B (3:09)

Absolutely. Yes. That's a. That's totally agree with that one. All right, well, let's move into our first segment of Q and A. Here we're gonna start today. We have two very unique perspectives with Financial Expert and GRC Expert online. So really excited to dive into this content and hear about what's going on with the current economy and how this is impacting GRC risk management professionals in their everyday so, Lauren, we hear a lot about macroeconomic forecasts, but tell us, how do those big picture signals, why are they so important to banks?

C (3:53)

Well, I personally as an economist, I think the macro economy is important to everyone. So if you know where things stand today and if you know what signals to be watching for into the future, you can kind of have that edge of knowing where, where are my risks? Where do I not want to be, say, over levered or over focused? If that segment of the economy is starting to show warning signs, we can look for leading economic indicators that I think of them like the canary in the coal mine. They give you that signal ahead of time that something's either wrong or very right. Maybe we're in a good economic time and we can be looking forward to more growth and you'll want different positioning for any phase of the business cycle.

B (4:33)

Interesting. And Tony, I'm interested to hear from you why on the risk side, it's becoming more important for organizations to connect that economic insight with their risk management processes.

A (4:48)

Yeah, I mean, like some of those macroeconomic indicators like inflation and interest rates, you know, those are very important to financial institutions. And, and the how in that question, how can risk teams connect with those pieces of data to their internal operations and portfolio performance? You know, the, the how is somewhat elusive sometimes for organizations because they have these gobs of data and these external systems, they have their internal risk and control matrix. How do you connect those two things together in a way that makes sense and is meaningful and is actually feasible to do so? You know that the how in that is simply just can using technology systems today to ingest those different data points that you want to evaluate and systematize, connect them to core data systems like your risk and control framework, and then be able to run an analysis on that data to determine how those things are trending up or down over time, correlate them with your internal metrics, and then surely at the end of the day, just really looking to find what those early warning signs are. And the, and the real challenge in all of this though, isn't just necessarily access to that economic information. There's gob's data out there. You want to make sure you get the right economic information. That's key, number one. But it's also Connecting those signals to that internal data as quickly enough to be able to make decisions. It can't be scratched. So lagging far behind that it's not even relevant anymore for a particular organization.

B (6:30)

Right. I want to dive into that a little bit further here. I want to you bring up inflation. So let's talk about that. I'd love to hear from you, Lauren, and then kind of circle back to the connection that you bring up, Tony. So, Lauren, inflation and interest rates are affecting almost every part of the economy today. So will you talk to us about inflation and what is inflation for those that might not know? And can you share what are some current day drivers that you're seeing of inflation?

C (7:03)

Sure. So inflation just means that over time things get more expensive. I know we all felt this so acutely, really in that 2021, 22 time frame in the wake of COVID when we had supply chain issues and shortages and just so many dislocations across the economy. Prices shot higher very quickly. I know for, for years we went to the grocery store and you see basically the same price on the shelf year in, year out, very, very small changes. And then all of the sudden prices are just shooting higher. It's almost something I think we enjoy complaining about. On the consumer side of things. Milk was this much or eggs were that much. But at the end of the day, that's inflation. Now, the interesting part of at least consumer price inflation is prices generally go up. They don't usually come down. Deflation is a very rare occurrence. But as we see how rapidly prices rise, we want that to be manageable. If prices rise too quickly. Right. Affordability just gets out of hand. Our wages often can't keep pace, and that diminishes our standard of living. It diminishes our purchasing power. So it's very important to know, first of all, inflation today, it's actually relatively elevated compared to long term averages. The Federal Reserve, our central bank, they're targeting inflation over the long term to be right around 2%. We're still a little bit above that. Even though inflation has come down from that peak in 2022 and three, we're running about 2.5% inflation today. So prices, they're still going up. They're going up less quickly than a few years ago. But I think consumers are still feeling that pinch point. And I want to be absolutely clear, the drivers here are very broad and very diverse. This is not just tariffs, although I know tariffs get a lot of the blame. It's not just things like the current middle east conflict. That's driving, yes, higher gasoline prices and higher oil prices. But generally today we see relatively accommodative, both fiscal and monetary policy. There's a lot of liquidity out there flowing through the system, driving prices, higher energy costs. Even excluding oil and gas, just the cost of electricity has gone up very significantly. With all of these data centers that we're building so sopping up so much electricity, wage pressures are still to the upside that's circling through the economy. So our view here at ITR Economics is for the next, I'll say three years for consumer price inflation to range really between 2 and 4%, which is not hyperinflation. Let me be clear. We're not going back to the 70s and 80s, but this is going to be more of a persistent problem. It's going to take up more consumer attention because you do have to be watching that budget when prices are changing very quickly. And for our central bank, the Federal Reserve, this is going to limit. They've been in a rate cutting stance, but if inflation is getting out of hand or staying above that 2% rate that they're targeting, they can't do too many more rate cuts. So at the end of the day, this also affects interest rates, which flow down to everything that we do to borrow, whether that's our government borrowing money to fund the deficit and the national debt, all the way down to my mortgage, my car loan, maybe credit card debt. This really will affect all sectors of the economy going forward.

