Concentration Risk

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CU officials and management have a fiduciary responsibility to identify, measure, monitor, and control concentration risk.  Concentration risk must be managed in conjunction with credit, interest rate and liquidity risks; as a negative event in any category may have significant consequences on the other areas, as well as strategic and reputation risks.

Concentration risk has increased in importance during the recent economic recession.  Poor risk management of residential and commercial mortgage loan concentrations, in particular, is having an adverse effect on credit unions nationwide; resulting in significant loan losses, earnings deterioration, capital depletion, and increased credit union failures.

The board of directors should establish a policy addressing its philosophy on concentration risk, limits commensurate with net worth levels, and the rationale as to how the limits fit into the credit union’s overall strategic plan.  Take a global perspective when developing the policy, including identifying outside forces (such as economic or housing price uncertainty) which will affect the ability to manage concentration risk.

The parameters set by the board should be specific to each portfolio and should include limits on loan types, share types, third party relationship exposure, etc.  The risk limits should correlate to the overall growth objectives, financial targets, and net worth plan.  The risk limits set forth in the concentration risk policy should be closely linked to those codified in related policies, including, but not limited to, real estate loan, member business loan, loan participation, asset/liability management (ALM), investment and liquidity policies.  Any Concentration exceeding 100 percent of net worth must be monitored carefully, and the board of directors should document an adequate rationale for undertaking that level of risk. More

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3rd Party Due Diligence

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To expand their services and product offerings, credit unions are increasingly outsourcing functions and programs through collaboration with third parties.  Third party relationships are essential and can enable credit unions to become their members’ primary financial institution.  That said, not managing and controlling these relationships can result in unanticipated costs, legal disputes, and financial loss.
The regulators goal is to ensure credit unions clearly understand the risk they are assuming and balance and control these risks considering the credit union’s safety and members’ best interests.

The vendor due diligence objectives for credit unions are to:

  • Ensure that outsourced relationships are initiated based on a sound business case and comprehensive due diligence in the selection process.
  • Ensure that outsourced relationships are effectively managed by providing for consistent, risk focused controls and processes.
  • Ensure that the credit union is in compliance with regulatory guidance and requirements pertaining to outsourced relationships.

Credit Unions can achieve these objectives by maintaining an active vendor management oversight function.  Specific practices should be supported by guidelines and checklists that ensure that vendor performance is monitored, contractual requirements are in place and regulatory requirements are met.

Herein is an overview of the key areas when developing a vendor due diligence program in your credit union:

  • Identifying key vendors and their risk levels;
  • Gathering information for due diligence reviews;
  • Conducting initial and ongoing reviews;
  • Tracking and documenting; and
  • An in-house  compared to an outsourced programs.

This blog entry you have just read was written by Edward Lis who is a former senior executive of three different credit unions. If you enjoyed this article I encourage you to learn more about Edward by visiting www.edwardlis.com or by calling 518-420-2108.

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