What topics should audit committees be discussing with management?
Portfolio stress testing
It’s important for organizations to stress test their portfolios, and audit committees should see the results of that testing. If committees are not receiving the data, they should ask management to provide it. If they are receiving the data, they should check to see that it goes beyond interest rates to include information about geography, product types, and other organization-specific breakdowns. The loan review team might be able to assist with analyzing large data sets. For financial institutions with heightened loan type (or product type) concentrations, it’s especially vital to continually assess and evolve stress-testing approaches.
Loan-level stress
The audit committee also should look at current loan-level stress-testing scenarios. Are they focused only on interest rates? If so, those scenarios might need to be adjusted to consider market shifts and the impact on both repayment capacity and collateral coverage.
Liquidity and deposits
The audit committee and management should discuss how current lending and credit extension are helping to increase or stabilize liquidity. Lending to transactional customers might no longer be the best use of capital, and low-yielding loan products should be reassessed.
Credit risk grading
Reviewing the credit risk grading approach is another helpful part of mitigating risk. Does the financial institution use a definition, scorecard, or model approach to grade commercial loans, and how has that process evolved? With the changing economic environment, this approach should be revisited regularly to evaluate frequency, consistency, and inputs. The volume of overrides should be scrutinized and used to identify potential weaknesses that need to be addressed.
Valuations
Determining if and how management is assessing the evolution of valuations in specific markets is vital. If the organization has an internal appraisal area, the audit committee can ask for regular updates on trends specific to core markets and collateral types and obtain market studies.
Managing market volatility can be difficult for every organization, but having these discussions can help audit committees understand both the opportunities and challenges in the current market and prepare for future market shifts.