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The biggest expansion of the banking rulebook is still on the horizon. The changes could lead to an overhaul of banking business models.
January 31 -
Capital is important, but ample loan-loss reserves, governed by stringent supervision, are a much more direct, responsive way to account for credit risk.
November 8 -
Financial institutions that do the same things should have the same oversight. Unfortunately, we're a long way from regulatory parity, even after Dodd-Frank.
September 5
For the foreseeable future, we are likely to be living with suboptimal economic growth. Bankers and policymakers will have to adapt to this reality in order to minimize the troubles such a macroeconomic environment creates.
It is sad that this is most likely our economic fate. Our economy has powerful resources in energy, technology and human capital, and is capable of expanding more rapidly. Our banking system has fortified itself with greater capital and stronger fundamentals, and accordingly would be in sound shape to support such expansion. However, be it sequesters or budget fights, Washington is mired in blame, finger-pointing and myopia.
In practical terms, this means banks have to be more cautious than is desirable from a macroeconomic perspective, but necessary from their own micro-perspective. In an era of slow growth or worse, only the highest credit standards and most careful market and operational risk controls will do. Risk appetites have to be re-evaluated and adjustments must be made to avoid going straight when the road has curved.
This needs to be an unusually cautious period on the part of bankers, which of course takes a toll on revenue and profitability, made worse by extremely low interest rates and narrow margins. One way for bankers to mitigate this squeeze is to concentrate on achieving greater efficiencies. Almost all institutions, even the best, can find meaningful opportunities to decrease expenses.
Technology, of course, helps but requires additional capital investment. In fact, it is often the mundane continuation of marginal day-to-day expenses that can be dealt with most swiftly. In achieving these efficiencies it is essential to avoid cuts that would imperil the institution's control infrastructure. But in my experience, banks can do both – be more efficient and avoid hurting safety and soundness in the process.
From a regulatory policy perspective, supervisors can take steps to avoid unnecessary stress on the banking system and a credit crunch. First, regulatory burdens must be minimized. Having pursued a burden reduction agenda when I was in office, I know that we can achieve necessary safety and soundness objectives while lessening burdens. Incremental regulatory burdens are constantly attaching to the hull of the banking ship, and only a constant effort by regulators to scrape off the old crust and restrain new growth of these burdens will keep the ship from listing instead of progressing at maximum speed.
Second, we must move away from the increasing tendency towards "short-termism" and the zeal for technical compliance perfection that is unachievable except at an exorbitant cost that in the end comes out of the consumer's pocket.
Several aspects of short-termism come to mind. Great bankers know that many borrowers can be helped through difficult situations by isolating and dealing with troubles early – while there's still a chance to affect the outcome. Interestingly, this is an important area where community group leaders and bankers often agree, and for good reason. Programmatically accelerating collection efforts against people and businesses that are going through tough times through no fault of their own can be enormously wasteful and socially undesirable.
Great bankers and great community leaders alike have told me this over the years. This, of course, has to be judiciously applied. Banks should not be in the business of automatic forbearance during down economic cycles. However, regulators and other policymakers can support selective work-out arrangements more vigorously without facilitating generalized forbearance.
Other aspects of short-termism, including a slavish emphasis on mark-to-market theory as opposed to a common sense approach to value, or an insistence on quarterly growth figures that are unrealistic and achievable only at the expense of long-term soundness, undercut banking stability. Policymakers and the industry should lean against this curious and dangerous addiction to substituting point-in-time mathematics for judgment.
Today more than in the past we are also in danger of raising compliance standards to levels that are virtually unachievable, or only achievable at asymmetric expense. While I would be first to endorse punishing venality, discrimination and programmatic poor practice, and I favor strong compliance systems, we are in danger of excessively demonizing honest mistakes. Getting the balance right between unacceptably poor compliance practices on the one hand and unattainable perfection on the other will be one of the key policy tasks of the next few years.
In sum, we are entering another difficult economic period, if we ever left the last one. Many of our current economic wounds have been, sadly, self-inflicted. But it looks as if we are stuck with a suboptimal reality. We can make this period more difficult on ourselves or not depending upon our own actions and the actions of official policymakers.
Eugene A. Ludwig is a founder and the chief executive of Promontory Financial Group LLC. He was the comptroller of the currency in the Clinton administration.
