For lenders, the current landscape presents daunting challenges.
For one, portfolio risk is increasing due to macro-economic factors like rising interest rates, weakening collateral values and the threat of recession.
Banking institutions are also facing operational pressures within their own organizations, as the costs of technology, staffing and resources continue to rise.
Meanwhile, the regulatory compliance burden continues to grow, and competition gets more intense every year.
What do lenders need to do to survive—and thrive—in this challenging environment?
By enhancing their loan monitoring practices, lenders can effectively address many of these most pressing pain points, while also setting their organizations up for long-term growth and success. Specifically, effective loan monitoring systems and practices enable banks to:
- Gain actionable insights on risks and opportunities;
- Enhance operating leverage; and
- Achieve resilience and adaptation.
In this first in our latest article series, we will address how loan monitoring can deliver actionable insights to help mitigate risks and uncover previously untapped opportunities in the portfolio.
Why is loan monitoring important?
To begin, let’s establish a working definition of loan monitoring.
As defined by the New York Federal Reserve Bank in its research paper “The Effect of Bank Monitoring on Loan Repayment” (Branzoli, Fringuellotti, published May 2020, revised February 2022), “bank monitoring consists [of] all supervising activities aimed at verifying and improving the likelihood that a borrower complies with its loan obligations.”
In more practical terms, loan monitoring refers to those activities lenders conduct to assess the risk of a particular loan, once the initial underwriting steps are completed and the loan is booked. Like a shiny new car that immediately loses 30% of its value after leaving the dealer’s lot, a new commercial loan can see its value to the bank decline precipitously immediately after the agreement is signed, based on risk factors like changing economic conditions, managerial missteps and collateral devaluation. Through continuous, dynamic monitoring, lenders can minimize this risk of loss.
The aforementioned research paper—which studied the effects of loan monitoring on a subset of Italian credit institutions—concluded that “the real effects of bank monitoring are substantial. Monitoring is valuable for individual banks, as it reduces delinquency rates.”
It’s clear that banks have a long way to go in this regard. Moody’s Analytics recently conducted a proprietary Loan Monitoring Market Study, in which we found that 43% of respondents are not fully satisfied with their bank’s current loan monitoring practices. Fortunately, 80% of these banks surveyed are making— or considering making— needed improvements to their monitoring processes. This translates to 1 in 3 banks that are already in the process of improving or considering improving their loan monitoring practices.
Actionable insights deliver strategic benefits
One of the key benefits of effective loan monitoring is the ability to access actionable insights. But what exactly do we mean by this term?
Actionable insights are those valuable data points that enhance an organization’s ability to use what you know to change what you do. In other words, they are those pieces of information that—when analyzed and interpreted accurately—can help lenders identify risks, reveal opportunities and achieve disruptive change in legacy methods and processes.
True actionable insights don’t come easily. To access them, banks need technology that can mine for the most relevant data and deliver it in a format that is easy to analyze and understand.
Today’s bankers understand that there are risks AND opportunities throughout the credit lifecycle. But it is exceedingly difficult to identify these risks and opportunities in real time. We are awash in data. How do we best access and identify those data points that are truly relevant, versus those that are simply noise?
Whereas a lot of work has been done over the years on improving portfolio management, in today’s dynamic, fast-changing environment banks need the ability to keep a close eye on the book to address an expanding range of likely or possible future scenarios. At the portfolio level is where banks have the most opportunity to gather meaningful data and produce actionable insights that can help them mitigate risks, recognize opportunities and achieve long-term growth and success.
What types of actionable insights? Through continuous monitoring and 24/7 risk reviews, lenders can obtain up-to-the moment views of their client’s financial position, allowing them to quickly make decisions on new credit requests and proactively offer unique solutions in anticipation of the borrower’s needs.
Similarly, access to real-time data from a variety of sources can help lenders assess emerging risks within a portfolio and individual credits, and proactively reduce exposures and concentrations by industry, loan type, borrower credit scores, collateral types, geography, and more.
But to take advantage of such actionable insights, lenders must have the ability to access, consolidate and analyze good, meaningful and relevant sets of data.
Enhanced loan monitoring delivers actionable insights
The key to an enhanced, proactive loan monitoring process lies in the ability to consider a broader data set that is updated with greater frequency than the annual financial statements that form the basis of traditional credit analysis during loan origination.
When automatically scheduled, this access to a robust, dynamic set of internal and external data is especially useful for monitoring because it allows lenders to deploy staff expertise at specific risks and opportunities in real time. This also increases operational leverage, because it is a much more efficient and productive use of in-house talent and resources, as compared with legacy manual loan reviews which relied on loan officers and credit analysts to request, gather and analyze annual financial statements and tax returns once each year.
What common elements make up an effective loan monitoring system?
To begin, the best technology platforms deliver a comprehensive set of loan performance and credit quality data on which they can build robust and meaningful analytics, which allows lenders to confidently monitor and easily share crucial analytics through the power of data visualization.
Leading solutions also provide peer benchmarking, a powerful tool that allows lenders to compare their portfolio makeup with those of peer institutions, enabling them to view and adjust comparative concentrations across numerous variables such as industry, geography, loan type, loan term and structure, collateral type, and interest rate.
Another core requirement of loan monitoring systems is to provide data unification and management functionality, allowing lenders to collaborate and work more effectively with unified data, flexible reporting, and easy-access views across the deal lifecycle.
Lenders can certainly tackle the loan monitoring challenge in-house, using home-grown technology, internal staffing, and rigorous procedures. But this approach requires a major investment of time and resources, and may not be the highest and best use of internal staff—particularly loan officers and relationship managers who would be better utilized in client-facing activities. And such internally developed processes would likely not support the integration of additional, external data sources to complement the data the bank has on its own borrowers.
In contrast, by accessing a proven third-party loan monitoring solution that was built through iterative development and continuous client feedback, bankers will be better prepared to uncover opportunities their competitors miss. This will translate to reduced credit risk, as well as superior portfolio performance and returns over time.
Learn more about our CreditLens™ Monitor solution.
