Just two days after the election I will be attending a lunch at which former senator Christopher Dodd, best known as the co-author of the famous (or infamous) Dodd-Frank law will speak to a business group. I hope he will be open to questions because one of the apparently unintended consequences of the regulations that continue to be developed more than a year after the bill’s passage is its negative impact on innovation within banks and, ultimately, the quality of the choices and services that banks offer customers.
Banks aren’t hiring much these days except in … you guessed it, the compliance department. The same banks that discourage or disallow new hires in revenue-generating areas seem to provide an open checkbook to their compliance groups, as the fear of regulatory action (often fueled by the internal compliance area itself) forces management to increase non-productive staff.
That is not a good thing, as not only does that group fail to generate revenue and increase the cost base, it also frequently slows down the revenue-generating abilities of all those it touches. Branch managers have more forms to complete, further keeping them from customers; similarly, commercial banking relationship managers need to spend even more time behind their desks rather than in front of customers to meet internal requirements. (Frankly, in some cases this gives them another excuse to avoid selling proactively.)
Most bank executives fail to question the surge in compliance requirements to determine if they can eliminate some of the bureaucracy. One step they could take is to bring in an outside expert to audit current practices. One concern I have heard bankers express about the value of that step is that a compliance consultant could suggest even more compliance requirements in a bid to feather its own nest, arguably a believable possibility. After all, how many Y2K consultants created fear and projects related to the change from 1999? Unfortunately, a demi-world of consultants and technology experts exists today that basically thrives by exploiting bankers’ regulatory fears.
One other aspect of the negative impact of compliance is that the product development process at most banks has become increasingly cumbersome and today resembles walking the gauntlet rather than the fast moving “skunk works” as seen at many top performing companies outside of banking. Oftentimes, a bank’s process appears designed to discourage creativity and dampen new ideas. Beyond the executive sponsor, the product approval process includes the involvement of a growing number of groups: compliance, legal, technology, operations, human resources and finance. One bank I spoke with recently said that it could take up to a year to introduce a new product. Another very large bank said that they did not have the staffing and focus required to introduce any new products for at least the next six months. In such cases, internal roadblocks kill potential revenue opportunities.
During a series of recent interviews, executives from two of the biggest U.S. banks used the exact same words in describing their current “strategic” approach, stating that their banks were pursuing a “back-to-basics” approach to their retail and commercial businesses. By this, they meant that both banks were eliminating what they viewed as low priority products to focus on a few key areas. That sounds like good news except that in each instance increasing compliance requirements, not a well designed strategy, propelled these changes. Line staff appears either unable or unwilling to fight this tsunami-like trend.
Why isn’t senior management outraged about customer focus losing out to internal forces? In some cases, legal and compliance personnel cow management; basically, they are too afraid of regulatory problems to push back. To them, the cost of compliance is more than worth avoiding any possible headache with regulators, even if the cost includes the internal paralysis that compliance can cause. In other cases compliance, like information technology (IT), is a black box that senior management does not have the time or interest to understand.
Too-big-to-fail banks are particularly focused on assuaging the regulatory gods that increasingly determine their fates. Recent conversations with some of these banks indicate the degree to which they are concerned both about regulators and bad publicity, with executives mentioning recent articles in which they were featured negatively. Indicative of the level of internal concerns, we just received notice from one such bank that all contractors, including consultants, had to undergo a background check prior to working there. The paranoia of the largest players provides some good news for regional and community banks that may be somewhat less of a target for regulators.
Of course, excellence in compliance is of critical importance to banks, as is excellence in other important functions, such as risk management and IT. But it cannot become an excuse for inaction. In our view “innovation” to the extent that it exists in banking is largely focused on introducing the newest technology, such as mobile check deposit. However, rather than offering a distinct competitive advantage, these initiatives quickly become undifferentiated costs of doing business, something that banks have to offer to stay in the game. Increasingly, nonbanks rather than much larger and more powerful banks are bringing product innovations to consumer and business customers.
In many cases, compliance is harming the customer’s banking experience as well as making it more difficult for the customer to get things done: more forms, more time, more CYA. Many of these hurdles are demanded by the government while others are similar to boat barnacles that require substantial effort to eliminate once they appear.
So, what should banks do? Smaller and mid-sized banks will be lucky if the bigger players continue to tie themselves up in knots, as this provides the gift that keeps giving. At the same time they need to establish a rigorous process to question each and every additional requirement that compliance/legal tries to impose: Why is this change necessary? Who dictated the change? Are competitors being forced to do the same thing? What is its economic cost versus its benefit? Pushing back is appropriate and should even be appreciated by a compliance group that is top rate. Compliance is not the enemy (at least not usually).
The big banks have a different and more serious problem. For years now, they have become piñatas for regulators and the press; that will not change no matter who becomes president. Only one very large bank I spoke with recently failed to complain about regulatory hoops. That bank basically sailed through the downturn, based upon its excellent risk management policies. In recent years, they maintained and grew their credibility with regulators. Conversely, most of the top ten banks are in the regulatory doghouse and will remain in it until they not only meet all the compliance challenges but also demonstrate that they are looking out for the customer.
It is no easy task to increase operating costs for compliance and related activities, reduce revenues due to governmentally imposed constrains and, oh yes, generate an attractive return at the same time. Compliance may be killing innovation, but it is one key factor that will ultimately fuel industry consolidation, as expenses continue to rise while banks struggle to generate revenue growth.
Mr. Wendel is president of New York City-based Financial Institutions Consulting, Inc. He can be reached at firstname.lastname@example.org.