The Case for Some Additional C’s of Credit

The following article is from The RMA Journal, April 2018 issue.

As a classic car enthusiast, I have always believed that the Volkswagen Beetle is the ultimate testament to design simplicity.

The Beetle was beloved by consumers everywhere during an extraordinary 65-year production cycle that lasted from 1938 until 2003. The Beetle’s value proposition and “no frills” engineering convinced over 21 million to purchase the “people’s car,” and the design logic is also believed to be the basis for similarly iconic higher-performance models such as those produced by Ferdinand Porsche. The best designs ultimately deserve periodic refreshes; nevertheless, Volkswagen continues to leverage the original “Beetle ethos” in its current models.

The same design thinking is needed for a set of credit concepts that have been taught for what may seem as long as the Beetle’s production cycle. I’m talking, of course, about the “Five C’s of Credit.” It’s safe to say that the vast majority of risk professionals have been trained on these principles, owing to the elegant nature of their design and their applicability to so many bank processes.

As we think about risk management in 2018 and beyond, I propose updating our design logic to embrace 10 C’s of Credit. Since “less is more” in good design thinking, the evolution of our industry requires additional technological enhancements while still preserving our Beetle ethos.

The figure below shows the original five C’s bordered on three sides by the proposed additions. Since the original five C’s have been well covered in previous RMA Journal articles, this one will focus on the proposed additions.

 C's of Credit

1. Culture

The risk management industry, regulatory supervisors, and boards of directors have all placed a heightened focus on culture and its measurement. This is arguably the one dimension that cannot be overstated in terms of its importance (and, in this writer’s opinion, should rank as the overall number-one item on our revised list of C’s). Deviations from a desired culture can result in heightened risk across all the traditional risk domains, and weak risk cultures are arguably at the root of most industry failures.

While cultural definitions may vary from firm to firm, the essential question to ask is whether your culture is strong enough to support de-risking of portfolios during somewhat benign environments or when you see elevated risks from your own early warning indicators. Those decisions are difficult and unpopular, but they can make all the difference during deteriorating economic cycles.

Strong support from the CEO and board of directors is key to supporting a “risk-intelligent” cultural mindset.

2. Concentrations

Excessive credit concentrations in lender portfolios have been a key cause of bank failures since the beginning of our industry. Sectors such as commercial real estate are often associated with boom/bust business cycles (and resulting bank losses), and much of that cyclicality has been imprinted in our credit memory chips. However, there will always be surprises, and a strong framework for limiting concentrations is your best defense against the unknown. The recent energy downturn is a good example that many lenders (including yours truly) underestimated in terms of its severity.

Smaller banks do not need to build complex capabilities, but a B.P.I.G. (borrower/product/industry/geography) report is a simple, Beetle-esque design principle that can go a long way toward improving your bank’s risk intelligence. If you fail to maintain a robust concentration limit framework, you do so at your institution’s potential peril.

3. Consistency

Although the level of complexity in the risk management space has increased with each passing decade, one could make the argument that consistency is more of a recurring issue for institutions. Inconsistent processes create variability in any system, and just about every risk domain can be affected.

Consistency does not mean being "consistently average." It means being "consistently excellent," which is why this “C” can be a major challenge. Training, organizational design, talent recruitment, process measurement, and technology are examples of several areas that can have a positive or negative effect on consistency. If we are inconsistent, customers (who are the reason why we exist) can be negatively impacted, so maintaining consistent vigilance around core processes is critical.

4. Correlations

In designing a strong portfolio management program, an important "close cousin" to concentration risk is correlations. Often, institutions look at asset, product, or geography correlations, but give insufficient review to how portfolios might behave as a whole during a downturn.

How will commercial real estate developers perform if mortgage defaults are rising? How will automobile dealers in commercial banking perform if auto loan defaults increase in your consumer portfolio? To truly address correlation risk, silos within institutions must be broken down and teams need to be empowered with decision rights to consider data across multiple lines of business. And yes, some correlations may prove to be specious using expert judgment. But if you don’t attempt to look at them, you are increasing the risk to your platform.

5. Complacency

It may be difficult to believe that complacency is present after the financial crisis and heightened regulatory expectations, but it is nonetheless a risk to actively avoid. Complacency does not imply that people are intentionally asleep at the switch, but it can manifest itself in many ways.

How many of your team members have been in the same position for seven, 10, or 15 years? If they have been in a role that long, will they be motivated to maintain the status quo—or will they be motivated to become agents of adoptive change relative to key processes, oversight, etc.? Moving team members around creates fresh sets of eyes and a sense of corporate renewal and team engagement. Similarly, how many of your policies, systems, and controls have been around for more than three, five, or seven years? Compared to the other C’s, complacency is often less overt and can be the unintended by-product when there’s a lack of commitment to corporate change.

There are potentially other C’s that could be considered (such as coding to represent data quality and reporting), but it’s important not to over-dilute what was already an excellent design. Just like the Beetle, the C’s may need to evolve over time, so create a culture in your organization that allows it to keep pace with the changing landscape.


The above is based on an excerpt from The RMA Journal, April 2018 article “The Case for Some Additional C’s of Credit” by Mo Ramani, chief credit officer and head of financial risk management at SunTrust Banks Inc. You can read the article in its entirety here.



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