B (10:26)

Lauren, thank you for sharing that insight. That's really helpful as we look into this next question for Tony and kind of circling back to what he brought up about inflation before we dived in, before you dove into that question. So Tony, how can risk teams connect external economic indicators like inflation that Lauren just talked about, or rate changes with their internal portfolio performance?

A (10:55)

Yeah, I think, I think we need to start that conversation with just talking about a mature GRC program. And if our audience members are thinking to themselves, wow, this is like really on one end of where I want to be. And this is like in the square where they're at today. Or this is something that they've done previously and are like, yeah, we've been there, done that. Most organizations fall on a continuum of risk management maturity all the way from being just reacting and ad hoc to growing, to being more standardized and repeatable, to then mean being more defined and collaborating. Then you're going to get into orchestrating different things where you're measuring success, identifying patterns and using data and analytics to predict financial outcomes and then further to then get to optimize where you're using those measurements to achieve continuous improvement, you're using patterns to predict results. That's where we're going. And so much of our conversation today is going to be around the farther end of that maturity spectrum of how can you go from just using a database of information and doing basic reports off of it and really moving into that orchestrated and improving side of that maturity spectrum. So to do that, we would take these, these external indicators that Lauren talked about, you know, Fed fund expectations, unemployment trends, inflation, and we want to tie Those internally to KPIs, your risk appetite thresholds you may have as an organization, even something as granular as your credit portfolio performance. And so an example of what that could look like in an organization could be like if some, if you had some economic indicators that are showing inflation pressure risings, a bank and credit union could correlate that then to historical increases in credit losses or delinquency rates. And then when those indicators move, the bank can then see potential risk trends before they hit their overall operations in their balance sheet. So that is, that is a very orchestrated and measured maturity that we want folks that are listening and those that are our clients to get to, because that is really where you can operationalize your GRC program and use technology and a means that really helps bring a solid ROI to your organization.

B (13:30)

Totally. That's really powerful. I think you talk about being able to identify those patterns and act upon it. I think that is just so important for organizations and risk teams that they really can action on these trends. Let's move in a little bit to same topic, but dive in a little bit deeper here. So Lauren, if inflation is one of the big macro forces we're watching, my next question for you is how are consumers responding to it? And maybe start by kind of grounding us a little bit in why the consumer matters to the broader economy. What signals do banks watch to understand whether consumers are still strong or starting to experience the stress that you talk about?

C (14:19)

Absolutely. The consumer really matters more than anything else to our economy. If we look at say, gdp, gross domestic product, that's the broadest measure that we can use to evaluate is our economy growing or contracting? And consumer spending represents about 2/3 of GDP. So we have seen periods in the past where our industrial economy has actually contracted. Our manufacturing economy has, has lost ground. But if our consumer can keep spending throughout that cycle, like the 201516 commodity price cycle is a really good example of softness in the industrial space. A Lot of companies felt that, but the consumer was doing relatively well and they kept spending. They essentially spent our way out of a recession. So we really want to understand the balance, not just of how consumer spending is trending, but really what factors could be limiting that or supporting it. Right now, inflation is a limiting factor. Inflation takes a bite out of your paycheck every time you get a wage increase or a salary raise. And so what we really want to balance it isn't just my nominal salary. It's what we call my real salary. Real means inflation adjusted right now. Real personal income, it's still on the rise, but we're starting to see that growth rate level off. So that's something I'm watching very closely. If our consumer is losing ground on a real basis, on an inflation adjusted basis, that tells us that maybe they aren't in quite the position to spend. And as far as their overall spending goes, I think there are really three legs to, to that stool. Wages are one. Today we still have a relatively low unemployment rate, relatively tight labor market, so that is still supporting wage growth. So we have more of that income coming in to go out and spend. But if we're not earning more, we can do a couple of other things, one of which is turn to our savings that we've socked away to go fund those purchases again. That's trending a little bit flatter today. So we're looking more and more at the third leg of that stool, which is borrowing. Do I take out a loan? Do I put this purchase on a cred card instead? One of the ways we can evaluate this is essentially the consumer's ability to service that debt. So we want to look at things like delinquency rates even within credit card payments. We can look at how many accounts are making only the minimum payment on their credit card versus some partial or full payment. That number is now above 10%. So we're not seeing again the bottom falling out. These are nothing like 22,006,07 levels. We've been in much, much worse position in the past. But to start to see our consumer fall into some old bad habits, that's something we want to be watching very closely.

