Since Lehman Brothers collapsed last year it has become painfully obvious that regulators are ill equipped to view institutional loan portfolios in a way that will help them adequately monitor the global financial system. Because of Lehman's relationship with numerous financial firms around the world, its failure immediately caused global credit markets to grind to a halt. This could have been prevented if regulators had the tools in place to effectively view complex debt instruments and the links between the financial institutions that securitize, hold, and insure them.
Currently available data provide regulators with only a snapshot of the loans held by a single institution — not a complete picture of the entire portfolio, let alone an understanding of the risk faced by financial institutions that hold securities based on these loans.
This problem is evident when looking at the institutional path mortgage loans take. First, the loan is originated by a lender regulated by the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Federal Reserve or the Federal Deposit Insurance Corp. Next, it is sold to Fannie Mae or Freddie Mac, which are regulated by the Federal Housing Finance Agency. Then, the loan is securitized and resold to organizations that are overseen by the Securities and Exchange Commission. Because there is currently no mechanism in place that requires these agencies to share data and communicate with one another, regulators are unable to reasonably access the data needed to assess the systemic risk in the banking industry.
The solution to this dilemma is the widespread adoption of electronic lending technology and open industry standards.
In electronic lending, all of the loan documents are drawn, processed, signed, and stored electronically. This computerized data flow means that all the data used to originate a loan, from credit scores to information on the collateral asset, can follow the note automatically. In the current system, the thousands of data points in a loan file are reduced to a handful by the time a securitized asset is sold. The paper involved in the process means that data is lost or destroyed during each step.
This goal requires implementation of technologies that facilitate creating and managing electronic loan assets. This would increase transparency in ways that would make regulators' jobs much easier by allowing them to view assets online, while also providing the means to document trouble spots in an efficient, uniform manner. And the paperless nature of electronic lending would facilitate cost savings for the financial industry in the form of everything from reduced audit costs to the time required to process each transaction.
Electronic lending technology would allow regulators to easily audit institutions, thus enabling investors to see on a computer screen thousands of different data points within loans that make up their portfolio for an accurate portrait of risk.
This could even be an add-on to the CAMELS rating system. Banks' transparency could be scored by such criteria as: inclusion of standardized data using existing industry open standards; total number of data points shared with auditors and shareholders; percent of portfolio in electronic form; availability of prospectus data in standardized electronic format.
Electronic lending would provide regulators with a much deeper view into covered financial service organizations with increased data available for electronic audit. And standardization of data would facilitate cooperation and collaboration between regulating bodies through the sharing of source data.
Much like law enforcement agencies needed to cooperate and share data after 9/11, this would allow regulatory bodies to connect the dots and have visibility into the systemic risk. Not only that, investors would benefit from the increased level of transparency previously unavailable to the banks and their auditors.
Whatever regulatory structure Congress eventually adopts, electronic lending technology should be part of it because it can provide regulators with the tools to look under the covers of the global financial system, and to manage the systemic risk in the banking industry.
This proposal has not been included in any draft legislation, but lawmakers interested in a more transparent banking system should keep this in mind: data contains the truth.
