To lend or not to lend? Ari Lehavi makes the case for improving decision-making among credit professionals
Every day, new customers knock on a bank’s door seeking to borrow funds. A bank’s credit professionals must be sharp and vigilant as they approve and monitor loans. A lapse in judgment – especially when consistently made across multiple employees – could harm the asset quality of a bank’s balance sheet.
Skills that may have been considered sufficient before the financial crisis are no longer adequate. If the day-to-day decisions of a bank’s credit professionals are systematically undermined by knowledge gaps and/or errors in judgment resulting from inadequate skills and knowledge, a bank is exposed to greater risk.
To determine the extent of this ‘people risk’, Moody’s Analytics has analysed the scores earned on the pre-course assessment given to enrollees in its commercial lending course. Rather than focusing on the average score, we look at the percentage of people who score below the 70 per cent passing threshold. Average scores may provide a high-level view of skills proficiency, but they often mask deeper issues – reflected in the divergence in performance across the entire population of students in the course. By using a metric that measures score distribution, financial institutions can better focus on improving the specific areas of underperforming employee segments.
Moody’s Analytics has created the simple but powerful metric called MPAIR, which stands for Moody’s Performance Assessment Indicates Risk. It reflects the percentage of people who did not pass the pre-course assessment. Measuring this percentage establishes that the higher the MPAIR score, the more inadequate the skills.
1 Average test scores were just above passing: The average test score across subjects in the pre-course assessment exceeded the minimum passing threshold by 2 per cent.
2 Financial Risk has the weakest relative score: Some 42 per cent of people answered fewer than 70 per cent of the questions correctly in this critical subject area.
3 Scores indicate pockets of inadequate skill sets in firms: major banks around the world show a wide disparity in test performance across all areas of risk.
4 An institution’s MPAIR score is highly correlated with its relative default risk: although there may be other contributing factors, the higher the MPAIR score, the higher a bank’s relative default risk (as measured by the Moody’s Baseline Credit Assessment rating).
Chart 1 shows that the average test score (based on pre-course assessments) is 72 out of 100, which falls just above the minimum passing score of 70. The Financial Risk section stands out as substantially behind the other subject areas. Financial institutions should clearly note such relative weaknesses as they consider training interventions.
Although the average score on the exam exceeds the minimum threshold, 31 per cent of people tested answered fewer than 70 per cent of the questions correctly (see Chart 2). These individuals display weaker skill sets that could impact the quality of their credit decisions.
Extrapolating beyond the data, the number of people in the industry with less-than-optimal judgment could be substantial. Therefore, this analysis tracks the percentage of people who score below 70 on the exam, referred to as MPAIR – the threshold where the Moody’s Performance Assessment Indicates Risk. The goal is to provide a targeted metric that highlights those critical credit skills requiring immediate training intervention.
Analysing the drivers of the test performance helps guide the prioritisation of remediation efforts. Chart 3 illustrates the performance of the four major subject areas according to their MPAIR levels. Chart 4 focuses on the subtopics of Financial Risk, as it exhibits the weakest relative performance. Even though some subject areas (on the right side of Chart 4) may need more urgent training intervention, banks should conclude that every area will need targeted remediation. For example, one-third of test-takers did not pass the Financial Risk Foundations topic.
Chart 5 shows the MPAIR scores for each of the major regional markets in which the Commercial Lending eLearning pre-course assessment has been administered. The data show higher levels of risk and vulnerability in the Americas relative to other regions. This variance may reflect differences in the skill sets, culture, or experience level of the test-takers. The regions in which a larger proportion of people had a higher MPAIR score should be more cognisant of leveraging training to address those gaps.
The competency challenges facing the broader industry ultimately emanate from how much individual firms focus on proficiency standards for their hiring, training and education practices. With 66 institutions represented in the Moody’s Analytics database, further insights can be gleaned about the level of skills of specific firms. The Americas region consists of countries in North, Central, and South America and the Caribbean. The EMEA region encompasses countries in Europe, the Middle East and Africa. The APAC region comprises countries in East Asia, South Asia, Southeast Asia and Oceania. Chart 6 shows MPAIR scores by institution, with the highest failure rate on the right (Moody’s Analytics selected the 21 global banks with the largest number of test-takers). The banks’ names are omitted, as the intent is to highlight the lessons learnt by viewing all firms – rather than criticise the capabilities and practices of any particular company. The striking insight from this chart is the high degree of variability in MPAIR scores across firms. These differences may reflect the standards of the region where each institution is located. Given the global nature of financial markets, however, the significant disparity in the performance of major banks around the world points to varying degrees of focus and priority around training and education.
The financial health of an institution largely depends on the day-to-day decisions made by its credit staff. By extending this observation, it could be reasonably surmised that firms with a larger portion of people who did not pass the test would also exhibit weaker financial performance. Chart 7 maps the MPAIR performance of institutions to their relative default risk, defined as the institution’s standalone default risk (ie, ignoring systemic explicit or implicit systematic support of the bank). The default risk is measured using the rate implied by Moody’s Baseline Credit Assessment. The chart indeed indicates the higher the MPAIR score, the higher the bank’s relative default risk. Although there are no doubt other contributing factors, the implications of this insight are powerful – institutions that invest in training and education also tend to have business characteristics that result in a less risky financial profile.
Improving commercial lending skills
Market participants at all levels should take note. Regulators and policymakers need to consider the implications for their respective jurisdictions. Heads of financial institutions, as well as business line managers and L&D professionals, may consider the insights from this article as a call to action. It can justify their drive to raise the standards of proficiency for their banks and can function as a mechanism to improve the financial health and competitive position of their banks. Ultimately, this article is designed to encourage banks to reassess the level of proficiency in the commercial lending industry and pay more attention to the training of practitioners to ensure their decisions are based on rigorous and competent analysis. Banks will need to invest in their people to equip them with the knowledge and sophistication required to be successful in today’s complex and fast-moving markets. So how can banks prepare their people? First and foremost, Moody’s Analytics urges institutions to go through a diagnostic assessment; they must understand where they have gaps before they can take steps to remedy those gaps. The next step is to set an objective. Banks must determine whether their aspiration is simply to close immediate gaps or to raise their overall standard relative to the industry. Whatever their goal, financial institutions must design a plan to achieve it, one that will invariably involve a targeted programme to upgrade their staff’s skill sets. Institutions that commit to enhancing staff skills, develop a well-thought-out plan, and follow through with proper execution will reap important benefits from