The community bank’s business case for enterprise risk management

Nov 22, 2016

The common saying “You can’t see the forest for the trees” has particular significance for community banks that confine risk management to one department in the organization.

While community banks may not typically offer exotic financial products with complex risks that larger financial institutions do, the absence of an enterprise-wide effort to measure and match risks to strategy can result in missed opportunities that are visible only from above the cluttered day-to-day view from the trenches. These are the opportunities, as well as risks, that are vital to a community bank’s competitive advantage in the market.

During the 2016 Risk Management Summit hosted by Sageworks recently, Jay Gallo, chief risk officer of Sage Bank in Lowell, Mass., provided an overview of how community banks can build an effective enterprise risk management framework and program. As Gallo described it, enterprise risk management is a process designed by a bank’s board of directors and management that is applied across the community bank enterprise. It is designed to identify and manage potential risks within the context of a risk appetite, to provide reasonable assurance that bank objectives can be met and to identify potential events that may affect the bank, he said.

Some banks may wonder why it makes sense to create an enterprise approach to risk management. The enterprise-wide approach, Gallo said, provides:

• Better information about risks
• Coordinated risk responses
• Consistency in approach and
• The ability to match actions throughout the bank to strategy.

A successful enterprise risk management program at a community bank will accomplish three risk management objectives, said Gallo, a former partner at RMPI Consulting. “It will ensure there is a written, risk appetite document that complements the bank’s detailed strategic objectives,” he said. “It will link that risk appetite charter to specific metrics that define risk tolerances and boundaries across the organization. And it will create a framework for cross-enterprise reporting and the active management of risks throughout the entire institution.”

Gallo also said that community banks can make a strong business case for developing an enterprise risk management program.

First of all, an enterprise risk management program helps community banks identify strategic advantages and opportunities. True competitive advantages are easier to identify with comprehensive information management, for example. And opportunities that are identified can be brought to decision-makers more quickly to enable faster responses, Gallo said. Finally, organizations are better able to focus on the best risk-adjusted investment opportunities, which is important since not all strategies carry the same level of risks.

Second, enterprise risk management can provide a reduction in the overall institutional risk for the same return on investment. Or, a community bank is able to generate a higher return for the same risk, he added.

Third, enterprise risk management paves the way for improved operating margins, according to Gallo. This is as a result of better portfolio management and credit risk practices, reduced problem loan charge-offs and related management costs, higher net interest income due to risk-adjusted pricing, and an improved efficiency ratio, which allows the bank to grow with steady costs.

The bottom line is that an enterprise risk management program will reduce volatility and surprises for community banks, improve their risk-adjusted returns and allow them to deploy people and capital to the very best opportunities available, Gallo said. It also can reduce redundancies within the organization, optimize the efficiency ratio and result in improved organizational communication and decision-making.

For more information on developing an enterprise risk management program, review the slides from Gallo’s presentation.