Discerning the New Financial Services Landscape

The financial services industry is undergoing sweeping change and bank directors will soon be operating in an environment ruled by tougher regulators and regulations. Everything from compensation standards to capital to board governance is under intense review and the demands on directors will only weigh heavier on their shoulders. While all is not yet clear, some contours of the landscape for the next decade are easier to discern.

High on the regulators’ list of changes is capital. Regulators will demand higher capital charges and Basel will come out with tangible common equity, Tier 1 leverage, and risk-based capital standards that will be more prescriptive. Capital calculations will be made up of leverage (which Basel II had sought to eliminate before the crisis started). But capital calculations, at least at the larger institutions, will continue to involve risk modeling with capital charges attached for the risk-based portion of the calculation.

Requirements for modeling and written plans will be on the rise, too. Regulators will demand liquidity plans and ratios, as will strategic plans. And the regulators will be less forgiving in terms of financial institutions that stray from their plans. Stress tests, ICAP modeling, and procedures are here to stay.

There will be increasing requirements that financial institutions view their businesses through the lens of risks more than rewards. Though enterprise risk management (ERM) programs did not show themselves to be stellar performers through this crisis, there will be increasing demand for independent and elaborate ERM mechanisms. Indeed, chief risk officers may be moving in the direction of having the independence of internal auditors.

Compensation will become even more a subject of oversight and debate. And there will be clear requirements that it be risk-based. The board’s compensation committees will be under greater scrutiny by regulators and the public. And there will be serious demands that they take risk management principles into account, not only in the compensation plans they create, but in the individual compensation decisions they make for, say, the CE0. Further, compensation and risk issues will not stop at the top five officers of the company but will be driven down well into the middle, if not the lowest, ranks of the enterprise.

Ever more refined rules over board governance are here to stay. The rules will emphasize board member expertise in financial services, independence, and board reporting. Improved reporting is indeed a positive step, and is an area where there can be a win-win-win for the bank, the board, and the regulator. Management and the report preparer benefit from clear reports that identify risks and opportunities. It is not possible to govern well without such reports.

Whether there is eventually a consumer agency or not, compliance requirements will mount. Clearly, government wants stricter compliance, be it the Congress or the regulators. Accordingly, anti-money-laundering will not disappear and will be joined by fair lending, suitability, and proper consumer disclosures generally.

For the foreseeable future, bank examinations will be tougher and all regulatory agencies such as the SEC, U.S. Commodities Futures Trading Commission, the bank regulators, and other regulatory authorities will have much itchier trigger fingers when it comes to issuing formal and informal orders.

So while these alterations seem clear, there are also numerous elements of the business that are still murky.

The extent of consolidation and the permitted size of institutions may be up for grabs. There may well be successful attempts in Congress to limit the size of institutions or even to break them up. However, it is unlikely Congress will go so far. Rather, we will see the creation of a more elaborate resolution mechanism and perhaps a prefunded private-sector cushion for resolution, probably in the vicinity of $50 billion.

Retail delivery systems will be more electronic, more card-based, and more Internet-based. While the branch will not disappear, it will likely not grow either, at least in number.

While there may be changes to the way regulators approach structured finance, one thing is clear-it’s here to stay. To be sure, structured finance was allowed to go too far without adequate regulation, but it adds value and it will continue to grow and innovate.

Globalization, too, may be stalled by legislation and regulation but it will not be stopped. The economics of globalization are simply too powerful.

The new financial landscape will not be easy to navigate initially. It will require directors who are dedicated, intelligent, and unyielding in their resolve to oversee successful financial institutions that restore faith in the system.

Guest columnist Eugene A. Ludwig is founder and CEO of Promontory Financial Group, LLC, a consulting firm for financial companies worldwide. Prior to this, Ludwig was vice chairman and senior control officer of Bankers Trust/Deutsche Bank and served for five years as Comptroller of the Currency of the United States.

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