Management of collateral received: an effective lever to reduce operational and financial risks

Since the financial crisis, banks are facing a major phenomenon: the rise of non-payment of their customers. These faults are both on home loans granted to individuals and businesses as the credits distributed through credit cards for individuals.

In this context, the management process guarantees received has become a key process, acting at the heart of risk management for banks.

All rates are raising

Indeed, in the life cycle of a credit report, several events on the efficiency of collateral management process. One of the most sensitive is the renewal or extension of credit. The decisions made at committee to grant or renewal of credit are guarantees that the charge business and management think they have credits on the client. Control of the processing chain of guarantees is essential to avoid poor management decisions.

The second event closely linked to good management concerns the lack of guarantees. Indeed, once the defect, the banks use as collateral attenuator risk. Thus, phase of recovery, banks may be attracted to the security taken to minimize losses on a client.

To better manage the collateral management process, a phase of risk mapping should be conducted ...

Collateral management therefore reveals major risks for the bank, it is necessary to control and secure. Three major types of risks can be highlighted:

• Operational risk: operational mismanagement resulting in disability of the guarantee and therefore impossible for the bank to exercise (nonexistent record of security in information systems, archiving error, failure to comply with legal requirements ...);
  
•  Financial risk: false reality of the value of collateral held by the Bank against its outstanding loans (no collateral revaluation, wrong entry in information systems, power in the wrong accounting categories ...);
  
• Regulatory risk: non-compliance with Basel II regulations, practices and eligibility of collateral monitoring and updating valuations of collateral received (incorrect application of weights, LGD unsatisfactory, non-compliance frequency of revaluation ...).

Complemented by an ... analysis phase dysfunction

Gaps (resulting risks outlined above) must be analyzed on the entire process chain guarantees received (Socket / decision, Entry, Accounting, Reporting, Conservation, Monitoring, Archiving, Production).

Analysis of improvements in the processing chain and identification of impacts and action plans should address the risk areas, operational management, accounting, IS / tools and organization.

It should be noted that the process guarantees may vary depending on the type of warranty studied. Indeed, the guarantees can be classified into three broad categories. The first category corresponds to guarantees and credit derivatives (against bank guarantees, sureties individuals, legal persons ...). The second includes all financial collateral (real guarantees) as the cash and gold deposits, collateral securities, collateral contracts of life insurance ... The last category is for non-financial collateral (real guarantees) such as physical collateral (real estate mortgage, ship mortgage, pledge of goodwill ...) and mobilization of commercial debt.

Food for thought to minimize risks within the process chain guarantees received

Minimize operational risk:

The main anomalies that cause the bank not to exercise the guarantees are generally related to information system (capture process), the system of conservation (preservation process) warranty "paper" and the legal aspects (process monitoring).

Process Input: With a collection, the bank will have no knowledge of actually making a guarantee on the client if it has not been recorded in the information system.
It is important to perform regular reconciliations between inventory records and physical safeguards present in information systems.

Conservation process: Similarly, if the storage place of the record of the guarantee is not located or located too late, the bank can enforce its rights.

It is essential for the bank to identify sites for the conservation of a rapid collection of files. These records must be traceable especially during changes of internal organization.

Process Monitoring: Finally, the difficulty for the bank to exercise the guarantees may also come from non-compliance with certain legal requirements when setting up a guarantee (eg a need to communicate information to each guarantor of unpaid the counterparty).

The bank must ensure compliance with legal requirements throughout the life cycle of warranty. Automation newsletters can minimize the risks.

Minimize the financial risk:

The main anomalies that lead to incorrect assessment of the reality of blankets from the revaluation (monitoring process) as well as inadequate knowledge of management parameterized in information systems (capture process).

Entry process: In the case of a breach of the rules in information systems, particularly in cases of multi-security commitments or guarantees associated with more commitment, it may be that operators back office does not adequately capture these guarantees.
To limit this risk, the procedures of entry must be available to operators.

Process Monitoring: In addition, abnormalities may be due to revaluation revaluations erroneous amount of security or lack of regular revaluations. In all cases, the amount of security on which the charge business will be based on a grant / renewal of credit will not reflect the economic reality of the guarantee.

To this end, regulators require banks to include a periodic review to adjust their value at market price. It is necessary to comply with this periodic review.

Misapprehension of reality blankets can bring operational decisions involving risk the bank compared to a counterpart

Minimize regulatory risk:

The main abnormalities that result in regulatory risk under Basel 2 concern the inadequate consideration of risk guarantee as attenuator in the COREP (reporting process)

Reporting Process - Valuation: To be eligible as credit risk attenuator, guarantees should be subject to regular reassessment whose frequency is imposed by the local regulator.
Frequencies and valuation methods must be checked to ensure proper eligibility of collateral

Reporting process - Weight: Weights are applied to the COREP, mainly standard method, depend on the type of warranty and quality guarantee.
The ratings of the guarantors (especially in the case of pledged securities or life insurance) must be updated at each balance sheet date to ensure eligibility of collateral.

Reporting process - Calul LGD: Recoveries help reduce the rate of LGD and therefore minimize the capital cost in the case of advanced calculation method.

Make sure the service performs recovery close monitoring on all doubtful and back flow recovery in systems risk

As we have seen, the management of collateral received is an essential process for reducing the risk for financial institutions. However, it appears that this process is not modeled and rarely under control.

However, real gains can be achieved both financially (reducing financial losses) and in terms of capital cost (value of the consideration securities for capital savings).

The difficulty with this type of project development is that it must be supported in a project involving many transverse directions (organization, back office, network, accounting, risk, marketing, ...) . This way of organizing project, and unavoidable though, does not facilitate rapid decision making and developments in "quick win".