Technological Response to Regulatory Challenges
With Dodd-Frank rulemaking slowing to a crawl (most recently a delay in finalizing the Volcker Rule) and ongoing debate in the European Union about where to go next with regulations in the wake of continued financial unrest, the only thing certain about future regulations is that there will be more and they will be increasingly stringent.
Financial institutions will have to supply significantly more data – from credit risk, counterparty credit risk, and capital calculations to market risk, profitability, and stress testing data. Moreover, they will have to deliver it to an expanding, interconnected network of regulatory authorities, faster and more often than ever before. While the new regulations are still taking shape, financial services firms know they will need increased transparency into risk and finance functions enterprise-wide to enable more frequent and rigorous stress testing and more accurate capital/liquidity ratios.
While the new regulatory landscape may not necessarily be welcomed, it is indeed inevitable. Forward-thinking financial services organizations are using this time to prepare for the new regulatory reality and are finding ways to leverage extended risk and finance visibility for immediate gains. At the foundational level, banks will need to improve data quality, systems and processes to meet expanded reporting and compliance requirements.
Where should organizations begin?
Align risk and finance. The role of the chief financial officer at financial institutions has expanded in the wake of the global financial crisis and ensuing regulatory reform. At the same time, risk and finance have become inextricably linked as stakeholders, both internal and external, increasingly expect that these two functional groups should work together.
The benefits of risk/finance alignment go well beyond regulatory compliance. A 2011 Economist Intelligence Unit global study of nearly 200 senior banking executives found financial institutions that benchmark themselves well on aligning their risk and finance functions also say they are doing better financially. Of survey respondents who rank themselves much better than their peers at alignment between risk and finance, 60% say they are performing much better financially and 92% say they are performing above average. The equivalent figures on financial performance for those who are average or worse at alignment of risk and finance are 8% and 32%, respectively.
Getting leaders of the risk and finance departments to understand the other team’s perspective is a common hurdle. To foster greater cooperation, organizations must create structures for executive and employee interaction so that the two departments understand each other. Personal meetings are extremely important and some banks are convening regular meetings between senior risk and finance executives as a formal part of work stream governance. Something as simple as positioning offices of finance and risk professionals in close proximity can help to foster cooperation and alignment.
Be proactive in preparing for stress testing requirements. Under the new regulatory regime, stress testing will be ordered as a follow up to regularly scheduled periodic reports. Stress test scenarios will be very specific to each bank as markets change and regulators see new vulnerabilities. Additionally, regulators will expect the results of stress tests more quickly and assume that banks will organize their risk data in a way that enables rapid response.
The value of proactively getting ready for this eventuality goes beyond ensuring regulatory compliance. Stress testing represents a tool for managing enterprise performance. The ability to run stress tests “on-demand” enables an institution to tune responses ― for example, contingency funding strategies ― as events unfold. In addition, this same approach can support organizations as they seek to more proactively manage their business, enabling a timely view of costs and profitability, as well as the performance of specific products.
Focus on analytical transformation: An important early step in preparing for compliance is considering unifying the analytical infrastructure to cover risk management and performance management and even financial crime and compliance. Doing so provides visibility across the entire enterprise and delivers insight when and where it is needed. The ability to connect developments and indicators in one part of the business with those in other parts proves essential in determining an organization’s true strengths and vulnerabilities.
While regulators continue with rulemaking, banks have an invaluable window of opportunity to bolster their risk management environment. Those that take advantage of this time stand to benefit greatly today and well into the future.