March 23, 2014
This statement is describing how credit spreads used to be set and how they are set now. Bankers used to use cost analysis. This is a process of calculating and comparing the benefits and down sides of loans or investments. It helps determine if something is a safe and sound investment or decision. Another way they were set were customer relationships. Bankers would get to know their clients before making business with them. I think this can be especially said for small town banks where everybody knows everybody. Bankers want to make sure that a person is responsible and trustworthy enough to do business with. However, most people are good people that will do whatever it takes to repay a loan, but sometimes they just can't. Things happen to people that make things difficult to repay their loans. The other way credit spreads were set was “country windage.” I'm not one hundred percent sure what that means, but I would guess that its kind of like a shot in the dark. Sometimes bankers just have to make an educated guess on a decision. You can't be completely sure or confident with every decision that happens in a bank. But, with enough experience things become easier and you are able to make the right decision. Now the credit spreads are set by the market. Bankers see how the market is doing and that is how they make decisions. Markets decide how a lot of things work when it comes to banking.
This statement is talking about risk management and when it is good to take risk and when it may not be so good to take risk. Obviously in banking there are going to be times where you have to take a risk. You just have to make sure that the risk will be effective and efficient. You also have to make sure that if the risk does for some reason fail, that you have the capacity to be able to recover from it. When taking risk, you need to be more conservative. The whole reason banks take risk is to get some sort of return out of it. So you need to make sure that if you take the risk that it will be worth it if it is successful. That is called the cost of risk management. Once again, you need to make sure that you can afford the cost of risk. Can your business still stay afloat if the risk fails? How will you recover from the unsuccessful risk? These things…