Thursday, August 7, 2014

Putting the Duel Back Into the
 Dual Banking System

In January, the Office of the Comptroller of the Currency (OCC) released a Notice of Proposed Rulemaking (NPR) to amend the existing 12 CFR 30 - Safety and Soundness Standards by establishing a set of formal safety and soundness standards specifically for national banks with total assets greater than $50 billion.  These proposed safety and soundness standards (called Appendix D) are based on the OCC's heightened expectations program.  The NPR also establishes explicit and enforceable standards for oversight by the boards of directors of these banks.  The public comment period is over and the OCC is digesting the responses received from the banking industry and the public.

The heightened expectations program was established to strengthen the governance and risk management practices in the OCC's largest national banks.  The gist of the heightened expectations program is that corporate governance and risk management practices in our nation's largest national banks need to be "strong", not merely "satisfactory".

Since the Federal Reserve and FDIC, federal regulators of state-chartered member and non-member banks respectively, have not followed the OCC's approach, it's probably safe to infer that they have staked their institutional expectations for bank corporate governance and risk management somewhere along the continuum between "satisfactory" and "strong", either in a blanket sense or on a bank-by-bank basis.  The potential liability to the boards of directors of these state-chartered banks are those already outlined in existing law, regulation, guidelines, and common law precedent.

With his effort to codify these safety and soundness standards in federal law, the Comptroller of the Currency has thrown down the gauntlet; metaphorically giving a glove slap to the faces of  regulators of the largest state-chartered banks, by implicitly fingering them as the bank supervisory custodians of lower (or at least unexpressed) expectations.  In more chivalrous days, such a derision of someone else's bureaucratic character would set the stage for an old-fashioned duel.

Except in this case, the Comptroller of the Currency will be holding a pistol with its barrel bent downward at a 90-degree angle, so that in whichever direction he points that pistol, he is likely to shoot himself in the foot.

Don't get me wrong, I am a big supporter of the OCC's effort to codify enforceable best-practice standards and install real accountability in our largest banks through the mechanism of heightened expectations.  See my previous blog posting - Strong Coffee and Weak Tea   But upon reflection, I now also strongly believe that doing so outside the forum of interagency cooperation, without an accompanying policy statement signifying interagency consensus, is the grandest of follies.  It could foreshadow a seismic change in the distribution of federal- vs. state-chartered banks among the population of banks with assets greater than $50 billion... a group small in number, but immense in banking marketplace presence.

At the present time, about two-thirds of the group have federally-chartered lead banks with the remainder having state-chartered lead banks.  Under the Comptroller's current informal version of his heightened expectations program those national banks are already being held to those higher expectations through the moral suasion exerted through the ongoing bank supervision process.  

The remaining banks in the group, the state-chartered banks, are not under the jurisdiction of the OCC and are therefore not subject to the heightened expectations program.  These state-chartered banks operate under governance standards presently outlined in law, regulation, and individual state or Federal Reserve or FDIC examination handbook guidelines.

The recent talk of Washington, among the Illuminati inside-the-beltway, has been the popularity of what have been called "tax inversions".  Where U.S. corporations are changing their tax domicile through mergers with other corporations in overseas jurisdictions with lower income tax rates; arbitraging their taxing authorities and thereby lessening their income tax burdens.  Something similar, onshore regulatory arbitrage, could happen if the Comptroller's heightened expectations guidelines are adopted in the Code of Federal Regulations without an explicit interagency policy backstop.

First, simply switching from a federal to a state bank charter in your home state makes the Comptroller's heightened expectations program go away - poof!  Second, as the "tax inversion" proponents have demonstrated, you do not have to move your operations to move your official corporate domicile.  In fact, there are many banks today where their official headquarters are in one city or state, while their corporate officers live and work elsewhere.  So the potential exists not only to convert to a state bank charter, but also to select any state bank regulator willing to roll out the Welcome Wagon in the states where the bank already has an established branch presence.

