Where the banking & capital markets industry stands today
Stress in the capital markets. Stress in the economy. Lack of capital. Burdened balance sheets. Bailouts. Conversion to bank holding company. Forecasting overhauls. Regulatory scrutiny.
And yet — a silver lining.
In this video interview, Banking & Capital Markets Practice Leader Bill Schlich offers his perspective on the state of the banking industry in light of the current financial crisis. He notes that even amidst crisis, a silver lining can be found in the rise of a new, risk-aware culture.
Bill Schlich on "Where the banking and capital markets industry stands today"
Clip 1: Where the banking and capital markets industry stands today.
Q:There have been tumultuous changes in the banking and capital markets industry in the last 18 months. What effect does the new administration in the White House have on the industry as a whole?
A: You know first of all, there continues to be tremendous stress across the capital markets. There continues to be stress between asset classes, at the consumer level, across not only capital markets, now the entire economy. I think with the new administration and I think with any banking issues in the past, there’s three things that need to happen. One is you need to add liquidity to the marketplace. Two is you need to fix balance sheets. And three is you need to make sure you shore up capital. And I think, you know, we’re moving along all three. Clearly during the year you saw a tremendous increase in liquidity being provided by the Fed [US Federal Reserve]. You’ve seen capital being infused into the banks and that’s been happening not only in the US, but globally. The third one is the one that I think we need to make more progress on, which is how do we clean up the balance sheets. How do we move some of this credit off the balance sheets, so we build capacity so there can be additional lending? I think right now we’re talking about helping the consumer. We’re talking about helping the banks. But until we move some of that credit — and provide some capacity — you’re not going to see any more lending. And what has to happen to have growth, you have to have more lending. Right now the banks, because of the way their balance sheets are, they’re not willing to lend or they’re not lending as they did before. You know, obviously the consumer has been through a tough time, they’re not willing to borrow as much right now. So until we set up something to pull some of those assets, or take care of those assets, it’s going to be — it’s going to be difficult. Again, the three things: liquidity, adding capital and fixing balance sheets. And I think the last one, where I think this administration needs to focus is how do they clean up balance sheets? You know, interestingly enough when the TARP [Troubled Asset Relief Program] got set up originally it was to buy assets. That clearly changed as the world changed and it reacted to the new environment, which is they need to shore up the capital markets by providing capital to the banks. We need to get back to how do we move that credit, provide capacity and then entice the banks to lend. Clearly, just dropping interest rates isn’t going to do it. There needs to be an impact on the balance sheets. Clip 2: How the bank holding company model will change Wall Street.
Q:One of the fundamental changes in the industry is the demise of the independent investment banking model and a movement to bank holding company status. Organizations such as Goldman Sachs and Morgan Stanley have converted to bank holding companies, which gives them additional protection from the government and additional regulation, but also gives them the ability to begin to attract deposits from customers to fund their operations and businesses. How will this impact the banking industry?
A: It’s a significant change. I think it’s one where the markets are signaling that the model that works is a more of a pure banking model, which includes deposit-taking. I think it’s going to require obviously a significant amount of change from a regulatory perspective for these organizations. Have they been regulated, have they been reviewed from the past? And then I think it’s going to be interesting to see with how these investment banks, and the banks, continue to grow but the investment banks grow the deposit banks. And clearly, you could do that by taking deposits in or through consolidation. I do believe you’re going to continue to see a consolidation in this industry where you’re going to see some of the smaller banks being bought up for their deposit base and for their branch networks so they can continue to get deposits. I think it’s interesting. You know, we say the investment banking model is gone. And it is. You know, capital markets are the most innovative in the world and I think you know in the next year or so you’ll start to see how the reaction to that is and whether or not you’re going to see the model come back. How it will change. Will there be smaller investment banks that focus just on M&A? Or will it be housed all in the banks? It will be interesting to see how that evolves over time.Clip 3: What US bank holding companies can expect from regulators.
Q:With bank holding company status comes additional regulatory oversight. What will regulators look for from the new banks and how are institutions reacting to the additional oversight?
A: Well I think it’s clear the regulators are going to want to know right from the top, what’s your business model? How does it work? Do you understand your business model? Do you understand the risks of that business model? So that’s kind of the top. And then, who are the executives and how do they fit into that business model? And then secondly they’re going to say okay, once you understand and they understand your business model and they believe you understand the risks associated with it, then it’s going to be, how do you accumulate that risk? How do you understand and analyze it? How do you report it? And most importantly, when there are issues, how do you react to them? And I think the one thing we’ve learned, it’s not enough just to get a strong risk infrastructure in place. It has to be able to move, change and evolve as things change over time.Clip 4: How the global regulatory regime will change.
Q:In addition to changes in the U.S. regulatory landscape, how will the global regulatory regime change going forward?
A: Coming out of this banking crisis, or this capital markets crisis we’re in, I think one of the interesting things is going to be what happens from a regulatory perspective. I think we’re all hoping it’s not an overreaction. We’re all hoping that it’s a thought-out process of how to fix, or change, or enhance the regulatory framework. Clearly, the optimal answer would be we’re just going to have one global regulator. Well that’s not going to happen. That’s not going to happen anytime soon. So first of all there has to be a close affiliation of regulators across the globe. That has to happen. And that has to happen sooner than later. You’ve seen great improvement from where we were a year or two ago, to where they’re acting much more together and there’s a lot more communication and dialogue. That needs to be enhanced and improved as you move into each of the geographies. In the US, there needs to be a combination of all the different regulatory buyers that we have. We need to make sure that we’re looking at each one of them. Whether it’s the SEC [US Securities & Exchange Commission], the CSBS [Conference of State Bank Supervisors], the Fed [US Federal Reserve], the FDIC [US Federal Depository Insurance Corporation], etc. And we look at each one of them. What functions do they perform and how can we do that in a better and more enhanced way? I think you’re going to see a combination of agencies. I think you’re going to see a model that evolves that’s much more like the current Fed model, in terms of how they regulate. And that’s going to take time and it’s going to be a painful, as all change is. But, I do think if we don’t get to a much more consolidated model both here in the US and globally, that we’re not going to get to where we need to get to.Clip 5: What firms must do differently to meet the demands of regulators and other stakeholders.
