OVERVIEW

Unlike Mark Twain's cat, which once sat on a hot stove lid and would never again sit even on a warm one, bankers should always be careful to get from an experience just the wisdom that is in it no more, no less. Banks need a sense of caution in a liberal credit environment, but they also need the courage and wisdom to take reasonable risks when credit is tight. Financial institutions succeed as long as the risks they assume are prudent and within defined parameters of portfolio objectives. This means policies and procedures must ensure that exposures are properly identified, monitored, and controlled, and that loan pricing, terms, and other safeguards against nonperformance or default are commensurate with the levels of risk that banks assume.

Bank failures are the result of lax credit standards, ineffectual portfolio risk policies, risks assumed beyond limits of a bank's capital, misreading performance barometers and neglecting technological upgrades (both system wide and specific), loan exposure, and ineffective risk rating systems. As we shall see, banks have come under increased regulatory scrutiny with many incurring losses on loan write-offs. An internationally known bank surveyed its problem loan portfolio and came up with a pattern of root causes (Table 1.1).