The latter option might even be attractive to those national banks with corporate domiciles in New York State.  In the State of New York, given the recent banker-bashing pyrotechnics by state officials, the state-level regulatory arbitrage calculus is more complicated... on one hand, there is the fire, and on the other hand, the frying pan.  By moving a corporate domicile to a different state and changing the home-state/host-state equation, the 1997 Nationwide Cooperative Agreement (signed by all state bank regulators) kicks in and at least the prospect exists for the state-level regulatory dynamics to change significantly.

The bane of bold leadership is that the Comptroller of the Currency becomes, by definition, a pioneer.  Pioneers were an important part of what made this country great.  But every pioneer weighed the implications of go-it-alone leadership against the benefits of collective action.

As hard and frustrating as the interagency agreement process can be, the OCC needs to push harder for an interagency policy statement on this topic because the ramifications of going-it-alone could radically change the present stasis in the balance of the dual banking system and put OCC on a slippery slope of becoming less relevant.  As the old saying points out, sometimes the lone pioneer is the guy lying face down in the mud with an arrow in his back.

Monday, July 21, 2014

Is the Show About to Start?

The banking industry and its observers have been talking about it since the U.S. officially emerged from the financial crisis and the follow-on Great Recession --- When are interest rates going to begin to normalize and, given that we used several novel (and untested) monetary policy tools in the U.S., will the path to interest rate normalization be fraught with unanticipated negative consequences for the banking industry?

The government-administered suppression of short-term interest rates through the Federal Reserve's Zero Interest Rate Policy (ZIRP) and its half-nelson push-down on rates along the longer end of the yield curve through three cycles of quantitative easing (QE) seems to be coming to a close.  The Federal Open Market Committee's (FOMC) own consensus projections show 2015 as likely to herald the first upticks in the federal funds rate in many years.

After seeing a significant drop in the headline unemployment rate over the last year to 6.1% (busting through Ben Bernanke's 6.5% reference point), last week Fed Chairman Janet Yellen, in congressional testimony, uttered a phrase - a  caution really - that should reverberate in the sanctums of bank Asset-Liability Committees (ALCOs) across the globe:
“If the labor market continues to improve more quickly than anticipated by the Federal Open Market Committee, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target likely would occur sooner and be more rapid [my emphasis] than currently envisioned,”
Also trying to make the case that the old show might soon be over and that the new show might be potentially surprising, are the respected intellects at Cumberland Advisors, who noted in a recent analysis piece - "Tapering is Now Tightening", that beginning this month, Federal Reserve System purchases of government debt falls below the volume of monthly U.S. government debt issuance.  The Fed is no longer fully absorbing new U.S. government debt issuance.

In a related piece, entitled "Hope is not a Strategy", they also present the case that the odds of a significant and surprising spike in interest rates, rather than a more interest rate risk-manageable moderate ramping-up of interest rates, may not be inconsequential.

For community banks, the emerging visibility of an interest rate tipping point, is a better news/bad news scenario.  The better news is that macro-structural net interest margin compression may ease up.  Banks have been suffering ongoing and painful net interest margin compression over the last few years, caused largely by the Fed's repression of interest rates, yield curve flattening, and the dropping loan volumes suffered during the economic decline phase of the Great Recession. Thankfully, at least loan volumes are slowly rising again.

This suffering has prompted many community bank boards of directors, particularly those in competitive and price-sensitive geographies, to seriously consider throwing in the towel and trying to sell out.  Rationally thinking that a reasonable return to stockholders in this environment appears out of reach -  at least without taking imprudent risks or taking on the uncertain payback of re-engineering their business models.  The noxious brew of net interest margin compression, flat non-interest revenue, and escalating non-interest expenses - largely due to new (or more forcefully emphasized) regulatory expectations has changed the underlying economics of the small community banking model.

It's only small consolation to the average community bank that there was a partial offset to margin compression via increased liquidity and safety preferences on the part of anxious consumers and businesses.  Surging pools of non-maturity transaction deposits helped lower the interest expense side of the net interest margin equation.

