Banking Stability Still Threatened by Poor Transparency, Governance

Print
Email
Reprints
Comment (1)
Twitter
LinkedIn
Facebook
Google+

As the Dodd-Frank Act turns two on Saturday, it's a natural time to ask whether its primary goal of stabilizing the financial system has been accomplished.

Despite the recent string of missteps by major firms — all caused by embarrassing management lapses — our financial system remains remarkably steady.

But steady is not the same thing as secure.

Barbara A. Rehm

The feeling that a disaster of system-disrupting proportions is lurking around the next corner is undeniable.

Why is this? Part of the problem is a lack of confidence in financial firms. The public doesn't trust executives to act with integrity. A related factor is the sheer complexity of the financial system.

It's less that the largest firms are Too Big to Fail than they are too complex to manage and oversee, and too interconnected to dismantle without causing destructive ripple effects.

No one believes the regulators really understand what's going on inside the banking giants and some of us aren't even sure the executives have a firm grip on their far-flung businesses. This problem takes on an added twist when you consider how quickly firms lose confidence in each other, freezing out competitors when a whiff of vulnerability surfaces.

Some critics think we can just turn back the clock and revert to a simpler financial system free of large institutions or much risk. I don't think that's realistic. To me, the solution has to lie in transparency and governance.

Notice I didn't say GREATER transparency or BETTER governance. That's because we don't have even the basics right yet.

Let's start with transparency and let's link back to Dodd-Frank.

Realizing that good information is fundamental to good supervision, the authors of the reform law created the Office of Financial Research.

The office was supposed to spot the next financial crisis before it was too late to prevent it. It was supposed to identify data blind spots, go get that information, aggregate it across all the big firms and analyze it. All that was supposed to help regulators stay ahead of the curve of financial crises. And in the end all this added information, this added transparency, was supposed to improve market discipline. Why? Because investors would have more, trusted information about the risks these firms are taking.

Done right, the office also would lighten the load on banks by standardizing and streamlining the data they must report to the government.

But two years later, the office remains an afterthought. It doesn't have a Senate-confirmed director or even much of a permanent staff. It's taken a baby step forward with its legal-entity identifier project but it's nowhere near fulfilling its potential.

If Congress ever does open up Dodd-Frank for reforms, the top of its list should be pulling OFR out of the Treasury Department and making it an independent agency. Then, perhaps, it will be able to take its mission seriously and deliver the sort of transparency that the financial system will need to avert another meltdown.

Without a strong OFR, all the large-bank units of the federal banking agencies are inundating banks with requests for data, each seeking different information in differing formats.

That's inefficient at best. At worst, it's inviting serious problems to fall through the cracks. We need centralized, comprehensive data collection and analysis and the OFR is our best bet. Without the transparency the office could deliver, we are setting ourselves up for another financial implosion.

The other key change we need involves governance and it starts with the boards of directors at these mega institutions.

I don't doubt that most of the people sitting on the boards of the world's largest banks are hardworking, well-intentioned people. But it's pretty clear they are not asking enough of the right questions of senior management and are not demanding accountability when things go wrong.

How else do you explain Barclays' Libor scandal, JPMorgan's trading fiasco, HSBC's money-laundering lapses, Wells Fargo's fair-lending run-in with the Justice Department?

"It isn't a failure of internal controls. It's not because the banks don't have 72 systems with 422 auditors and tons of books on the shelf. It's because nobody gave a damn, and that is a board-level problem," said Karen Shaw Petrou, one of the brightest minds analyzing the industry today.

"Many boards are not well-informed enough about risks" their companies are taking, she said. "It's not that the banks are too complicated. It's that there is a lack of actionable information on which knowledgeable decisions can be made."

Petrou, co-founder and managing partner of Federal Financial Analytics, said every board must set risk tolerances, draw a line on how many mistakes is too many and then be prepared to mete out harsh discipline.

"They don't need to be complicated, fancy formulas," she said. "They need to be clear: you get out when the [risk-tolerance] thresholds are breached…. And there must be consequences for lapses."

Troy Paredes, on the board of the Securities and Exchange Commission, capped off a speech last week about the future of financial services with his views on the role directors should play.

JOIN THE DISCUSSION

(1) Comment

SEE MORE IN

Who's Who in Auto Lending Investigations
As U.S. auto lending has boomed, the industry especially its subprime sector has become a growing target for a slew of prosecutors and regulators. Here are seven government agencies to keep an eye on.

(Image: Bloomberg News)

Comments (1)
The one other responsible parties that're missing in action here are shareholders. Most notably that means large institutions that fail to act like owners and discipline the hired help. They 'd be doing themselves and the stability of our financial system a favor in the long run if they'd insist on separating the chair/CEO positions, holding directors' feet to the fire and making sure that everyone really is paid for furthering shareholders' interests rather than their own. Of course, the fear among some is that the same will be done unto their own shops. Neil Weinberg, Editor in Chief, American Banker.
Posted by Neil Weinberg | Wednesday, July 18 2012 at 6:10PM ET
Add Your Comments:
Not Registered?
You must be registered to post a comment. Click here to register.
Already registered? Log in here
Please note you must now log in with your email address and password.
Already a subscriber? Log in here
Please note you must now log in with your email address and password.