Managing the Credit Risk Attitude in Australian Retail Banks across the Business Cycle

Abstract

The management of credit risk attitude in Australian retail banks is examined in this thesis. An underlying query is why retail banks repeatedly have been “economically irrational” in managing credit risk across numerous credit cycles. The period of study is 1996-1999 - characterised by a benign economy, intense competition and technological/analytical innovations. Initially, the theory of credit rationing, which is an economic construct, is examined. Subsequent analysis of the data uses models from the theories of decision making under uncertainty (particularly prospect theory), organisational culture/climate and the Balanced Scorecard. Based on the grounded theory approach, the largely exploratory research incorporates data, theory and methodological triangulation. The research design includes individual interviews, focus groups and one questionnaire, with participants including Senior Credit Managers and Lending Officers. Several models are developed. The multi-level model of “credit culture” is created to incorporate: Organisation culture, which resides at the subconscious, enduring “assumptions” level; Credit principles/culture, which resides at the relatively enduring “values” level and is the credit functions’ interpretation of organisation culture; Credit risk attitude, which is the Senior Credit Managers’ weighting of the credit risk versus income reward tradeoff at a point in time; and Credit infrastructure/climate, which resides at the behavioural level and operationalises the credit risk attitude through the controls and disciplines by which credit risk is managed throughout the organisation. The overall model of credit risk attitude across the business cycle incorporates the phases of shock/remorse, resolve, cautious optimism and disaster myopia. The drivers of credit risk attitude model highlights the tradeoff between revenue growth and the visibility of credit losses (particularly the availability, threshold and representativeness heuristics). The Credit Confidence Survey measures the credit standards currently being applied. The Balanced Credit Scorecard provides a performance measurement framework with the dimensions of credit principles, policy, risk management methods, business processes/systems, staffing and controls. Additional heuristics/ motivators affecting individual and group decisions also are outlined. A primary conclusion of the research is that retail credit managers benefit from using advanced risk management techniques to maximise the risk-adjusted return on assets, whilst maintaining non-volatile losses within the FI’s risk appetite.