Prudent Banking

In general, being “prudent” or “act with prudence” means careful and wise handling, exercising good judgement and common sense, i.e. a way of acting based on sound judgement and carefulness and by that become trustworthy. An essential factor for successful banking operations is the perception of having thrustable behaviour and culture.

The notion Prudent Banking has been well-known and well-used in the banking industry for more than 100 years and also in current regulatory framework it is commonly pronounced, e.g. when the EU regulators in the CRD talks about ensuring sound and prudent management of a credit institution. The authorities (EU, EBA, Swedish FSA etc.) articulate that institutions shall have robust governance arrangements, which include a clear organisational structure with well-defined, transparent and consistent lines of responsibility, effective processes to identify, manage, monitor and report the risks they are or might be exposed to, adequate internal control mechanisms, including sound administration and accounting procedures, and remuneration policies and practices that are consistent with and promote sound and effective risk management. None of them has however explicitly defined the notion as such.

Even if Prudent Banking does not have any exact common definition, it is very much about having solid, clear and trustable governance and internal control, sound risk management and maintenance of the risk appetite established by the institution. EBA state in their Guidelines on internal governance that the objective of the guidelines is to ensure effective and prudent management. Prudent Banking should rather be seen as an umbrella term describing the overall approach on the operations.

The prudence perspective is not isolated or limited to the credit area, rather to all kind of operations being performed by a bank. Whereas trust is crucial for a bank, any stakeholder need to feel confident that the bank is operated in a sound, robust and trustable way. This means that a bank also needs to act in the best interest of the customer. This is described as acting in the best interest of the customer (sw. omsorgsplikten) in general and as responsible lending in the credit area.

To summarise, Prudent Banking means sound and reasonable risk management practises in line with your values and risk profile but also to be responsible towards the customers and from a society perspective.

However, it is very important to understand that being prudent does not mean that every regulatory framework should be read literary. Instead, the interpretation and application of the regulatory expectations needs to be adapted to your governance structure and other individual prerequisites, e.g. the operational model that you have chosen, and last but not least by using common sense. A bank should of course try to be adaptive towards the regulatory expectations but reading and applying regulatory text literally without putting it into the relevant context and reflect run the risk of creating illogical and unnecessary complex processes.