The sovereign debt crisis affects all of us, whether we're managing risk at a trillion-dollar bank in North America or at Main Street Bank in Small Town, USA. Even if we don't have customers overseas, our customers at home may be affected either directly or indirectly by events on the other side of the Atlantic.
In this interconnected world, your customer in Kansas City could be affected if its revenue sources depend on one or more customers with significant European exposure.
The situation is not improving. Although the Greek Parliament approved a new round of spending cuts as a condition of obtaining a second bailout ( €130 billion, or $172 billion) from the euro-zone finance ministers, worries about Greek default persist. And Greece is not the only concern.
On February 7, Moody's Investors Services warned that Britain could be next in line to lose its triple-A rating, and it lowered its outlook for the Austrian and French economies to "negative." It also cut the debt ratings of six other European countries, including Spain, Italy and Portugal.
These actions follow similar moves by Standard & Poor's, which downgraded its ratings for the sovereign debt of nine euro-zone countries in January. France and Austria slipped from a AAA to a AA rating, while other struggling nations were further downgraded by one or even two notches. It also assigned a negative outlook for France, Europe's second largest economy behind Germany, and 13 other nations in the currency bloc.
We all know this is troubling news for European institutions that are struggling through a deep recession, and that it presents serious challenges for global banks in North America. But it would be a mistake to think that the effects of this crisis are limited to the large players.
To mitigate the risks that sovereign debt may present to your portfolio, consider the impacts of the following: a strong dollar, weak capital markets but higher capital requirements, and political and regulatory pressures. Stress testing and scenario analysis will give a community bank a better understanding of what it may mean to its portfolio if, say, its steel manufacturing customer loses a third of its revenue from its European-based customers.
As the dollar emerges stronger during this crisis, U.S. consumers will enjoy lower-priced imports. But your customers who export, and those with significant investments in the euro zone, may experience negative impacts to earnings and investments.
Liquidity strategies should be reviewed in light of the current situation. If you need to fund your institution in the capital markets, you may run into difficulties. Banks with a strong retail customer funding base are more fortunate. The interbank money market will remain credit-sensitive. Counterparty risk management will become increasingly important, and institutions will need to have accurate and timely exposure information and management systems in place.
Also, expect higher capital requirements from regulators on both sides of the Atlantic and from the markets. Those requirements will reduce management’s ability to use leverage, impacting banks' ability to grow loan volumes, already a challenge in this economy. Political pressure to keep credit flowing will continue.
You can expect also that regulators, rating agencies, and securities analysts will scrutinize the quality of the data used by management in decision making. The annual RMA/AFS Data Quality Surveys continue to show that the industry is far from satisfied with the quality of data used in the credit and portfolio management processes.
A frequent refrain of RMA is that the foundation for strong enterprise risk management is the institution's risk appetite. Having a well-defined risk appetite that is understood by everyone in the organization is a crucial risk management practice that will help mitigate your risk from this or any other crisis.
This is also a good time to review your operational risk management. Strong operational controls will improve your bottom line through reduced losses, higher productivity, and improved product quality and customer satisfaction.
Risk management may be more complex at the large, global institutions, but risk events that erupt in other parts of the world can also knock at the doors of small banks here at home.
Jack Wixted is chair of the Risk Management Association.
