Year 2008 was a humbling and significant event for the Investment Banking and Risk Management professions. Many epitaphs will be written for legendary institutions that disappeared overnight and will be spoken about for decades to come in terms of the crunching global impact and the associated learnings. About $650bn of sub-prime bonds outstanding in March 2008, about 75% of them being rated triple A at issuance, and banks raised around $600 billion in 2008 worldwide to survive. The ongoing global credit crisis and the systemic risk tsunami is leading to a review and potential overhaul of the regulatory frameworks around the world. Combined with the global & pan asian $5 trillion regulatory interventions to help deal with the global economic and financial turmoil, current developments will reshape the financial markets of the future. It remains to be seen if the pendulum will swing from the much touted Supervisory mode back to Regulation mode. It’s a tough choice between light touch and heavy handedness. This article highlights some of the trends that I observe around the world around Regulatory oversight and possible impact for Risk management principles.
Regulation vs. Supervision – In the US, the US Treasury mandated executive pay ceiling of 500, 000 for institutions receiving exceptional TARP funds in an indicator, Regulation is back in full force for some time at least. At the US senate hearings this week, some of the captains of the financial sector were themselves advocating stronger regulation.
UK’s FSA has long been considered to be at the forefront of new thinking on regulatory frameworks, prudential policies but with a market friendly intent. It has been fairly known for its advocacy of a “light touch” based supervision approach vis-a-vis regulation approach. But since a few months, FSA has tightened its regulatory touch and requires some of UKs largest financial institutions to provide it with weekly disclosures on risk and performance, vis-a -vis monthly or quarterly requirement earlier. Each supervisor and regulator is scrambling to enhance its supervisory staff strength and capabilities, which has always been a challenge. Bigger fines and active role in executive hiring are some other facets that one sees.
Super Regulator – Many are talking of the need to have a “Super Regulator”. Something that UK FSA, Singapore MAS and Australia APRA (Australian Prudential and Regulatory Authority) has been experimenting for a while now. It will be interesting to see if USA will follow the route of a federal “Super Regulator” that combines and perhaps even supercedes silo functions of OCC, FDIC, SEC, US Treasury, and host of other state level regulators. Australia – APRA adopts a twin peaks model – Regulation being split into Prudential or traditional oversight and Market behavior with focus on business conduct and investor protection.
Stress Testing – There is a lot of focus on deeper and industry wide Stress Testing. I remember my time in Singapore & Malaysia during the 1997 Asia currency crisis, and some of the supervision departments in Asia – Bank Negara(Malaysia), MAS, Bank of Thailand, Reserve Bank of India (India) started exploring projects to model industry wide Risk to be able to simulate scenarios and impact around a system wide impact. I believe that this might be something that needs to be revisited back today in broader global system risk context & strong links between global financial services.
Liquidity Management – Focus on organizational level Liquidity management function and across the value chain. Specially with many global cases of the failure of the traditional principle of a Central Bank Discount borrowing window as a possible short term liquidity shortfall lender of last resort. This will be a key pillar of the rating frameworks of the supervisors in their onsite and offsite assessment. Some of the broad thinking is to embed the preparedness of an organization’s ability to tap short term liquidity into extra capital. Does this mean more focus on CFAR vs VAR ?
Traditional Measures of Bank Capital Requirements – Harsh scrutiny of the traditional measures of measuring a banks financial viability – e.g. Right before my eyes in Seattle, Washington Mutual with a Tier 1 Capital ratio of 8.4%, crumbled like a pack of cards, with liquidity issues, deposit over runs and free fall stock price before dramatically taken over by FDIC overnight and being sold to JP Morgan Chase. Similarly Wachovia, that was sold to Wells Fargo has a 3rd quarter Tier 1 ratio of 7.49%. National City Corp. had a Tier 1 capital ratio of 11%. All these being above the US 6% threshold for being well capitalized. Spain has a model wherein its banks need to increased their capital chests during good cycles, as a buffer against bad cycles. Something that FSA and a few other regulators are exploring.
Remuneration tied to Risk taken – One of the interesting comments made by Morgan Stanley Chairman during this week Senate hearings was around Call back or was it Claw back ? Those of us who have been in Sales functions understand Claw back quite well i.e. the need to pay back bonus/commissions etc. on a deal that backfires. Morgan Stanley has a policy (not sure if existing or new) that requires return of bonus/remuneration even after leaving the firm if in violation of some core guiding principles. Also see a lot of chatter around remuneration tied around amount of risk taken in the transaction. It will be interesting to see how far this really goes.
So let us pay close attention as the current evolving trends and developments are going to reshape the financial sector with an impact that will be felt for decades to come.
References/Sources: Dow Jones Financial News, Issue 635,A year in numbers; Business Week Dec 1 2008(Peter Coy, Enough Shock treatment) , FSA, The Financial crisis and future of financial regulation, The Economists Inaugural City Lecture; Wall Street Journal, Alistair Macdonald, Jan 2009; APRA Website & Consultation papers; MAS website & Consultation papers.
Sai Sireesh is Director of Risk Management & Compliance Strategy & Solutions, Worldwide Financial Services for the Microsoft Corporation. Mr. Sireesh has over 18 years of global experience across Risk and Compliance Consulting, Financial sector Strategy and blueprints execution. He has worked in North America, Australia, Singapore, Malaysia, Philippines, Thailand, Indonesia and India, is a regular contributor to the Journal of Regulation & Risk, and has authored several global research studies and articles.