Your Yin Broke My Yang – The European Financial Review

June – July 2017, by Rolland Johannsen

Relationships between bankers and their prudential regulators have always been complex and complicated. However, over the last decade the appropriate balance between banks and their regulations has become seriously distorted. Restoring this balance is necessary to maintain a strong, stable and growing financial services industry capable of supporting a changing and vital economy.

Relationships between bankers and their prudential regulators have always been complex and complicated. Most bankers understand the need for regulations and welcome clear, rational, and consistent regulatory oversight. The reasons are clear. First, most experienced bankers know that understanding, monitoring and managing a whole host of risks, bankers can become myopic – interpreting risk levels through their own filters and perspectives. Experienced, professional reviews by examiners with a broader perspective can help alert management to areas of escalating, emerging, and insufficiently managed risk. In most instances executive management and the board appreciate the information and recommendations, and work diligently to adjust policies and procedures to both mitigate existing risk and institutionalise practices that protect the bank going forward.

Second, banking is a very competitive industry. To paraphrase a former colleague, “God must love banks and bankers because He/She made so many of them.” And, the industry is only becoming more competitive as new entrants use new technologies, business models, payment services and distribution techniques to attack and erode banks’ historical franchises. Successful banks have embraced the challenge and are creating innovative approaches that will provide better and more value-added solutions for their customers and better returns for their shareholders. All these banks want is a clear and level playing field from a regulatory perspective. Effective regulation defines the “strike zone” and helps to protect customers and the industry from unscrupulous competitors who ignore their risk management and customer protection responsibilities in order to capture market share and maximise short-term profits. While it is possible to identify many villains who contributed to the “Great Financial Crisis”, there is no question that the failure of our regulatory agencies to apply and enforce existing regulations effectively, rigorously, and consistently helped to intensify its impact. A consistent regulatory framework, consistently applied is the key to fostering a long-term, sustainable, and effective competitive environment that rewards beneficial innovation rather than forcing all financial institutions to gravitate to the lowest common denominator.

Third, and, perhaps, most importantly, effective regulatory oversight creates clarity and balance. It is the “yin” to the industry’s “yang”. Modern banking cannot (and should not) exist without effective regulations and regulators. The environment is too complex, the risks too large, and the consequences of failure too severe to allow a laissez faire attitude in which all, or select, financial institutions create their own rules and police their own activities. At the same time, our global economy cannot survive (let alone thrive) without a strong, stable, and innovative financial services industry. As a result, regulatory agencies have a broader responsibility than just enforcing existing regulations and punishing evildoers.  One of their most important responsibilities is to help create a stronger and more competitive industry that can adapt to a rapidly changing environment in ways that support and enable economic growth within clear risk tolerance guidelines. The best regulators know that their job is not to eliminate risk, but to ensure that management understands regulatory expectations, identifies the appropriate types and levels of risk within their markets and institutions, and is diligent about measuring and managing that risk. It is this balance that has helped the United States create the finest financial services industry in the world and an economy that has not only grown significantly, but has proven resilient to severe economic trauma. When this balance is managed and maintained, the dual objectives of growth and stability can be achieved.  When it isn’t, the consequences can be painful.

So, Where are We Now?

When I was a baby banker just starting out in the industry, my first boss described my job very clearly, “You only have two responsibilities – protect the bank and protect our customers.” To him, those two responsibilities were inextricably linked and everything else was just implementation. Today, many bankers may find that guidance quaint and simplistic. However, it is at the core of where we now find ourselves from a regulatory perspective. And, unfortunately it is clear that many of our regulators believe that too many banks and bankers have either forgotten, or have chosen to ignore, these fundamental principles. Is this fair? Probably not.

Much has been written and discussed about the evolution of our current regulatory structure and environment. Was it a reaction (over reaction?) to the financial crisis or a long-needed improvement to a system that was out-of-date and out-of-touch with a rapidly changing world? This is an interesting debate, but, at the end of the day, irrelevant. What is not irrelevant, and growing more evident by the day, is that the industry/regulatory balance so crucial to maintaining stability and fostering economic growth is seriously out of whack.

Many bankers are confused. For years they have focused on safety and soundness as their primary regulatory responsibility. Most understand that a number of their brethren chose to sacrifice this responsibility in exchange for short-term gain. This is not the first time this has happened, and it probably won’t be the last. They also understand that in these types of major crises the innocent suffer along with the guilty. They don’t like it, but they understand it, and many have redoubled their efforts to strengthen their risk management practices and balance sheets. Strong arguments can be made that the banking industry has never been in better shape from a safety and soundness perspective than it is today.

Most bankers also know that a key element of the safety and soundness equation is a strong, stable, and loyal customer franchise. And, those that didn’t know it, sure learned it fast in the middle to end of the last decade. They know that reputation and trust are built over years and both have to be earned every day. It is a core belief of successful banks that protecting and growing the customer franchise is critical to protecting the bank. Those that don’t believe it, disappear. The confusion arises because many bankers don’t think their regulators understand this fundamental equation; that they have developed separate, and sometimes conflicting, agencies, guidelines and practices to focus on two sides of the same coin.

There has always been a certain amount of tension between financial institutions and their regulators.  This is both natural and appropriate. Productive tension can make both sides better. Clearly, nobody is well served if the relationship becomes too cozy and the lines become blurred between the regulator and the regulated. At the same time, very rarely does anything positive result when tension disintegrates into full out antagonism as the natural order of a relationship. It is understanding this relationship and creating an environment where issues can be discussed fully and honestly, without immediate threat of intimidation, that will restore the appropriate balance necessary to maintain a strong, stable and growing financial services industry capable of supporting a changing and vital economy.



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