B (17:07)

Interesting. And I know you talk about putting, seeing consumers put things on credit cards, taking out those loans. So diving into that a little bit. Tony, how can, as consumer credit trends are starting to evolve, how can organizations monitor those changes early enough to adjust their risk management strateg strategies?

A (17:29)

Yeah, I mean, Lauren, Lauren, you know, emphasized the reality that these are really important metrics. For organizations to track consumer stress is, can affect all kinds of things like our credit card portfolios, auto lending, unsecured loans, small business credit. All those things are really important to financial institutions. They want to know what consumers are thinking and feeling and the habits that maybe bad habits that they're starting to, to take on. So to, to talk about that we, we have to really engage in a conversation about risk for and a risk register associated to an organization. So because you want to be able to tie those economic stress factors to particular risks like credit risk or operational risk or compliance risk or even third party risk, the different risk associated to third third party vendors as a part of this economic climate, you know, and the reality is, is, you know, as economic volatility is increasing, these risks that we talk about are going to be even more interconnected and organizations are going to need the technology to translate those different economic signals into these actionable risk insights. And the way that GRC has operated in the past is there's been four different approaches in general to be able to manage a particular risk scenario. You can do your top down risk assessment which are scenario focused. They're typically subjective. You're, you're proactively thinking about a what would happen if kind of scenario. You have your internal controls, you're looking at your, those are backward looking, they're more evidence based, they are reactive typically because you're looking at what has been true in the past. And you can do a bottom up risk assessment too. Those are very asset focused. Let's assess these particular areas within our organization and they tend to be objective by nature, tend to be a little high on their assessment, the amount of labor it takes to be able to execute on those. And then the topic of our conversation here today has been a lot around key risk indicators. Then when we really see those as being very forward looking and they're based upon real data and once you get those set up initially the labor intensity associated to those is pretty low. So it's just a matter of having the systems in place operationally to monitor those on an ongoing basis. And it gives you those proactive insights to be able to proactively monitor your credit performance and really get a track and understanding as an organization of those early warning indicators.

B (20:18)

Absolutely. I know you touched on the early warning indicators earlier too. I'm, I'm curious, can you dive into that a little bit deeper? And how do banks really can you have give an example of spotting those early signs of consumer stress? And for the risk management teams, can you dive into That a little bit deeper.

A (20:38)

Yeah. I mean, ignorance is not bliss in this, in this scenario, in this day and age and, and when we're so inundated with data, there's never a situation in which you should be able, like I did not know or I was not aware, because we can be aware of these type of things. And financial institutions, they're going to want to be able to see where their delinquency rates are, where they need to make modifications on their loan, where their collection activities are having them. And so the real value of modern GRC is the ability to connect again, those macroeconomic signals with internal risk data. So I'll give another example. It's like if we consider consumer stress indicators rise, right, and those early stage delinquencies increase, then a technology system could trigger a risk committee review or could trigger an analysis on a portfolio, or it could change operational procedures like tighter underwriting policies. Those are all things that using those early warning indicators can then translate into operational insights.

B (21:52)

Thanks. Yes, I think having these key risk indicators that you talk about and being able to go to your board and go to your team and say this is coming, I think that's really important. Let's dive a little bit deeper here and we talk about commercial real estate and how it's been a major topic recently. So, Lauren, I want to talk to you specifically and get your insights here on what indicators should B banks be watching in the commercial real estate sector.

