Many banks are trying to reduce risk by only allowing senior execs to make all key commercial lending decisions. Is that approach actually having the opposite effect? In this episode, we discuss the potential perils of "turning the faucet" off with your bank's commercial lending.
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Transcript:
Jim Young: Hi, and welcome to The Purposeful Banker, the podcast brought to you by PrecisionLender, where we discuss the big topics on the minds of today's best bankers. I'm Jim Young, director of content at PrecisionLender joined again today by Dallas Wells, our EVP of strategy. Today's topic is one that's frankly going to be front and center for banks during this current time of market turbulence, and that is risk mitigation. Dallas, we've talked a lot on this podcast before about this concept of a pendulum swing from risk reduction to growth and back and forth right now. Where is that pendulum?
Dallas Wells: It's about as far towards the risk end as it can possibly get. So the interesting thing we've observed about the industry, and this is not a unique observation to us, obviously it's kind of how the industry works, but these pendulum swings are really wide and really extreme. So banks don't tend to just sort of make slight adjustments to their risk strategies. It tends to be, risk off put everything on the books, growth at all costs, now that's all reasonable costs, of course, I don't mean to make the industry out to be a bunch of Mavericks, but the growth becomes the priority. Then when the cycle shifts and when things change, and lately over the last several cycles that tends to happen really fast, there's a really sudden event that causes it and banks don't slowly adjust back and sort of read what's happening around them. They just turn the faucet off, just stop.
And it's been interesting to watch this time. We are 12 years out from the last crisis, so the industry's gone through some pretty impressive changes since then in terms of how they operate, how they make decisions. Lots of people tease banks about being dinosaurs and slow moving, and they're not very agile. But in all reality, the industry has spent many billions of dollars getting pretty lean and mean and efficient over those last 12 years. And so, as this happened, I kind of expected banks to handle this a little differently, right? Everything's data-centric. They're making decisions in independent little pods and they're reviewing what's happening with their business. They're letting people on the front lines make more decisions, they're better informed, there's better technology controls. It's working kind of the way everybody dreamed that it would, but then this happened and banks just sort of wiped away all that stuff. And the way we've described it internally is that they've almost reverted to like it's 1995.
So a lot of those systems that they've put in place, a lot of that independent decision making has gone away, and instead it's very much a command and control kind of approach and it's intentional. Where banks say you're not allowed to make these decisions anymore, you can't color outside the lines, there's nothing outside of the box. Anything unusual, in even the slightest bit, has to get run up the chain of command for approval, so executives are making hundreds of decisions a day because they're deciding on every little thing that happens in the business.
No new money goes out the door without executive approval, no new vendor contracts of any kind, no workout agreements without senior approval from within the credit group and from within the line of business. Lots of extra checks and balances, so this is where banks have gotten really cautious and this is why the faucets turn off, is when human beings have to intervene and make these decisions and sign their name to it for something to happen, the business just stops and credit kind of dries up and banks go in their cave and lick their wounds and wait for the good times to come back again.
Jim Young: Okay. I promise you, I'm not trying to get cute here with this next question, but you talked about making hundreds of decisions and I think back to stuff like the whole Steve Jobs, "this is why I wear this one black mock turtleneck," is I need to reduce the number of decisions and that I've got a certain number of really important decisions that I have to make, and my brain basically has to be on that. What you're describing is very, very smart people, making a lot of very, very, very important decisions. And that strikes me as, and here's where I'm going to sound cute, but I honestly don't really have a better word for it, that strikes me as risky. I mean, I get the idea is to be really, really turning the faucet off is typically considered like the most low risk thing, like if your faucet is leaking, you turn the water off and figure out what's going on, you don't try to fix it as it's leaking. So, but in this case, it sounds like what you're saying sounds kind of risky.
