It’s been more than a decade since the 2008 financial crisis known as the Great Recession, driven largely by over-exposure to sub-prime and non-traditional mortgages and mortgage-backed securities extended to borrowers in the preceding years. Coupled with a dramatic rise in interest rates, it resulted in eight million home foreclosures, 30 percent of ARMs became delinquent and home prices declined an average of 40 percent.
To prevent a recurrence, the government quickly enacted financial regulations and reforms including the Dodd-Frank Act, bailing out banks that were “too big to fail” and creating the CFPB and other oversight agencies that financial institutions said unduly increased compliance burdens and made it difficult to serve customers. However, today capital ratios are strong, the global financial system is stable and lending to borrowers who can’t afford their loans is less common.
While now less likely to experience a severe liquidity crisis, financial services organizations must continue to monitor their overall condition and plan for the potential impact of a recession, defined as two consecutive quarters of negative GDP. As a board member, you should consider:
Loan portfolio composition. Today’s high inflation is driving up the cost of goods and services, and rising interest rates mean more profitable loans. Those trends may lead to a rise in non-performing loans as customers divert funds to pay other essential expenses. If the economy enters a recession, unemployment may rise causing an uptick in loan and credit card losses as consumers become unable to repay.
It’s a delicate balance requiring constant attention. Watch for an inverted yield curve – when short-term bond rates rise above longer-term bonder rates – which historically indicate a recession. The yield curve changes daily; as of early August, the spread between three-month and 10-year bonds was 0.1 percent, compared to early July when the spread exceeded one percent.
Scenario planning. Avoid costly, last- minute decisions. Review key performance indicators now to understand how they influence the bottom line. For instance, forecast revenue in a small, medium and large downturn and model the impact each forecast has on expenses. Then, develop pre- emptive strategies, such as:
- Hold on to current customers. It’s less expensive than attracting new customers. Ensure delivery channels are efficient and convenient, keep an eye on customer satisfaction scores and reach out to customers now to deepen relationships.
- Monitor the pipeline, value and percentage of deals closed. An economic downturn could mean fewer leads and smaller deals. Empower managemen to push the sales team to be thorough in pursuing each opportunity to attract deposits and close loans.
- Understand your depth of people and other resources. Put a plan in place and prepare alternates to step in where and when needed to meet customer and shareholder expectations and to ensure you do not rely too heavily on any single individual for a smooth and efficient operation.
Transparency with stakeholders. Keep stakeholders informed, instill confidence in leadership, reduce workplace stress and strengthen relationships by communicating often and openly about board and management planning and pre-emptive activities.