Q:One of the things uncovered in a recent Ernst & Young survey is that only 14 percent of global banks have an enterprise-wide view of risk. In light of that statistic and in light of the new requirements from the regulators, how should institutions position themselves to give the necessary information to the regulators and other external stakeholders?
A: Like anything else, it has to start at the top. It has to start with making sure they understand their business. What businesses they’re in, and what risk and what inter-related risks there are across businesses. And so once you first understand your business — you understand your risks — then you can start to understand what you should be looking at from a risk perspective. So, before you get into technology or even the process, you need to make sure you understand the business you’re in today, where you’re going, what the risks are and how they’re interrelated. I think we learned a lot about making sure you understand how risks interrelate across businesses in the last two years. Where is all the credit risk? Clearly it wasn’t sitting in one place in the investment banks or the banks; it was across the organization. And how well can you accumulate and pull together. So, once you know what your risks are and you understand your business and you know your risks, then you need to figure out, okay, how do I pull that information together and I think that’s going to be a very big challenge. How do I pull together and put in a meaningful way, so that it can be reviewed and understood. Then you have to understand, okay now if I know my risks and I’ve pulled together and I’ve analyzed it, who looks at it and how do you use it? And I think that’s really important. How does it get used? Who are the users? Who gets the reports? The reports will be very different based on different parts of the organization — who’s using the information. And then lastly and most importantly, how does that framework stay flexible and change? I think one of the things we learned is, as things change over time, your risk framework and your risk infrastructure has to be able to change and adapt to it.Clip 6: Why risk governance is everyone's business.
Q:How can institutions embed a risk aware culture?
A: Like anything else, change can be difficult. I think first and foremost, and you know this is going to sound cliché, but it starts at the top. It’s the tone at the top. What is — what is the CEO saying about risk? I’ve been in organizations with CEOs who say “Look, we’re going to have the right risk culture, we’re going to be aware of the risk and we’re going to make sure we understand it. That we manage it correctly and at the same time that we’re going to be able to be in the markets, be innovative and make as much money as we can.” It has to start at the top. It has to filter its way down, so everybody understands what, where their position is.Clip 7: How firms can forecast more effectively.
Q:Some have said that institutions were relying too much on lagging indicators as opposed to forward-looking indicators. Regulators and others are now looking for institutions to do more forward-looking forecasting and scenario-based planning. What are institutions now doing to forecast more effectively?
A: There are always things you can do around skill sets and people and technology. But I think what’s most important is for the institution to understand, and have a process in place to understand, where are they today and how do those risks interrelate? Where do they think they’re going to be short- and long-term? How are the businesses going to change? And how do they have to change their risk perspective? You need to know — one of the things I think we’ve learned — is you need to know where you’re going. Risk never stops. It’s not, “We have the right risk infrastructure or the right process for today.” Tomorrow is a different day, things change, balance sheets change, businesses change. I think one of the things we learned was as some of these businesses grew and they grew really fast —some of the interrelated risks across businesses weren’t really being viewed appropriately. So I think what you have to have is a mindset of “risk isn’t today’s issue; it’s today’s issue and tomorrow’s issue.” So where are we going to go tomorrow? Where are we going to get to? And how does that impact what stress test or what scenario tests we should be doing? At the same time it has to remain flexible, because, as we know, things change every day.Clip 8: Why there's a silver lining in the current financial crisis.
Q:As painful as the crisis has been, what positive changes might result?
A: There’s certainly a lot of focus on the capital markets and that focus is coming from governments, from regulators, from consumers and from the institutions themselves. So I think that’s always a positive. I think people are realizing that there needs to be improvements around risk and again, it’s managing the risk for the business you’re in. So it’s understanding business models. What’s the right business model? What are the right risks? So I think it’s a great opportunity and I think most institutions are taking that opportunity to reassess where they are along the risk infrastructure. Where are they, where do they need to get to? I think it’s clear that’s the focus the regulators are going to have. And so I think it’s clearly the end we’re going to get to. So if there’s one silver lining in this, it’s going to be the refocus we have on business models and risk. Clip 9: What the bailouts mean for the balance sheets.
Q:What do institutions in the industry need to do to keep things moving on a continuum of positive change?
A: I do believe — and we said it earlier —I do believe it’s a balance between bailing out the consumer and bailing out the capital markets. It’s a very delicate balance and it’s one that I think the current administration is going to be challenged with. You know there is a concern if you bail out the consumer too much, what happens to the capital markets? If you don’t bail out the consumer, what will happen to the economy? So it’s a very important balance. It’s one that’s going to be difficult, but again we talked about providing liquidity, shoring up balance sheets and then taking care of capital from the banking institution’s perspective. And I think while that sounds simple, it’s not. I think two of the three we made great progress on. The third one, which is cleaning up balance sheets, there’s still a ways to go.
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