Enter the latest Semiannual Risk Perspective recently issued by the Office of the Comptroller of the Currency.  Unlike its previous editions, where its counsel regarding interest rate risk could be likened to a yellow flashing caution light; the tone of the current edition changes to a red flashing warning light - stop and look both ways before proceeding.

Previous editions of the Semiannual Risk Perspective repeatedly warned community banks against engaging in what I'll call "down and out banking" - attempting to increase asset yields by moving down the credit quality scale to fund less-creditworthy obligors and by moving out along the yield curve by extending maturities in order to capture incremental yield.  In one case, as rising rates impact variable-rate portfolios (or short maturity fixed rate), it's a formula for transforming interest rate risk into credit risk as marginal borrowers cope with the stress of higher debt service requirements.  In the other case, you flirt with underwater securities portfolios and the liquidity and credit-risk issues that come with the territory.

The Semiannual Risk Perspective makes a teachable moment out of this by highlighting a couple of sobering statistics - National banks with less than $1 billion in total assets have increased long-term asset concentrations from 17% in 2006 to 31% at year-end 2013 --- almost a doubling.  And by the way, that's an average.  I'd love to see the median long-term asset concentration and the range, so that we could get some visibility about where the top half lives.  Any call report data miners out there?

Moreover, strong deposit inflows, uneven loan growth, and net interest margin pressure has created a situation where the growth in investment securities portfolios in those same banks has been centered in mortgage-backed securities - creating the potential for duration extension in a rising rate environment.

And let's not forget the bank capital management gymnastics that will come from the new capital rule effective January 1, 2015.  Smaller banks have a one-time, irrevocable option to neutralize certain Accumulated Other Comprehensive Income (AOCI) components - essentially unrealized gains and losses on available-for-sale securities.  If the option is not selected, AOCI will be incorporated into the Common Equity Tier 1 capital ratio.

This AOCI neutralization creates both "shadow capital" - market value gains that could be converted into measured regulatory capital at the expense of the future income stream - and "shadow losses" - market value losses that could erode measured regulatory capital if liquidity or other risk management imperatives forced the unexpected disposition of some, or all, of these available-for-sale securities.  This "shadowy" regulatory capital treatment needs to be incorporated into real world capital planning, including in stress test scenarios.

Lastly, there's the issue of  "The Surge" in non-maturity transaction deposits and how elastic those balances will be in a rising interest rate environment.  Historical balance analysis has only limited benefit as we are in uncharted waters here.  In a ZIRP and QE environment, there is little opportunity cost to a consumer or business to keeping a boatload of cash idle in a transaction account at a bank.  That equation changes in an interest rate normalization scenario.  How it changes remains to be seen.  But one thing is probably sure, human nature tends toward the hopeful outcomes in life and probably in interest rate risk modeling too... and as the folks at Cumberland Advisors mentioned - hope is not a strategy.

For important background regulatory guidance documents on interest rate risk, please consult the 2010 interagency Advisory on Interest Rate Risk Management and the 2012 update Frequently Asked Questions.

Note to Readers:  Thank you for bearing with me during this period of radio silence on The National Bank Examiner blog.  Under the theory that two tires on the same axle go bald at a similar rate, I had to have surgery to replace my other hip joint.  Result: a wonderful success.  Goodbye to the chronic pain of arthritis.  Thank you, Dr. Courtney Sherman, of the Mayo Clinic in Jacksonville, Florida!

Sunday, May 18, 2014

Footnoting Bank Supervision

Consider this press release from the Board of Governors of the Federal Reserve System,  the press release from Cullen/Frost Bankers, Inc., and this story in the San Antonio Express-News discussing the Fed's Order approving the acquisition of WNB Bancshares of Odessa, Texas by San Antonio, Texas-based Cullen/Frost Bankers, Inc.   

