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A return to form: in the wake of the global financial crisis: tradition is the new innovation and credit risk management is ready for its close-up.


If all the financial world is a stage, then it could be argued that credit controls the curtains. As a profession, credit and risk management has operated in the wings, charged with protecting a company's assets and judging who sees what of their goods and services, along with how much and under what terms. This simple fact has put the credit professional in a position to be maligned or even parodied by other staff (hence, salespeople who refer to the company's credit department as "sales prevention"), but the harsh reality of the global financial crisis has shifted the position of risk management to one of prominence in many companies, lending a deserved bit of gravitas to the warnings of credit managers and pushing them ever closer to the CFO at board meetings. "A couple years ago you'd have the CFO on one end and the financial team on the other side and then further down, a credit manager," said Jeff Jankowiak, partner at International Risk Consultants, Inc. "I cannot tell you the amount of credit executives sitting next to the CFO now."

This shift in position has also been accompanied by a shift in the nature of risk itself, both in the amount and intensity and in the philosophies adopted for managing it. Theories and schools of thought have always varied from person to person when it comes to hedging a company's risk, but in many instances, the most innovative companies are the ones that can stick tightly to the fundamentals while still managing to make things work.

Risk at Large

Competing theories abound regarding whether or not the world's current recession marks a monumental change in the way the global economy destroys and corrects itself or just the occurrence of a notably different, but still predictable, recession. On the side of the former ideology is John Caslione, founder, president and CEO of GCS Business Capital LLC and co-author of Chaotics: The Business of Managing and Marketing in the Age of Turbulence, released last month. "We have had somewhere between seven and eight recessions since the second World War and this one's different for a number of reasons," said Caslione, citing global economic interconnectivity as just one reason this recession is different from any other. "In every single recession since the war, it was the U.S. economy that pulled, and in that updraft, everybody else came with us," he said. "No more. Now national economies are intimately linked, interconnected and interdependent. During good times we're all riding high, but when the bad times hit and we have this interlocking fragility, we are all weighted down." Additionally, the concentration of wealth around the globe, as well as the inclusion of repressive governments in the world's list of elite economies, also denotes a marked change in the current downturn, one that is expected to continue and could present serious problems for companies looking to do profitable business overseas. "The greatest concentration of wealth these days tends to be with countries that are autocratic" he said. "I think that'll add to some of our turbulence."

Caslione argues that these differences have collided to create a uniquely modern recession that is fundamentally different from previous downturns, the ramifications of which could be felt for years to come. In what Caslione called the "new normality," future risks and recessions will become harder to predict and rather than periods of boom and bust, these two things will be intermittent, the effects of management mistakes will be magnified and more fluid risk mitigation strategies will become necessary.

One risk listed by Caslione is that, in this new economic era, risk will shift to places that have traditionally been considered risk free or at least somewhat reliable. "The incumbents are in the most vulnerable positions because we've built business models around the status quo," said Caslione, who offered a list of mistakes companies make in turbulent times. Among the specific behaviors that companies should avoid during downturns, said Caslione, are changing performance metrics to focus on cost-cutting, cutting back on technology and cutting back on top talent. "Companies cut top talent because they cost the most," he said. "But this is the time we should be accelerating our innovation." Caslione also noted that companies tend to adopt other overly conservative, bottom-line driven policies during downturns and that the goal of reducing risk degrades into eliminating risk entirely, which, as many have noted, is an exercise in futility. "You can't reduce all risk," said Caslione. "It's not possible."

When Caslione refers to business models built around the "status quo," he's specifically describing the ways in which companies only have two stated plans: one for good times and another for bad. His argument, however, suggests that in the future, companies, management and credit will need to have more than just two plans as trends collide and things happen more quickly and less predictably. "With the risk, we're going to have to engage in more and more hedging strategies, and embrace and execute early warning systems and scenario planning," said Caslione. Rather than having two distinct sets of policies and practices that dictate company and credit decisions during booms and busts, Caslione recommended that businesses consider several different plans according to different scenarios that may or may not happen. In this way, should something go sour suddenly, whether it's with the economy in general, within an industry or simply on a risky account, there's a clear course of action of which a company can immediately avail itself, saving precious time and positioning it better to ride out the crisis.

