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6 conundrums in search of a solution

Bankers should be talking about more of these—now

6 conundrums in search of a solution

In recent months I’ve chosen to post a few comments on some of the social media sites relating to financial issues and institutions. Unfortunately, I often feel that the views taken, especially by those who originate topics, are either shameless spamming for products or consulting services, or reflections of an immature and incomplete understanding of the current environment for community banking.

My own take is that we learned a great deal during the Great Recession but, somehow, the really important lessons failed to penetrate deeply into the consciousness of many bank managements.

What we should have learned

Here is my relatively short list of lessons to be learned. Banks should take care to  not only avoid repeating the errors that led to these lessons, but also avoid the same sorts of outcomes in the future.

1. It’s not just credit.

First and foremost, bankers have to understand that poor credit quality is not the only existential risk to a bank.

We all know firsthand or through extensive anecdotal evidence that bad credit can destroy a bank’s capital base and the confidence of depositors. What we’ve also seen in the years since the collapse of Lehman Brothers are such things as the banking industry having too much capacity and that reputations of individual institutions can be very fragile.

2. We are not dealing effectively with credit risk.

If you and I think of the entire credit cycle—underwriting through servicing to ultimate repayment—as a pneumatic tire, most of us would agree that we often have some flat spots.

My experience as a credit administrator for two large banks for their day and time suggest that underwriting activity is a lot easier to standardize than loan servicing. I also sometimes see this in my expert witness work where a bank has a seemingly strong loan policy and underwriting but its ongoing follow up is inconsistent.

Often there’s no evidence of whether Loan Review or the auditors were aware of lapses that created losses prior to their discovery.

We’re dealing with human beings and we’re all capable of errors and lapses. What we cannot and should not tolerate are casual violations of internal credit controls. Some banks have more work to do in this area.

3. The industry’s talent shortage portends a coming “amateur hour.”

We have a shrinking base of qualified lending talent. Each year brings more retirements to the ranks of seasoned lending staffs. We as an industry have curtailed formal credit training and continuing educational opportunities and we are ceding credit opportunities to non-banking competition.

We have cherry-picked the “easy stuff” like commercial real estate projects and paid less attention to the more varied and diverse credit needs of our customers and prospects.

This inattention has created a vacuum into which many non-banking entrants have penetrated, with too little market-level pushback from traditional community lenders.

4. Regulation and supervision—neither work very well today.

Regulation is a consequence of the importance that banks have in our modern economic society. It’s also a way of implementing and enforcing through the legal process certain legislated societal goals. This reality is at the core of all significant banking regulation ranging from Truth in Lending and Community Reinvestment to Dodd-Frank.

The conversation we urgently need to have as a nation is whether the cumulative effects of bank regulation have been constructive or harmful.

The key question: Is banking a part of the national economy where social engineering schemes should be tried and implemented? 

Supervision is the need for assuring a healthy banking system. At its simplest sense, this means a system not plagued by credit problems that endanger liquidity and capital while complying with laws prescribed by the process of regulation.

And, how much of the current and recent regulatory and supervisory environment for banks is punitive rather than corrective?

5. There is too much banking capacity today.

Our nation’s history is replete with examples of the economic tensions between rural and urban. Rural America was historically fearful of urban financial interests and so the ability of banks to grow naturally and organically was circumscribed by artificial restraints on branching, product offerings and the mixing of credit products and services with virtually any other economic activity.

It’s no wonder that technology overran these artificial constraints and left our industry with too much “throughput” capacity. We simply have much more infrastructure than needed for the volumes available. A more sensible discussion is how should we assimilate this excess capacity rather than just how do we attempt to preserve it.

6. We often don’t do adequate due diligence on our trade areas.

While a rising tide may lift all ships, a weak economic environment creates strong headwinds that can undermine credit quality by its impact on local businesses. This is a difficult area for community banks with their relatively more limited geographic franchises than larger institutions.

Concentrations become a serious threat and can destabilize a trade area quickly. We have to be vigilant in our assessment of local business conditions and how quickly these can change, especially where business concentrations exacerbate our own loan portfolio concentrations and are a natural and inevitable part of the landscape. A healthy curiosity and something like the skepticism of a jury evaluating  “evidence” will always serve our stockholders well.

These are many of the points that I think we should be talking about as an industry. A mindless preservation of the status quo and nostalgia for former ways that are technologically obsolete are neither politically possible nor economically responsible.

Ed O’Leary

Banking Exchange Contributing Editor Ed O'Leary, a veteran lender and workout expert, spent nearly 50 years in bank commercial credit and related functions, working with both major banks as well as community banking institutions. His last job before retiring was as the CEO of a regional bank headquartered in Alburquerque, N.M. He earned his workout spurs in the dark days of the 1980s and early 1990s in both oil patch and commercial real estate lending. O'Leary began his banking career at The Bank of New York in 1964, and worked at banks in Florida, Texas, Oklahoma, and New Mexico. He served as a faculty member and thesis advisor at ABA's Stonier Graduate School of Banking for more than two decades, and served as long as a faculty member for ABA's undergraduate and graduate commercial lending schools. Today he works as a consultant and expert witness, and serves as instructor for ABA e-learning courses. You can e-mail him at [email protected]. O'Leary's website can be found at

In mid-2016 O'Leary's "Talking Credit" blog received a bronze excellence award for the Northeastern Region from the American Society of Business Publication Editors.

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