C (22:24)

Absolutely, this one gets a lot of attention. And the good news is that commercial real estate, non residential real estate, it actually tends to be a lagging economic indicator. And I know that sounds like a bad thing, it's actually a good thing because that means there are other indicators in the macro economy that are moving sooner. They're giving us those quicker insights. Housing is a really good example. Residential construction, it tends to lead ahead of even things like GDP and the industrial economy, whereas non residential construction, that lags behind in both cases by about a year. So if you're following the housing market, you can very clearly see signals coming that will be affecting the non residential construction market about 24 months in the future. And that's due to really just the nature of these two sectors. Right. Things like interest rates flow through much more slowly to those big projects rather than residential construction. So we want to be watching things like, you know, the housing market is a fantastic read on the consumer. Do they feel confident enough to be out there buying housing right now? Today we're seeing some very strong constrained affordability. Mortgage rates have gone significantly higher, whereas they had been grinding lower and lower and lower for well, a decade plus. House prices are higher. And we found this very interesting dynamic in just the past couple of years that builders were still out there building, but they weren't building the right types of houses, the right square footage, maybe houses in the right location, houses at the right price point. So while there's inflated inventory in some areas, we're also seeing that some folks especially would be first time homebuyers. They just can't find that right house at that right price point and it's keeping them out of the market altogether. I really look to affordability. Again, the offset between are we earning more money? Are, you know, salaries and wages increasing enough to overcome some of that gap versus what have mortgage rates, house prices, other things like insurance, Costco get kind of rolled into that affordability bucket. Today it really varies geographically, so you can have some very concentrated risks. If you look at the middle of the country, things are a little bit more affordable. There are actually only two states where we find the average household is earning more than they should be earning to comfortably afford the average house in that state. Those two states today are West Virginia and Louisiana. The rest of the country is really underwater now. In some places it's closer to break even. Right? You can, what do they say to do? Go out to eat less, don't buy your cup of, you know, fancy coffee in the morning, eat less avocado toast. I feel like that's what they told the millennials. But on the coast, this affordability problem is so pinched that for example, today in California, the average household is earning $125,000 less than they should be earning to comfortably afford the average home in that state. And even in California, I don't think there is that much avocado toast to make up that gap. So we actually find that that's driving people out of the state altogether. They're going to better cost of living areas. And as I said earlier, consumer spending accounting for 2/3 of GDP. That's going to be a drag on gross state product if we do have outflows of population rather than inflows. Now, all of this tends to lead ahead of those big commercial projects here. I mean, things like offices, schools, hospital. We've seen a real interest in recent years in things like warehouses, factories, manufacturing facilities have gotten a lot of attention and a lot of investment has flown to flowed into that space. But the question is, right, how much building has taken place and do the fundamentals support it? Whether geographically from the population that will need those other types of buildings. But also are things like these fundamentals if, say we built a manufacturing facility, but now we're starting to see some challenges in the sector of whatever is being produced there that can have a hit on things like vacancy rates. We can see that flow through to property prices. And at the end of the day, that's, that's a real risk for a credit portfolio if you don't have the fundamentals to back up that loan.

B (26:41)

Thank you. That's a lot to, a lot to digest there and thank you for sharing that insight. And I think, Tony, I have my next question for you. I know Lauren talked about concentration risk and I want to tap into that a little bit further with you, Tony, and talk about how do financial institutions typically monitor that concentration risk in areas like commercial real estate? And can you talk about that from a GRC perspective?

A (27:10)

Yeah, and then that's a, that's a big question. And let me first comment to say, you know, just the, the overall housing, commercial real estate, this is on my LinkedIn, but I used to be a general contractor and it's very, very real to me the strain that interest rates can cause for builders as well as those that are looking to purchase homes and just the housing affordability crisis that we are in. And very real, very personal examples, I think for us and for those that are on listeners today, when we think about, you know, concentration risk, you know, we have to consider the maturity spectrum that I talked about earlier, the reality that, you know, we're all on a spectrum of our growth, both in our own personal lives as well as, you know, organizationally. So we need to think about starting from, or I should say, the content that you are working with internally as an organization is going to be really key as you get into these more specific areas of monitoring when you're tying economic signals to internal, internal data points. So just be encouraged that many organizations are still at that crawl phase where they're just, they're just standing up a couple here, a couple here, a couple there to be able to begin this operationally monitoring. But then you can get to the, to the walk phase, right? Crawl, walk, run in terms of being able to grow into this type of deep monitoring within your organization, like, like concentration risk. And you also may be wondering, like, well, what are, what are some of the, what is some of that content? What are some of those things that we could track? And so let me give you a couple examples. Like you could look at a metric like total construction and land Development loans that are outstanding. That'd be one metric that you could look at. You could also look simply as total commercial real estate over your, over your capital or 30 to 90 day past due loans to consumer policy exceptions or there's a lot of things out there that from a content perspective that, that we have that could help jumpstart you on your process of going from crawl rock run to be able to operationalize this. So when we think about sector specific monitoring, thinking about what housing in California versus housing in Louisiana, you know those external indicators of construction starts or housing affordability index, the vacancy rates, overall pricing, compared those to your internal indicators which could be things like exposure concentration or loan to value trends or overall loan performance. But you know that's where you're going to tie in those sector specific things. And, and I'll, and I'll let folks know that a strong risk management program that connects sector level economics trends is a mature spot to be and it is really helps identify a bank's very specific exposure in very specific ways. So again to translate that even further, you know, if you have vacancy rates rise, that could increase the monitoring of you know, office, your office lending portfolio, if that's specific to you. So there's so much detail in, in the nuance of this idea of operationalizing risk insights tied to your economic trends that could be done. But I just want the audience to know that it's a spectrum, right? Crawl rock run and start with, start small and work into it as you consider where you're at.

