To continue the discussion from my last post, we also must realize that the small business borrower typically doesn’t wait until we are ready to perform our regularly scheduled risk management review to begin to show problems. While a delinquent payment is a definite sign of a problem with the borrower, the occurrence of a delinquent payment is often simply too late for any type of corrective action and will result in a high rate of loss or transfer to special assets.
There are additional pitfalls around the individual risk rating of the small business borrower or the small business loans; but, I won’t discuss those here. Suffice to say, we can agree that the following holds true for portfolio risk management of small business loans:
- Active portfolio management is a must;
- Traditional commercial portfolio management techniques are not applicable due to the cost and effectiveness for the typical small business portfolio; and Collection efforts conducted at the time of a delinquency is too late in the process.
One last thing, the regulators are starting to place higher demands on financial institutions for the identification and management of risk in the small business portfolio. It is becoming urgent and necessary to take a different approach to monitor that portfolio.
Just as we have learned from the consumer approach for originating the loans, we can also learn from the basic techniques used for consumer loan portfolio risk management.
We have to rely upon information that is readily available and does not require the involvement of the borrower to provide such information. Basically, this means that we need to gather information (such as updated business scores and behavioral data) from our loan accounting platforms to provide us with an indication of potential problems. We need to do that in an automated fashion. From such information we can begin to monitor:
- Changes in the business score of the small business borrower;
- Frequency and severity of delinquencies;
- Balances maintained on a line of credit; and Changes in deposit balances or activity including overdraft activity.
This list is not exhaustive, but it represents a solid body of information that is both readily available and useful in determining the risk present in our small business portfolio. With technology enabling a more automated assessment of these factors, we have laid the groundwork to develop an efficient and effective approach to small business portfolio management. Such an approach provides real- time regular assessment of the portfolio, its overall composition and the necessary components needed to identify the potential problem credits within the portfolio.
It is past time to take a new approach toward the proactive portfolio management of our small business loan portfolio retaining the spirit of commercial credit while adapting the techniques of consumer portfolio management to the small business portfolio.