There’s a lot of talk about an upcoming recession. And when we say a lot, we mean there are people shouting, “A recession is coming! A recession is coming!” while others, at the same time, blow out the smoke, assuring us it won’t happen soon.
In an August interview on Bloomberg Television, Brian Moynihan, CEO of Bank of America, declared, “We have nothing to fear about a recession right now except for the fear of recession."
The mixed messages make it difficult to understand how to navigate these tricky times.
But banks’ preparation for an economic downturn shouldn’t center around guessing when it will happen so they can grab one of the last remaining lifeboats. Instead, their approach should be to build an infrastructure at the bank that allows for quick responses to real, tangible effects that land on the bank’s balance sheet – no forecasting required. With this agility comes opportunity, as instead of hiding to avoid any and all risk, a bank can proactively take market share when the competition starts passing on too many deals.
A Blast From the Economic Past
To see how this can play out, let’s first turn to what we’ve seen banks do in the past recessions.
Below are results from the Federal Reserve’s Senior Loan Officer survey covering the last several credit cycles (recessions are shaded).
As we can see, there were huge spikes of tightening credit standards during recessions, as banks sought to de-risk as much as possible. The spike during the financial crisis was particularly severe, with nearly 80% of banks tightening credit in 2009 and 2010. Yet banks actually had almost no losses from loans they booked in these years. The losses came from earlier vintages of loans.
Many banks stopped lending all together. Some had such severe losses that they didn’t have sufficient capital and tried desperately to shrink their asset base. For the few banks still willing to extend credit to new customers, there were solid credits and almost no pricing pressures. Profitable growth was easy to find, and a few banks gained market share that is still paying dividends a decade later.
But How Do You Get There?
So, how do you manage to zig when the rest of the industry is zagging?
You start with a clear picture of your own risk tolerance and which types of customers have always been profitable (on a risk adjusted basis) in your bank. Those are your guiding stars. With those two guideposts, you simply work backwards to constantly nudge your bankers to win customers that fit the profile while staying within the accepted risk levels.
That sounds easy. Obviously, achieving it at scale in a constantly changing environment is a massive challenge that requires some infrastructure. Investing in this infrastructure now, while times are good, is critical to the long-term success of banks. Spend the money on the right analytics and the right delivery technology to guide your bankers. It will end up being the mother of all bargains when the next downturn hits.
The competition will grind production to a halt while they try to figure out where their risks lie, and what kinds of customers are still safe. Meanwhile, you can confidently keep chugging along, taking some of their best customers while they’re distracted.
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