Risk Management for Credit Unions
Risk is an inevitable part of investing, and credit unions are no more immune to it than any other financial organization. However, those credit unions that successfully mitigate and manage these risks are ultimately successful in reaching their goals and safeguarding their members’ interests.
At its core, risk management for credit unions involves analyzing the various types of risks associated with credit unions. To do this, organizations employ a combination of predictions and forecasts.
Once they have sufficient data, they must assess the possible losses and harm that specific types of risks could bring. Finally, they must formulate plans to eliminate those risks and safeguard their long term objectives.
A sound risk management plan is the key for credit unions to safeguard the livelihoods of its people, prevent losses, and property damage.
Important Components of a Risk Management Plan
Every good risk management plan has a few essential components. They are as follows:
The first step in formulating a risk management plan, a list of all the possible risks a credit union might face is known as the risk universe. There are different types of risks an organization might consider, including IT, operational, regulatory, legal, political, strategic, and credit.
The next step is to classify these risks into core and non-core. Core risks are those that are imperative for the company's growth, while non-core are those which can be eliminated.
Measuring and assessing risks
This step involves quantifying the exposure of the credit union to the different types of risks and identifying the magnitude of loss it can cause.
Certain types of risks are easy to quantify, while others require a mix of art and science. For instance, it might be easy to measure market risks using historical market data but analyzing organizational risk might be more of a judgment call.
Once possible risks are identified and measured, the next step is to minimize the possible impact of these risks. As discussed earlier, it may not be possible to avoid core risk, but non-core risks can always be minimized or eliminated. A few ways to mitigate risks include buying insurance, selling off liabilities, hedging, and diversification.
Reporting and monitoring of risks
To ensure risk levels remain at a controllable level, credit unions must engage in regular reporting on aggregate and specific risk measures regularly. Risk reports should be sent to risk personnel, so they can adjust risk exposures as and when needed.
Risk governance ensures all employees are performing their duties according to the risk management plan. In essence, it involves determining roles of different employees, assigning specific duties for each role, and also providing authority to board members and individuals to perform activities such as approval of core risk, setting risk limitations, and exceptions to risk.
Types of Risks for Credit Unions
Let’s take a look at the seven main types of risks a credit union might expose itself to:
Credit risk - Each loan made by credit unions brings its fair share of risk. If a member defaults on their loan agreement, a credit union has to bear the brunt. The best way to minimize credit risk is to conduct due diligence activities such as investigating the employment status of the borrower, having a legal contract to surrender salary or other benefits if they fail to pay the loan, and using shares as collateral against the loan.
Interest rate risk - Interest rates that fluctuate and damage a credit union’s earnings and capital, create interest rate risk. When interest rates increase, credit unions might be under pressure to increase dividend rates on shares as well. Its essential in this scenario to manage interest rates in a way that it doesn't negatively impact its balance sheet.
Liquidity risk - Liquidity is the ability of credit unions to meet cash flow requirements without affecting it's day-to-day functioning. It's important to maintain liquidity at an optimum level to ensure funds are being allocated purposefully and there is enough cash to meet unexpected demands without incurring losses. Inability to meet member withdrawals and make loans is considered inadequate liquidity, whereas if the union is missing critical opportunities to invest excess funds, it's considered as excess liquidity. While evaluating it's balance sheet, credit unions must ensure they have enough assets that can easily be transformed into cash. This is a good way to mitigate liquidity risk.
Transaction risk - This type of risk arises with fraudulent and error-filled financial transactions. Also known as fraud risk or operational risk, this risk essentially measures the integrity with which employees do their job, as well the processes an organization might have in place to avoid errors. As is evident, transaction risk is avoidable given the right procedures and processes.
Strategic risk - This risk arises from poor business decisions, inappropriate execution, as well as an inability to adapt to the latest developments in an industry. It's important to regularly review an organization's strategy to ensure it keeps pace with ongoing changes.
Reputation risk - Negative publicity can severely damage how the public perceives a credit union. This is known as reputation risk, and can put it's future in jeopardy. One of the best ways to avoid this is to build a strong public perception. With various public platforms such as blogs and social media available to voice one’s opinion, credit unions should take advantage and put forth a favourable narrative.
Compliance risk - This type of risk refers to a failure to follow regulatory and legal requirements imposed by it's governing state. It goes without saying credit unions must regularly study rules, laws, and regulations imposed by their state government to avoid administrative action. They must ensure their internal policies, standards, and procedures comply with state and federal requirements at all times.
With every reward, there’s a risk. The key for successful credit unions is to effectively analyse and manage risks, so as to prevent long term damage. A strong foundation of reliable processes and policies can go a long way in managing and mitigating potential risks for credit unions.
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