Steps such as these, however, can only cover so much, Caslione added. "We're not going to be able to predict everything," he said. "None of us has a crystal ball. All we can do is engage in our best thinking with the best information we have."

Business as Usual

Despite the somewhat dramatic implications of Caslione's argument about a new era in global economics, one of the root causes he listed for the world's current financial crisis was one heard by pundits, politicians and pulpit preachers across the world. "One of the problems we've had is that we've pursued short-term profitability too fast and for too long," he said. "We are negligent to make the short-term investments now to build a strong company for the long-term." Political and economic short-sightedness is frequently named as a culprit in many of history's financial crises, and a generic criticism of capitalism as a whole, but if the causes for previous recessions are the same as this current recession, wouldn't it make sense that the implications of this recession are the same as others? Caslione's observations are worthwhile and there is a wealth of good to be gleaned from them, but how different can things really be now, after what many consider another chapter in a long line of global recessions?

"I don't know that any of this is all that unusual," said Chris Kuehl, Ph.D., NACM economist and managing director at Armada Corporate Intelligence. "We've reached the point where we don't trust anybody younger than us because they haven't been through all the slings and arrows that we've seen, but the recession that we're dealing with now is not markedly different than the ones we saw in the '70s and '80s."

"I think the business cycle is alive and well," he added.

Kuehl's opinions, although not quite as provocative as others, are shared by many of his colleagues who believe that, despite globalization, the ascendancy of autocratic governments and downfall of traditionally safe economies, this is business as usual and just as predictable as other economic shifts. Still, Caslione's themes of chaos and turbulence and commentary from members of the banking and risk management industries tend to echo one another in different, enlightening ways. While the market may be in the process of correcting itself, like it has before, many observers note that preventing a similar crisis will require some fundamental and innovative changes in the way risk is measured and mitigated.

Fire Control

"Banking is a boring business," observed Darin Narayana, chairman and co-founder of ANSRSource, an offshoring advisory firm. "When banking gets interesting, watch out. Trouble is ahead." Narayana, along with Byron Shoulton, vice president, international economist at FCIA Management, and John Walsh, vice president at International Banking Group-U.S. Bank, in a roundtable moderated by Kuehl at FCIB's most recent International Credit Executives (I.C.E.) Conference, offered his observations about when to suspect trouble in the world of risk and capital management and about what needs to change to preclude these problems from continually dogging the global economy every eight to 10 years. "One of the fundamental weaknesses in our American management system is that nobody asks questions," he said. "What we need is a bunch of dumb questions, because that will lead to some powerful thinking." Referring to credit rating agencies that have received partial blame for the financial crisis due to their use of securities scoring models that allegedly were based on the assumption that housing prices would continue to go up forever, Narayana noted that a simple inquisitive pause might've saved everyone a great deal of grief. "When somebody says to you, 'housing prices will go up at 6% for the next 30 years; did someone ask 'really?'" he wondered.

Shoulton, a familiar face at FCIB events, responded to Narayana with his own observations on the role questions played in the precipitous decline of available credit globally. "I work for a U.S. company that takes on a lot of risk and we do ask a lot of questions," he retorted, adding, however, that "we did not ask the right questions." In previous presentations, Shoulton has referred to credit rating agencies and scoring models in a fashion similar to Narayana, and he noted that while technology has come a long way toward making things more efficient and easier for companies, relying on something that lacks human input can often prove dangerous. "I don't care how sophisticated your model is," he said. "If you don't have human input on an ongoing basis, it has no practical value in the risk you're taking."

In terms of risk management, Narayana's assessment of the industry was broad and refreshingly blunt. "Our risk management rules in America are nonsensically ridiculous," he said. "We just don't know how to assess risk. We need to rethink how we should measure risk and companies have to rethink their cost model. Some great companies are already doing that." Other members of the panel discussion were a bit more solemn in their opinions of what needs to change in risk management and banking to prevent future crises. "Within the U.S. the whole idea of how lending is done has proven to be more risky than less risky," said Walsh, who noted that faulty lending eventually spread around the globe, turning U.S. problems into global ones. "There's still a lack of transparency on some banks' balance sheets and there's extreme risk aversion in the marketplace. For banks, this is forcing down credit quality and it's a difficult question." Walsh's insight as a banker suggested that in the current environment, credit is still elusive and risks are still present, but they're even greater for banks not receiving help from governmental stimulus efforts. "We are seeing a change in the environment," he said. "It's the middle market suffering the most, especially when there's an increased cost to capital. We're not pushing the medium market banks to grow; we're focusing on the large banks."

