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Banks’ risk culture and its impact on credits

13-09-2016 | Insight | Taeke Wiersma, Christopher Greenwald

After the credit crisis, the importance of proper risk management at banks has become indisputable. In 2015, RobecoSAM incorporated a new question on banks’ risk culture in its yearly Corporate Sustainability Assessment. This information has a direct impact on Robeco’s credit investment decisions.

Speed read
  • Banks’ risk culture has greatly improved, but we’re not there yet
  • Innovative risk culture question introduced in RobecoSAM’s CSA
  • The results directly impact Robeco’s credit investment decisions

Over the past years, banks have made important improvements in shrinking their balance sheets, divesting non-core assets and increasing their capital positions. Investments in compliance and risk management systems have gone up considerably. There is much more awareness and banks have a better sense of the consequences of wrongdoing as a result of the credit crisis, but more work is still needed.

To find out just how much banks’ risk culture has improved, RobecoSAM introduced a question on this topic in its Corporate Sustainability Assessment (CSA). As part of the overall Risk Management criterion, this question addresses elements such as the incorporation of risk metrics into the incentive structure, the existence of training programs in risk management throughout the organization, and the integration of risk criteria in the employee evaluation process as well as the product approval process.

‘We also asked companies if they had taken any measures to proactively identify potential risks, as opposed to simply reporting risk incidents, and if they had initiatives to continuously improve risk management by sharing innovative ideas throughout the organization,’ says Christopher Greenwald, head of SI Research at RobecoSAM.

Banks are more advanced in risk incentives and risk integration…

‘In comparing the responding banks with the companies that responded across all sectors, we see that a higher percentage of banks have integrated risk management measures into the incentive scheme for employees,’ says Greenwald. ‘Roughly 80% of banks have risk-related incentives for managers or senior executives, against 55% across all sectors.’

Banks also demonstrate a higher degree of integrating risk elements into other areas of the company, such as the HR review process, product development and regular trainings throughout the organization on risk management practices. ‘Some 80% to 90% of the responding banks could provide reasonable examples, compared with only 55%-75% of companies in other sectors,’ Greenwald clarifies.

‘We also see leading banks coming up with new ways to manage risk,’ he continues. ‘They increasingly incorporate risk analysis in employee surveys, which is a key mechanism for signaling risk issues to management in a systematic way. We also see a move at some banks to risk management functions that are clearly separated from influence or pressure from the business lines. Moreover, a few leading banks have de-centralized responsibility for risk management, ensuring that responsibility for risk is shared by all employees in the organization. For example, some banks now use internal social networks to reach employees and gather information about risks that may be identified by staff throughout the organization.’

… but lag behind in proactive measures, despite major controversies

On a more critical note, banks perform only in line with or slightly worse than other sectors in demonstrating a process of continual improvement or proactive initiatives to identify risks. ‘These results are particularly surprising given that risk management issues continue to plague banks in the recent past,’ says Greenwald. ‘Slightly more than 7% of all of the banks assessed had a major risk management controversy during 2015, against less than 2% across all sectors. These are major controversies representing significant fines or penalties that are materially relevant for the financial results. Clearly banks are in much greater need to move beyond compliance measures in order to adopt more proactive risk management practices.’

‘Risk & crisis management is a key ESG factor for banks’

‘Taking the sector as a whole, too many banks continue to approach risk management reactively in terms of making risk reporting stricter, rather than thinking about innovative improvements to ensure that incidents do not occur in the first place, says Greenwald. ‘Here banks should take a more proactive role in linking risk management to growth and profitability. Risk management should not be viewed solely through the lens of risk reduction, but also as the essence of successful banking.’

The impact on investments in bank credits

The information gathered in the CSA is an important input for Robeco’s credit analysts. Risk and crisis management, of which risk culture is an important part, is one of the five key material ESG factors the analysts have identified when they assess banks. ‘A bank’s ESG profile is one of the five building blocks on which we base our fundamental view,’ says Taeke Wiersma, Co-Head Credit Research at Robeco. ‘The other four building blocks are the bank’s business position, strategy, corporate structure and financial position.’

In addition to the risk and crisis management factor, the four other ESG factors the credit analysts look at in the banking sector are corporate governance (e.g. board independence); business ethics (e.g. interest rate manipulation); sustainable investment integration (e.g. if - and to what extent – do banks include ESG variables into their lending decisions); and financial product governance (e.g. excessive fees).

ESG factors impact credit fundamentals in over 30% of the cases

‘Rankings from RobecoSAM on criteria that can be linked to those key sector factors provide the credit analysts with a lot of insight and have an important effect on our final fundamental view on the banking credit in question,’ Wiersma explains.

The weight of ESG factors in general can differ per sector and per company. ‘We have experienced that in over 30% of the cases ESG factors have a meaningful impact on the credit fundamentals of individual companies,’ says Wiersma. ‘In around 25% of our investment cases, ESG factors contribute negatively to the fundamental view, and in around 7% of the cases, they have a positive impact. This is in line with the fact that we, as credit investors, are mainly focused on the downside risks,’ he concludes.

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