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Every lending organisation needs a good credit policy but at what point does ‘good’ policy become ‘too much’ policy?

There is of course a trade-off between risk control and operational efficiency but their relationship isn’t always as clear as you might think and it continues to evolve as the lending industry moves away from hard-coded, one-size-fits-all rules to more dynamic strategies.

So how do we know when there is too much policy? In my opinion, a credit policy is more like the army than it is like the police force – it should establish and defend the boundaries of the lending decision but problems arise when it becomes actively involved within those borders.
This manifests itself in the common complaint of policy teams spending too much time managing day-to-day policy compliance and too little time thinking about a policy’s purpose; creating a culture where people ask a lot of questions about ‘how’ something is done in a particular organization but very few about ‘why’ it is done.
This is a problem of policy process as well as policy content.

The process should not shift accountability along a sign-off chain
Credit policies tend to generate supporting processes that can easily devolve to a point where even simple change requests must pass through a complex sign-off chain. Where does the accountability reside in such a chain?
All too often, only at the top; of course it is important for the most senior approver to be accountable but it is even more important that the original decision-maker is accountable and the further up the chain a decision moves the less likely this is the case. Each new signature should not represent the new owner of the accountability but rather the new additional co-owner with the original decision-maker.
Of course there are situations where a chain of sign-offs is a genuine safe-guard but in many more cases they serve to undermine the decision-making process by removing that key relationship between action and accountability. As a result the person proposing an action is able to make lax decisions while the person agreeing to them is removed from the information and so more prone to oversights; bad proposals consume resources while moving up and down the sign-off chain or, worse, slip through the gaps and are approved.

The first step back in the right direction is to remove the policy team from the sign-off process. Since the policy already reflects their views, their sign-off is redundant. Instead the business owner should be able to sign-off to the fact that the proposed change is within the parameters set out in the policy and should be held accountable for that fact.
By doing this the business can make faster decisions while simultaneously been forced to better understand the policy. But does it mean that the policy team should just sit back and assume all of the policies are being adhered to? No. The policy team still plays two important roles in the process: they provide guidance as needed and they monitor the decisions that have already been made, only now they do so outside of the sign-off process. In most cases there is sufficient time between a decision being made and it being implemented for a re-active check to still be
The only cases that should require direct pre-emptive input from the policy team are those that the product team feels breach the current policy; which brings us to the second solution.

The content should not assume accountability, the person should
A credit policy that is rich in detail is also a credit policy that is likely to generate many and insignificant breaches and thus a constant stream of work for the policy team. Over time it is easy for any policy to evolve in this way as new rules and sub-rules get added to accommodate perceived new risks or to adjust to changing circumstances; indeed it is often in the policy team’s interest to allow it to do so. However, extra detail almost always leads to higher, not lower, risk.
Firstly, a complex policy is less likely to be understood and therefore more likely to lead to accountability shifting to the policy team through the sign-off chain as discussed above. By increasing the volume of ‘policy exception’ cases you also reduce the time and resources available for focusing on each request and so important projects may receive less diligence than they deserve.
But an overly complex policy can also shift accountability in another way: whenever you describe ten specific situations where a certain action is not allowed you can often be implied to be simultaneously implying that it is allowed in any other situation and thus freeing the actor from making a personal decision regarding its suitability to the given situation; the rule becomes more accountable than the person.
The first point is easily understood so I’ll focus on the second. By filling your policy with detailed rules you imply that anything that doesn’t expressly breach the policy is allowable and so expose the organization to risks that haven’t yet been considered.
The most apt example I can think to explain this point better relates not to credit policy but to something much simpler – travel expenses.

I used to work in a team that travelled frequently to international offices, typically spending three to four days abroad at any one time. When I joined we were a small team with a large amount of autonomy and my boss dictated the policy for travel-related expenses and his policy was: when you’re travelling for work, eat and drink as you would at home if you were paying for it.
He told us not to feel that we should sacrifice just because the country we were in happened to be an expensive one – it was the organisation’s decision to send us there after all – but similarly not to become extravagant just because the company was picking-up the tab.
It was a very broad policy with little in the way of detail and so it made us each accountable; it worked brilliantly and I never heard of a colleague that abused it or felt abused by it.
That policy was inherently fair in all situations because it was flexible. However, in time our parent company bought another local company and our team was brought under their ‘more developed’ corporate structures, including their travel claim policies. These policies, like at so many companies, tried to be fair by unwaveringly applying a single maximum value to all meal claims. In some locations this meant you could eat like a king while in others austerity was forced upon you.
In don’t have data to back this up but I am sure that it created a lose-lose situation: morale definitely dropped and I’m certain the cost of travel claims increased as everyone spent up to the daily cap maximum each day, either because they had to or simply because now they could without feeling any responsibility not to.
Of course this example doesn’t necessarily apply 100% to a credit policy but much of the underlying truth remains: broader policy rules makes people accountable and so they needn’t increase risk in any many cases they actually decrease it.

A credit policy that says ‘we don’t lend to customer segments where the expected returns fail to compensate for their risk’ makes the decision-maker accountable than a policy that says ‘we don’t lend to students, the self-employed or the unemployed’.
Under the former policy, if a decision-maker isn’t confident enough in their reasons for lending into a new segment they can’t go ahead with that decision. On the other hand though, if they have solid analysis and a risk controlling roll-out process in place, they can go ahead and, unhindered by needless policy, can make a name for themselves and money for the business.
The latter policy though makes the decision-maker accountable only for the fact that the new customer segment was not one of those expressively prohibited not to the fact that the decision is likely to be a profitable one.

Of course encouraging broader rules and more accountability pre-supposes that the staff in key positions are competent but if they are not, it’s not a new credit policy that you need…


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