Should Banks Invest in Risk Management System?

The International Monetary Fund (IMF) has observed that although Kenyan banks are sufficiently capitalized and posing good returns, the asset quality is an issue that need extra scrutiny. Some of the best key indicators that made the IMF send the cautionary message include the rising levels of the nonperforming loans and failure to maintain sufficient loan loss reserves. As the old adages goes, prevention is better than cure. Therefore, it is always judicious to take note and act when such red flags become apparent.

Most banking crisis’ in many countries emanate from consistent accumulation of non performing loans. This is the reason the regulatory authorities are usually very stringent on the type and nature of loans granted by banks and the level of loan reserves maintained. The loan provisions generally act as cushion to customer’s deposits and shareholder’s fund in case of default like bad loans.

Lending institutions are required to set aside an allowance from the profits to cater for such possibility. Central banks in various countries provide guidelines on how much is set aside for various loan classification based on the guidelines from the International Financial Reporting Standards. Under provisioning can lead to overstatement of profits while over provisioning can lead to understatement of the profits which will affect other issues among them taxation, level of dividends.

World over, there are many examples of economies that went through financial crisis emanating from among other things high levels of non performing loans.

Banks should maintain strong credit risk management systems to minimize the level of non performing loans. It is a duty these financial institutions owe not only the shareholders but to the depositors and the entire economy in general.

The alert by IMF needs to be taken seriously and appropriate measures to be taken to avert costly measures that may be required in future. Banks must continue investing in robust risk management programs, processes and technologies to ensure that they are not caught flat-feeted.