November 18, 2014

Rapidly-changing environment provides strong opportunity for banks

While some banks may feel challenged by their constantly-changing environment, the situation grants them an opportunity to better their reputation and stand out from the competition, two experts wrote recently in an American Banker opinion piece.

Banking industry constantly evolving
Juan Pedro Moreno, Accenture's senior managing director of global banking, and Steve Culp, the company's senior managing director of global finance & risk, asserted that the entire industry is evolving as a result of emerging markets, rising competition and a slew of new regulations.

However, these challenges are providing banks the opportunity to develop innovative solutions and make the most of their current situation, they asserted. Those that succeed in navigating this complex landscape could potentially improve their reputations, and also stand out from the competition.

Regulatory uncertainty
Banks face a complex regulatory environment, and the rules and regulations they must abide by have been created by lawmakers and regulators passing several landmark reforms over the last several years. The Dodd-Frank Act, which is close to 1,000 pages in length, provides these industry participants with more stringent compliance. 

Capital requirements
Regulators and lawmakers have imposed capital requirements on banks all over the world. The Basel Committee on Banking Supervision, as well as other organizations that cull membership from various nations, have spearheaded such efforts.

The Basel Committee created guidelines designed to ensure that banks would be more resilient, by offering these financial institutions guidelines that would involve them holding more and better capital. The idea is that if these organizations suffered a period of sustained capital outflows, they would still be able to survive.

US capital guidelines
Supervisors of different nations have created varying interpretations of the guidelines, and U.S. government agencies approved their version of the Basel III capital requirements last year, dictating that banks would need to hold a common equity tier 1 capital ratio of 4.5 percent of risk-weighted assets, and a common equity tier 1 capital conservation buffer of 2.5 percent of RWA.

The final rule approved by U.S. government agencies indicated that all banks would need to hold a leverage ratio of at least 4 percent and a ratio of tier 1 capital to RWA of at least 6 percent. Ben Bernanke, chairman of the Fed at the time the regulations were finalized, spoke to this situation in a statement.

"This framework requires banking organizations to hold more and higher quality capital, which acts as a financial cushion to absorb losses, while reducing the incentive for firms to take excessive risks," he said. "With these revisions to our capital rules, banking organizations will be better able to withstand periods of financial stress, thus contributing to the overall health of the U.S. economy."

Banks' Liquidity Coverage Ratio
In September 2014, U.S. federal regulators finalized the Liquidity Coverage Ratio, which obligates large banks to hold enough liquid assets to survive a funding crisis. The LCR is a ratio of a bank's liquid assets to its projected net cash outflow. Banks will need to meet this requirement if they:

  • Have at least $250 billion in consolidated assets 
  • Hold $10 billion or more in on-balance sheet foreign exposure
  • Own a subsidiary depository institution with at least $10 billion in assets

In addition, bank holding companies - as well as savings and loan holding companies - would need to meet a less-strict LCR if they have at least $50 billion in assets.

Various policies under consideration
At this meeting, officials also mentioned various policies they were considering, including one that involved attempts to factor liquidity risk into capital surcharge calculations and a different longer-term funding standard, according to American Banker. In addition, these members of government spoke to developments that could reduce the impact the LCR has on city governments and banks.

Lael Brainard, Federal Reserve governor, weighed in on the situation during her opening remarks, saying that while the LCR has made progress in alleviating the concerns people have about the risk surrounding short-term wholesale funding, there is more work to do, the media outlet reported.

Adapting to a new normal
As a result of these regulatory developments, banks will need to not only adapt to a new normal where they must hold more of the highest-quality capital around, but also evaluate their capital using a method that does not center around RWA, the two authors wrote. They predicted that these financial institutions could soon encounter new requirements pertaining to their total assets, and that this shift could impact banks' business models.

Banks will need to be far more careful in their use of capital, and the experts used decisions to allocate financial resources to business lines as an example. These organizations will need to pick and choose which business lines receive capital, and this could result in many traditional lines ceasing to exist, they wrote. Capital will likely be allocated to business lines that are capable of generating a desirable return on equity.

How loan sales can help
As many banks struggle to leverage their scarce resources effectively, one technique they can use is buying and selling loan portfolios. In the current interest-rate environment, financial institutions are seeking out high-quality loans that offer a decent yield and have been underwritten in a fully-compliant manner.

One company that has been successful in orchestrating deals of this type is Garnet Capital Advisors, which is highly-experienced and has covered the full range of loan types.

Banks that are looking to improve their current loan portfolios must consider both internal and external sources, and working with a loan sale advisory like Garnet can help financial institutions acquire the right loans.