Dallas Wells: Well, it's certainly not sustainable. There's a lot of stress in the industry and lots of long hours and decision fatigue, the conversation I've had a lot over the last couple of weeks is people just describing, man, this is just, it's a grind, right? When it first started, it's crisis, right? It's an emergency response and it's all hands on deck and it's long hours and there's almost some adrenaline that goes along with it, some excitement about dealing with a crisis in front of you. But at this point, we're enough weeks into this, that it's a grind and you can feel a lot of burnout already. And we're kind of just getting started with the economic fallout. So from that perspective, we're relying on some human beings that are kind of way beyond the red line to make, as you say, some very important decisions.
So it is risky. And I think that's why you see banks just go to the total risk off, nothing happens. That's in some ways the genius design of the system, is it adds so much friction that just nothing gets done. And that's almost intentional, maybe it is intentional in some places of just, we're going to make it so hard to make decisions that you just won't make any.
Jim Young: Unless it's obvious, right?
Dallas Wells: Yeah. So I think there will be some missed opportunities, there will be some wrong decisions. There always are. Nobody's going to nail this thing perfectly. So it's by design, but I think it adds risk and I think it undoes a lot of progress that was made in recent years where those systems weren't put in place just for the good times, right? Those things were put in place for exactly these kinds of situations too. And it's almost like banks have decided they don't really fully trust all of that. And instead they want to go by gut feel and the 30, 40 years of industry experience of some of their executives to steer through this rather than a system that's five years old, and I can understand the comfort level there, but most definitely some risk.
Jim Young: Yeah. You just touched on exactly where I was going with, and, honestly I can speak from personal experience and this is what you get, I'm just wondering to what extent this is a case of you have the sort of fancy new piece of technology, and there is a way to use that technology, it's designed for this sort of thing. And it's not really a shortcoming of the technology, it's a shortcoming of the user to not know that, hey, if you just do these two things, it'll do the same thing that you're now spending hours doing manually. That's sort of a diagnosis, I don't know if that is what the solution is on that, is to tell people to trust the systems that they have or what.
Dallas Wells: Yeah. It's like trust the GPS, it actually will work and you don't have to use the paper maps. You can say that all you want, my dad's still using the paper maps, right? Look, it's a clear issue that doesn't have a simple, easy answer, but I think what you will see is, you'll see some differences in performance and you'll see some differences in how quickly banks come out of this. So the interesting thing is if you look at the math of it, banks fight and scrap through over the last decade, fighting and scrapping over percentage points of market share and basis points of margin. And it's kind of like tooth and nail for each little victory there, and if you kind of look at banks over multiple decades, so an executive's longterm career at a bank, their performance actually doesn't come from the 95% of the time where they're kind of scrapping and clawing. It comes from these crisis periods and how they actually react to those.
So what decisions did you make? And also as you shifted and changed direction, did you pick the right direction? Did you move fast enough? And you can make up many years worth of gaining market share in just a couple of months of being aggressive in the right spots. So it's the easy decision to make, to just kind of shut it down, go by gut feel, go slow and cautious, but that's not where the performance comes from. The performance comes from the banks that are willing to trust those they've put in place and lean on them a little bit. And that's where the out performance comes from.
Jim Young: Well, so is the solution then, if I'm a bank in this scenario, where I've gone through the quote-unquote "digital transformation" I put in systems here, but I had that immediate reaction of turn everything off, turn the water off and clench tight on this sort of thing. How do you undo that? Can you slowly sort of release control or is it, you let go and then, I guess that's about sort of my thing, is there a part of it that it's like, I get what you're saying, but I don't know that I can undo that part of it.
Dallas Wells: So to me, the way I'm thinking about this, what keeps coming back to mind is probably one of the first podcasts we ever did years ago was this concept of an OODA loop. And I'll tell the backstory just because it's a good story, but there was a-
Jim Young: You don't think everybody knows what we were talking about in the podcast four years ago? Dallas, I assume everyone remembered the story, right?
Dallas Wells: Surely everyone remembers that fondly. As you look at the Korean war, which was really the first war where we started having some of these dog fights with fighter jets, it was the first air battles of those kind and the American planes at the time, we're pretty outgunned. They were the particular MiG aircraft that they were in combat against had longer range, faster speeds, better weaponry. They were just, as you listed the spec side by side, they were inferior aircraft. But the outcomes didn't show that, the outcome showed that by in order of magnitude, there was more kills for the Americans then than vice versa. And so there were lots of studies done about why that was and that it wasn't just bravado and superiority, that there had to be a reason for this. And what it actually came down to is that the American planes did have two distinct advantages.
