Question

A financial institution has a 6-year history of not having seen any of its loans go into default, and a 10 year history of not having lost any money on a loan. They have $25 billion in assets under management. The Chief Executive Officer decides that the institution should dissolve the Loan Restructuring group, which would reduce headcount and save $3.0 million in salary, overhead and other costs. As the Chief Risk Officer, how might you react? (You already objected to the closing of the group but your concern was not accepted by the CEO. Don't answer by saying "They should keep it open". Give a technical answer).

Answer 1

The loan restructuring group normally negotiates with the borrower the terms and conditions of loans like repayment of principal, reduction of interest rates and others things so that the financial institutions does not lose all of the capital. It is able to recover major percentage of its loan. Now just because the financial institution has not seen any default on its loan in the last 6 years or it has not lost any money in the last 10 years this does not mean that in future even there would be no default. It might that the economy is doing well so the companies are generating positive cash flows and are able to repay the loan but what if the circumstances change, in that case there would be some default or delay in payment no matter how strong the business fundamentals are. Dissolving the loan restructuring group would also not be a good ides because in case default happened then you would have to set up a new team from scratch to handle the situation and it would take time and would be costly. This is similar to taking a health insurance, as long as you are doing well you feel like your premium is going waste but the moment you fell ill you would realize that insurance was the best decision. If the concern of the CEO is to reduce the cost then there can be reduction in headcount but dissolving the entire group is not the right approach.