04 Mar
2016
Can banks bear the incremental costs of regulatory reforms in the long run?
Regulation has become the main investment item for banks
For more than a decade, regulators have been particularly long-winded and creative in producing new standards and prudential rules: CRD IV, SEPA, IFRS, FATCA, BCBS 239, CRA, EMIR, AQR, IFRS. These obscure acronyms conceal the new nightmares of the banking world’s leaders. Each year brings its new batch of reforms and it is very likely that regulators will keep going on.
The original intent is commendable, as these reforms are generally aimed at enhancing the strength of banking institutions and contain the risk of a failure or even a systemic crisis. But it is clear the accumulation of regulations is an increasingly heavy burden for banks, to the point that they now allocate a very significant part of their investment capacity to so-called “regulatory” programs; this constraint often force them to stop or postpone other projects, such as product and service development, operational efficiency or innovation initiatives. For example, BNP Paribas has assessed the impact of the new taxes and regulatory on its income at € 500 million in 2016. Regarding the banking sector, regulation continues to weigh on the companies’ RoE: an average of more than 13% in the early 2000s, to about 8% today.
Many people are in favor of a lull and slowdown pace of reforms, but until they are heard and the pressure eases, banks continue to invest heavily in their information systems and strengthen the staff dedicated to control and compliance functions.
Are banks doomed to be suffocated, overwhelmed by successive waves of regulation?
If it is true that “regulation” is synonymous with “obligation”, do banks must resign to dedicate most of their resources to projects the positive outcomes of which are sometimes difficult to see? At the very least, we believe it is possible to improve the benefit / cost ratio of these regulatory projects, by complying with a few principles.
Principle # 1: avoid investing too heavily or too hastily
Before acting, it may be useful to take some time to first analyze and understand the regulator’s expectations. This reflection time can also be used to benefit from the work and feedback from other banks. In the case of BCBS 239, eleven general principles were enacted in January 2013 by the Basel Committee to strengthen governance, improve data reliability and reporting quality regarding risks. However, these requirements allow a relative flexibility for each bank to develop a compliance plan and meet its own customized target and trajectory.
Principle # 2: look for potential financial and operational benefits
Compliance can lead to many benefits (including financial ones) if we pay a close attention to it. For example, risk data’s reliability may provide a reduction in the provisions amount, or even a better consideration of risk’s cost and equity in the customer’s pricing. The cost of capital that will be required by the regulator is also a major stake, as it made it very clear that it would translate the quality or non-quality of compliance processes into financial ratios requirements.
Principle # 3: pool investments
In compartmentalized organizations (trades, central functions, subsidiary entities …), efforts are often multiplied. A source of substantial savings can be reached by increasing cooperation between business’ divisions, and even seeking synergies with other banks. In 2014, six major banks (including Barclays, JP Morgan Chase, Goldman Sachs, State Street, etc.) decided to join forces to form a common KYC platform (Clarient Entity Hub); About a hundred “customers” have since chosen to join it.
Principle # 4: take advantage of “re-thinking the existing model”
Implementing regulatory reform can have a significant impact on the information system, organization, and processes. Rather than considering it as a cosmetic measure, it can be the opportunity to rationalize, simplify and carry out projects which would have been considered as non-priorities: for example, by re-designing and rationalizing the related systems (which besides can also lead to a potential reduction of maintenance costs).
Principle # 5: implement an efficient program management
Depending on the required transformations’ span, the bank could often have an interest in structuring its compliance approach and set up an ad hoc program management system: governance, program office, dedicated teams … This steering and facilitating mechanism must be totally cross-functional, so it can serve as an oversight body for the General Management, and as light as possible (action must be close to the ground).
Principle # 6: involve the business lines
“Compliance is too serious a matter to hand it out to “compliantologists “. Beyond requirements, it is the intent of the rule that must be understood by the operational staff. The efforts needed to control and ensure the consolidated information’s accuracy will depend on the staff empowerment regarding the quality and completeness of the data they handle daily. It is therefore essential to involve the business in compliance programs.
The implementation of these few principles does not exempt banks from making significant investments to meet the regulator’s requirements. Meanwhile, they can seize the opportunity to limits its scope and maximize its benefits. At a time when banks’ financial leeway tends to decrease, these orientations can make a significant difference.
[Automatically translated by Lingotek]