One was that they had an open canopy, so the pilots could see in all directions really easily. I'm butchering some of the technical descriptions here, the terminology, but the joystick, right? How you steer the plane, the stick on those planes allowed them to react much faster. So what essentially happened is, is that they could observe what the enemies were doing and then make a quick reaction, and there was a pilot there called John Boyd who was just starting his military career at this point, who kind of built this into a framework that he called the OODA loop. So it was observe, orient, decide and act. So you look around you, you orient what's going on in the situation you make a quick decision and you act, and his theory was, that got proven to be correct multiple times over, is the speed of that loop was way more critical than all the other factors, than all the other issues with the planes. Or even if the decision that you made was necessarily right or wrong.
The important thing was is that you made a decision and then quickly observed again, what was the outcome of that decision? And so, because of the nature of those planes, they could make three or four decisions in the time that the enemy pilots could make one. And so you make enough quick maneuvers, you can pretty quickly be three, four, or five steps ahead of them and the advantage far outweighs all the others. So John Boyd went on to a pretty decorated career of, he had a standing bet, I think it was called 40 bucks and 40 seconds. He had a standing bet with any fighter pilot as they would come and do these training sessions, he would have you dead in the sights within 40 seconds, and the bet was 40 bucks.
He made a pretty good sized living doing that, he never lost that bet. And it was just because of that approach that he had of quickly deciding. So anyway, he eventually got a job at the Pentagon using some of the same logic and it turned into military strategy that's still used today. So I go into that long backstory because banks are set up like, and they're operating right now, like old school, military units. It's top down, it's very command and control, the generals make the decisions. They tell the colonels, the colonels, tell the captains and so on all the way down until eventually somebody actually does a thing. And the person making the decision is by both time and distance, very far removed from the actual action and from the actual outcome. And so it takes a long time for the decision to reach. It gets mistranslated in between, and then it takes a long time for the outcome to kind of get filtered back up to the decision makers.
John Boyd's approach was, let these smaller independent units make quick decisions and get constant feedback from those. So they have an overall objective that's pretty clear to them, clear and simple, and then let them have some independence and actually achieving that objective. So as that's made its way into the business world, there's lots of different names for it. It's enacted lots of different ways, but basically flat organizations handle crises like these better because the people that are on the front lines in this case, your bankers, they're actually dealing with your customers, they're face to face with them. If they know what the overall objective of the businesses from the executives, then they should have enough information to be able to observe what's happening around them, orient themselves, to what the situation is, make a quick decision, and then actually act on it with kind of full authority to make some decisions.
So if you think about a big bank, it doesn't even have to be that giant, but a multibillion dollar bank, you've got thousands of customers dealing with thousands of unique situations right now spread across maybe dozens of markets. And you've got all kinds of executives and middle managers trying to make decisions there. The person best able to make that decision is the person in the room, who's had a multiyear relationship with that customer, understands their business, and can make the best judgment about what comes next. So that's a really long way of going about saying it, but I think it is this situation is exactly what that framework is designed for.
There are banks that are, that are operating that way. Even if it's just letting a market president own their own little business unit, they know the metrics that they're held accountable to. They know that if there's too bad of credit losses, they're probably looking for a job in a few months, let them make some independent decisions and act quickly.
Again, I get that's easier said than done, especially mid crisis, but wanting to make all those decisions yourself, that's something that a lot of executives are, they're mandating that right now. They're putting that in place and saying, I want to sign off on everything. It's my neck on the line. So I want to make all those decisions and you're actually more likely to survive if you don't do that. That's a hard reality to come to terms with, but it's the truth.
