanced economies worldwide combined with ongoing military conflict in Europe could further stress an already deteriorating credit environment. For banks, a highly effective credit risk review function is critical to weathering the storm.

But what exactly does a highly effective credit risk review function look like?

In short, it’s a team that has the independence, authority, people, processes, and tools needed to recognize and escalate credit risk management and loan portfolio deficiencies that, if left unaddressed, might otherwise be identified by regulators as impacting safety and soundness. A highly effective credit risk review team is a game changer and an important link in a bank’s credit risk management value chain. It instills confidence in management, the board of directors, and regulators that credit risks are well understood and managed. The specific requirements of the function will inevitably vary from one financial institution to another, depending on its size and complexity, but there are a few qualities that set strong credit risk review functions apart.

It starts with culture.

Creating the right environment

Regulatory requirements dictate that credit risk review teams operate independently and maintain a stature appropriate to the size of the financial institution and the scope of its activities. To meet those requirements, banks most certainly need to have the right people in the right roles—but the ability to attract and retain talented credit risk review specialists will largely depend on a company culture that truly values and prioritizes the function.

A healthy culture upholds the function’s independence and stature, but its stature must also be earned. Highly effective credit risk review teams have a deep understanding of the business and the credit risks they face. Moreover, their primary focus is on quality, not quantity—they know that their value is not merely a product of the number of findings they identify; rather, it lies in their ability to uncover themes and patterns and discern their relative materiality to sound credit risk management. An overemphasis on quantity may compel reviewers to spend too much valuable time on secondary matters, and inadvertently encourage a “gotcha” mentality, which ultimately dilutes the function’s stature.

Credit risk review leadership must set clear scope and expectations for credit review roles within a dedicated credit review policy and ensure that employees are equipped with the resources they need to meet those expectations. A credit risk review team that has the respect of bank leaders and a company culture that supports its effective challenge and authority to take decisive action or escalate risk when needed will earn the trust of the board of directors and regulators. One that must continually fight to be heard, or that operates under rigid or ambiguous direction, could ultimately become a liability.

Identifying the right talent

Finding credit review professionals with the experience, specialized skills and well-informed perspective needed to excel in the role has never been easy, and that probably won’t change any time soon. Even so, a key element in ensuring a highly effective credit risk review team is maintaining a consistently high bar for talent. Many leading financial institutions consider it a best practice to staff credit risk review with professionals who have prior first or second line of defense experience, and talent transfers between lines of defense are a prerequisite for promotion into certain senior-level roles. Some institutions also hire former regulators. Prior line of business, risk management or regulatory experience is oftentimes heavily weighted when recruiting credit review professionals.

However, the best candidates not only possess essential credit skills and expertise, but also the right mindset. Credit risk review professionals must apply independent judgment while carefully considering opposing viewpoints, and must consistently exhibit strong critical thinking skills, transparency, and curiosity. And while independent judgment should be a hallmark of credit risk review, the function is still part of the bank. Reviewers who possess strong emotional and social intelligence can foster strong working relationships with business and risk leaders, ensuring that their voice is heard and accepted when issues arise. Prioritizing these qualities over skills that can be learned and developed on the job should lead to better fits and more successful long-term hiring outcomes.

Modernizing the function

If culture building and talent are the first two components of building a highly effective credit risk review function, the final piece is identifying and implementing essential technology. Given the economic and geopolitical uncertainties ahead, now is the time to optimize credit risk review processes to ensure staff are productive and have easy access to vital data and insights.

While many banks have already included credit risk review in large-scale digital transformation initiatives, those that haven’t can still take advantage of the influx of new tools designed to make the function more efficient. Platforms tailored to credit risk review professionals enable better decision making and improve the timeliness and relevance of the day-to-day work. Reliance on insights and reports produced in other areas of the bank, which are inherently biased as they are built for other purposes, may be viewed as an impediment to credit risk review’s objectivity. Tools that are scalable to your bank’s needs and source data directly from bank systems help safeguard credit risk review’s independence. Furthermore, technologies that offer integrated analytics and automate data mining and analysis can dramatically speed up workflows while providing tailored insights to better inform and support testing and review conclusions.

For most financial institutions, investing in these technologies will be a critical step towards supporting a credit risk review function that can remain highly effective in an environment of increasing risk. Moreover, it will be essential to building a function with the scope and stature to meet heightened regulatory expectations. And if macroeconomic uncertainty increases as 2023 progresses, be prepared for those expectations to rise with it.

Kelly Jenkins is the Managing Director of FI Consulting’s Commercial Practice and has over two decades of experience managing and leading credit risk review teams at mid to large sized bank and non-bank financial institutions.