The U.S. government's efforts to stabilize the economy and increase bank lending were a hot topic at I.C.E., with panelists reflecting on what risks there actually are in a world where financial institutions are "too big to fail." "If you allow things to be propped up and not fail, there is no risk," said Kuehl. "No bank should be too big to fail," said Shoulton. "Other banks that have performed well should be allowed to flourish." Others suggested that such massive spending measures could pose an inflationary risk by flooding the system with money and potentially making export sales harder to come by. "I think high inflation is one of the very big risks going forward," said Shoulton, whose views were echoed by Narayana. "There's going to be flooding in the house because of all the water we're using for fire control," he added.

Back to Basics

Identifying the inherent risks in the global economy, whether they're the ones that got us here or the ones we'll face moving forward, is only one step in the management process. Now that they've been named and considered, the real task comes in mitigating them. There are several ways to shore up risk and profitably extend credit, both as a vendor and as a lender, but throughout Kuehl, Shoulton, Narayana and Walsh's discussion, the oft-repeated suggestion was a return to credit basics.

"Two of the growth industries in America are going to be risk management and regulation," said Narayana. "It's character that matters. We have to go back to basic assumptions." Shoulton agreed. "There's no question that we as a sector have kind of gone away from the basics here and that, clearly, we have to go back," he said. In a separate forum, led by Jeff Jankowiak, FCIB Chairman Dave Weidinger, CMA, senior director of credit & accounts receivable at the McGraw-Hill Companies and Gene Perry, director of credit & collections at Exterran, Inc., the panelists offered other no-nonsense suggestions for effectively managing credit internationally for today's risk-centric environment. "We've got to go back to Credit 101, go right back to the basics," said Jankowiak. "Don't be afraid to ask for information from your customer," he suggested. "You have the best support in the world and that's the newspaper. The word credit is on the front page five times." Now that the term "credit crisis" has entered the public lexicon and credit conditions have become part of several newscasts, the professionals charged with managing credit can understandably use this fact to their advantage. "It's key in everyone's mind," said Jankowiak. "I was shocked that we were going through one big situation and everyone said that they would never release this information ... until we asked."

"Everyone's hunkering down, but also looking where else they can get sales," said Weidinger. Indeed, a rise in risk can often be accompanied by a drop in sales, but companies can often look within their own portfolios for answers. "We're looking at alternative methods to lower our risks and the other thing we're trying to do is analyze the portfolio and look at the customers that we're not selling enough to," he added. By finding certain customers who could use more product to enhance their own business, a vendor can shore up its own sales losses while helping its best customers. "If their capacity is a certain dollar amount only, but you know the market can hold more of your product, see if you can say to that customer 'I want to get more product to your customers downstream and work with you on this,'" said Weidinger. Commitment to one's customers can also have a long-term positive effect on a company's business, as Perry noted. "We're hoping that by working with our long-term customers that, when the crisis is over, they should remember us," he said, adding that his company has also gotten back to basic, thorough credit evaluations. "We're looking very deeply at the footnotes and the contingent liabilities and we're trying to look at as many financial statements as possible," said Perry. "We've also developed a watch list of the top 25-50 riskiest customers in order to heighten the awareness of risk," he added.

Many of these suggestions are fairly by-the-book in terms of international credit, and it speaks to the severity of the crisis and the reach of globalization that this is now happening domestically as well. "In domestic credit," said Walter Rebello, international credit manager and Latin American finance manager for Ravago Holding Americas, Inc., "no one was looking at financials a couple years ago. Now everyone is doing that. I think we're back to what international's been doing. It's different world now." But no matter how much the practices or profile of risk management change, it's important to remember, now and then, that the basics are basics for a reason.

Jacob Barron, NACM staff writer, can be reached at
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Title Annotation:International feature
Author:Barron, Jacob
Publication:Business Credit
Date:Jun 1, 2009
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