Jim Young: Yeah. I also go back though, to that Korean war scenario, and I would have been curious what would have happened if, to say the MiGS had been the ones with the OODA loop system, because like what you were saying, it was a kind of a marriage of there's the system, but there's also, you have a plane that is designed to operate within that system really well. And so as a bank, what you're talking about is, a lot of these banks have that system in place. They maybe haven't gotten comfortable with it or trust it at this point, but the system part is a key component to this sort of thing. I don't know that necessarily, if you don't have that, you want to throw everything out to everybody and say, go get them. If you don't have an ability to really observe, right? After you've taken an action, if you can't really observe that action, then the whole loop breaks down.
Dallas Wells: That is very fair. And again, some of that is bank imposed, so I'll use our software as an example. We have software that individual relationship managers can see their own deals that they're working on, they can see their own portfolios and then it's possible within the software for that relationship manager's boss to see what's going on in all of his or her direct reports in their portfolios. But then also relationship managers can technically look across the bank and see what other bankers are doing. We've seen some banks do really well with that, of kind of encouraging some positive peer pressure, some of them have even built some intelligence into the system, through Andy, our virtual coach, in there saying, "Hey, find deals that are like this one. And then point them to that banker that did that deal."
Let them share some knowledge on deals that are similar in good ways or in bad ways. Let them talk about the risk. Let talk about the opportunities and learn from that. Most banks, as we are implementing our software with them, they look at that and they go, "oh no, I don't, I don't want any of that stuff to happen. I wanted all that restricted down." So we have varying levels of basically curtains that we can pull down of, you can only see deals within your market, or you can only see deals where you're an owner on them, or deals where you're a part of the deal team. And lots of banks get super restrictive with that. And it causes all kinds of, of issues.
You say, all right, well, we want to do some analytics, right? And provide you some reporting. And there's literal gaps in the reports where it's a blank spot. They're like, what's with the blank spot here? Well, that's where you hid the data from people, right? So you don't have access to see that. That is dozens of times over what happens inside of banks. Some of it there's regulatory reasons for doing it, there has to be a wall between some deals and certain parts of the bank. I get that. That's not what this is about. This is about, are you really arming your decision makers and your people that are dealing with your customers right now through this crisis, are you really giving them the full access to everything they need? Do they know who their profitable customers are? Do they know what other deals like this in the bank look like? Do they know what the outcomes of other similar deals have been?
Do they know that you've got 20 other deals in the same industry and 10 of them are in workout right now? And do they know the status of that? Do they know what caused it? In most banks, that answer is no. So you've purposely created these silos where you're not letting people learn from what's on your own balance sheet and you're asking now to make some really critical decisions, effectively blindfolded and handcuffed. And that's what you have to undo. Even if you don't have a lot of fancy systems that you can't stand up really quickly, I think you can remove some barriers on the stuff that you have, and you can do this in whatever span of control you have within your bank. So if you've got a team of five people, share what you know, share it widely, let them share information with each other.
And if you lead a team of 500 people, then you can really make a difference here. That I think is a thing that you can decide pretty quickly. And we've heard of banks doing this in some, again, reverting backwards a little bit, using things like desk sheets, which is, we sent out some market information. This is latest and greatest intel that we've got on what's happening right now. Literally you can print this off and put it on your desk as you're talking to your customers. If you have to get old school with it, so be it. But you have to open up the channels of data, information. These are really fast moving markets and fast moving outcomes. You got to let people have some visibility into that.
Jim Young: Gotcha. All right. Well, I think that'll do it for this week show again, thanks so much for listening and a few friendly reminders, if you want to listen to more podcast or check out more of our content, visit our resource page at precisionlender.com or head over to our homepage to learn more about the company behind the content. If you've got topics that you want us to cover or areas that you have questions about that you want us to look into our dataset, feel free to reach out to me. Email jyoung@precisionlender.com. That will be in the show notes as well. Again, we love to get ratings and feedback on our platforms, iTunes, Google Play, or Stitcher. That'll wrap up this episode. Dallas, thanks for coming on.
Dallas Wells: Yep. Thanks Jim.
Jim Young: You've been listening to The Purposeful Banker.
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