Global banks brace for financial reform impact

  • Share

The most sweeping set of financial regulatory reforms in a generation is about to gain considerable momentum. While policy questions remain open, it’s clear that the ambitious and far-reaching agenda set out by the G20 and the Basel Committee will permanently change the way global banks do business.

These reforms raise three key risks for the banking sector:

1. Changes in the way banks do business
It seems inevitable that differing national political and regulatory priorities will create an uneven field of play, giving rise to regulatory arbitrage and incentives to migrate certain business activities to more accommodating jurisdictions.

Derivative and hedge fund activities will be particularly exposed. Banks will face limitations on certain activities, including restrictions on proprietary trading and certain derivatives activities, as well as on the ownership of hedge and private equity funds.

Even where not directly restricted, banks can expect margins to fall on derivatives, on securitized products and across many aspects of consumer banking.

Wide-ranging operational impacts stemming from the need to develop and sustain resolution plans may significantly affect financial conglomerates’ operational, funding and legal entity structures.

Top 10 risks for the banking industry

2. Strain on technology and operations
Demands on IT infrastructure and data will increase exponentially. The bar will be raised for reporting on aggregate risk positions, concentrations and counterparty credit exposures to both management and regulators.

Specific and highly granular reporting and disclosures will also be required for many aspects of derivatives, securitizations and consumer businesses. Regulators have indicated that “quick fix” solutions will miss the mark — banks must make fundamental improvements and investments in this area.

Operational areas will need to adjust to the new standards for derivatives clearing and reporting. In addition, risk management must adapt to higher standards for underwriting and analytics, as well as establish day-to-day processes to support enhanced stress testing, reporting and governance practices.

3. Increased costs and capital requirements
The impact of ‘Basel III’ capital proposals, increased focus from national banking supervisors on stress testing, scenario analysis and macro-prudential concerns is also likely to drive up capital demands even further for the largest and most interconnected firms. Additional capital requirements for swap activities will also increase these needs, and the likely thrust of so-called “living will” proposals toward financial and operational self-sufficiency of material entities is likely to trap capital and liquidity within those entities. The result could be a push to re-evaluate legal entity structures and cross-entity activities.

The Basel liquidity proposals will force banks to hold buffers of prescribed liquid assets and reduce their reliance on short-term funding, requiring significant changes to funding structures.

The cost of raising capital and liquidity seems certain to rise, driven by the extent to which the markets and rating agencies believe that the reforms have ended the era of financial institutions that are “too big to fail.” Leading rating agencies are holding fire until late 2010 or early 2011 before passing judgment on this, with downgrades possible.

The full cost to banks of the new regime remains to be seen, but with some analysts estimating that about a fifth of annual profits may be at risk, it is clear that anything banks can do to mitigate the costs of managing these changes will be an essential component of near-term and strategic planning. Banks should start immediately to assess the global impact of the reforms on their specific business models and develop a prioritized and integrated road map of projects to address these.

Read our business risk report for information on the risks facing all industries in 2010.