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Banks Should Not Skimp on Risk Management

Most Russian banks do not skimp on risk management costs. The only exception are aggressive retail lenders too fixated on cost-cutting, said Mikhail Mamonov at the HSE's XV April Conference

Faced with economic stagnation and dwindling profits, bankers are working hard to cut costs and improve efficiency. But cost-cutting does not automatically improve corporate governance and may result in under-resourced borrower screening and selection processes, potentially leading to higher lending risks.

Research Fellow at the Laboratory for Economic Analysis and Projections of the HSE's Centre for Basic Research Mikhail Mamonov looked at whether Russian banks are capable of managing portfolio quality by adopting better business practices, faced by a gradual resolution of the bad debt accumulated during the 2008-2009 crisis and by Russia's declining economic growth rates.

Mamonov used the monthly accounting data and quarterly profit and loss statements of Russian banks for his report ‘Do Russian Banks Skimp on Risk Management? A Study of Linkages between Cost Efficiency and Credit Risk Exposure'. He created a data panel based on the monthly data of all banks filing such reports with the Bank of Russia between the 1st quarter of 2004 and the 3d quarter of 2012.

Mamonov then applied cost efficiency calculation methods and performed a series of regression analyses to determine a cause-effect linkage between efficiency and credit risk. He found that Russian banks are affected by both poor management and unfortunate circumstances, meaning that they could improve their portfolios by adopting more efficient practices, but the worsening macroeconomic conditions will offset any such improvements by some 50% on average.

His findings do not support the hypothesis that Russian banks in general skimp on risk management – this is only true for a small group of banks characterized by very high – perhaps artificially boosted – cost efficiency and aggressive lending practices designed to maintain or expand their market positions.

At least 25% of some 100 banks fixated on cost-cutting/skimping face higher credit risks than an average Russian bank. Given that these banks increased their share in the loan market from 1.6% in early 2010 to 16.4% by the end of 2012, their continuing growth is a potential threat to the banking system's stability. When a bank in this position is involved in interbank lending, its bankruptcy can adversely affect other banks.

Mamonov suggests that the CBR should tighten its prudential standards to contain aggressive lending by those banks which are skimping on things – eg by imposing higher capital adequacyratios and increasing the banks' required contributions to the deposit insurance fund.

 

April 07, 2014