B (31:10)

Well said. Thank you. And before we move into our last segment of the episode today, I just wanted one more question for you Tony, to kind of wrap up this element of how a modern GRC platform and program can really help organizations. So can you tell us how are modern GRC platforms helping organizations move from that reactive risk management to more proactive decision making?

A (31:39)

Yeah, yeah, you know, it's, it's, it's really a summary of a lot of the stuff of everything that we talked about today in that the power of GRC is truly orchestrating the risk audit controls, compliance, all from one place. And you know, I, I want our listeners to have a vision for like when economic conditions shift that you can, there is a world in which you can be able to automatically update your risk indicators, you can automatically monitor your exposure, you can automatically be able to prioritize the audits that you want to engage with. You can adjust your risk appetites in a real time basis based upon those economic signals that are coming in. So you know, the goal in this too is, is not just to observe it, right. So there's so much information that we get all day long and we observe a lot of those things and particularly economic change. But the goal is to again operationalize it, get you get yourself the dashboards that cross risk visibility, be able to make those faster decisions. And one of my most the alliterations I really like is data decision direction in the context of grc. Right. So much of what we do in GRC is to get the necessary data in order to make the effective decisions which help set the direction of the organization. You know what I really want our listeners to walk away with?

B (33:17)

Tony, I'm going to stop you right there and you're one step ahead of me. Our last section, we always like to wrap up the podcast with what we want our listeners to walk away with. So we have a segment called Strategies for Success, Practical Advice Call to Action. So I'm going to pause on your you answering that and I actually have a question for you of like what do you want listeners to walk away with? And how should GRC professionals think about the link between the economy and governance and risk and compliance?

A (33:55)

Wow. I'm so I'm curious about how what Lauren's going to say here too. But I would tell you that really at the end of the day, our key point here in our discussion is that economic trends influence consumer and borrower behavior and that behavior affects organizations or banks, credit unions, portfolios. And a modern GRC technology helps to be able to monitor or manage those risks proactively. And it doesn't have to be just data in the wind. It can be data that can be used to help you make effective decisions.

B (34:34)

Thank you. And yes, I'm interested to hear what you have to say as well, Lauren. Specifically, I think one thing that I'd love for you to leave our listeners with is what are key things that banks, credit unions, financial institutions should have on their radar that might not be already on their radar or they might not be thinking about?

C (34:56)

Sure, I, I hope they do have a dashboard essentially of these KPIs on their their radar. But if I could add to one on the consumer side, we really want to focus on that real income are folks still out earning inflation on the business side, this is where I'm getting a little bit more worried about general costs starting to squeeze margins. We actually have a term for it here at ITR Economics. We call it profitless prosperity. And what I mean by that is we're entering a rising price environment where it's actually going to be relatively easy to grow the top line. You're going to have to put through price increases. And if you're just just focused on, say, top line sales or revenue, it can look like your business is being very successful. But what does that mean for your margin and for your actual profitability? At the end of the day, that is going to be a real squeeze going forward. And I think this is the one item more than anything else that's going to separate the winners from the losers. So avoid profitless prosperity. That is something I would be following in your loan portfolio or in your own business.

B (35:59)

Okay, you heard it here, everybody. Avoid profitless prosperity. So we'll take that as a note. Thank you both so much. This conversation has been amazing. Thanks for joining GRC and me and listeners, let us know what you think in the comments.