At December 31, 2013, WNB Bancshares had $1.5 billion in total assets and Cullen/Frost Bankers, Inc. had $24.4 billion in total assets.  This small acquisition would grow Cullen/Frost Bankers, Inc.'s total assets by only about 6%.

What catches your eye, tickles the antennae, and raises questions is footnote 33 on Page 19 of the Fed's merger approval.  It states:

"Cullen/Frost has committed not to engage in any expansionary activities, including branching within its existing market areas, until such time that the Board has deemed Cullen/Frost to have clearly developed a policy to support future expansion in its compliance program, including fair lending [my emphasis], and to hire additional staff with requisite knowledge and experience to manage and control the bank’s fair lending risk, which might be heightened by expansion." 

Now, if all factors were deemed satisfactory (the approval Order raises no compliance issues), why would the Fed even insert that footnote requiring the agreement of the bank to immediately refrain from any expansionary activities?   Not even one measly strip mall or street corner branch until the bank 'ups its game' in the area of compliance risk management, including the area of fair lending.  "No (more) soup for you!" as the old Seinfeld show character would say.

And what sets the mental klaxons sounding and sirens wailing is that one of the compliance management issues raised is fair lending.  Any bank examiner knows that fair lending is an electric and radioactive compliance issue - one of the few third rails of compliance supervision.  So much so that it ranks as high, or higher, on the compliance scale than another high profile compliance issue - Bank Secrecy Act/Anti-Money Laundering (BSA/AML) compliance.

Bottom line, you just don't raise the hypersensitive issue of fair lending and not be expected to explain, in detail, why you demanded this stand-still commitment from the bank.  The Fed has not offered an explanation and, so far as I know, no one in authority has requested one.

Direct talk (and action) by the Fed has been supplanted by oblique and hazy references coupled with a significant corporate commitment to refrain from further expansion, all buried in a footnote on page 19 of the approval Order.  The Fed's press release introduction doesn't even mention it.

The folks at the Fed in Dallas and Washington ought to be looking sheepishly down at their shoes; they lost bank supervision style points on this one.  I just hope that the Fed's new Large Institution Supervision Coordinating Committee (LISCC), which has bank supervision responsibility for our nation's systemically important financial institutions, doesn't contract this same malady.  The Captains of Finance, black-eyed and bloodied from years of public floggings a more direct approach to bank supervision, surely noticed this little gem.

Sunday, May 11, 2014

Time for Bank Charter Reform?

Credit: "Plato's Cave" Kombo Chapfika, 2008

This week's superb article in the New York Times, Loans That Avoid Banks? Maybe Not  is notable not only for its content and analysis, but also for signaling modern implications for the basic existential question in our industry, "What is a bank?"

The triptych above entitled "Plato's Cave" gives a surrealistic interpretation to Plato's famous Allegory of the Cave (summary here).  The allegory's general concepts can be applied to the question: "What is a bank?" in the sense that we see the world  through a personal frame of reference and a collective frame of reference.  We also see that world through lenses that could be characterized as plain sight, microscopic (seeing things close up), telescopic (seeing things from a distance), and panoramic (the shape and spirit of the times we live in).  Because we perceive the world we live in through these various frames of reference and lenses, we are always challenged by the difficulty of distinguishing between what is apparent and what is real.

For example, the usual and customary way of sizing and ranking banks in the U.S. is by total balance sheet assets or total deposits.  That traditional way of sizing banks stems from our legal and accounting frame of reference about the form of a bank - cash, investments, loans, premises, deposits, borrowings, shareholder capital at risk, and a charter granted by a government authority.

A banker friend of mine in Miami, the Americas director for a large European bank, has for years sized and ranked his "bank" in the Florida marketplace as the sum total of the balance sheet assets of the subsidiary U.S. commercial bank, the parent's foreign branch in Miami, and the assets under management (AUM) of both entities.  In other words, in his formulation of bank size, the bank is the sum total of all of its customer-facing touch points... its spheres of financial marketplace influence.

My friend's sizing of his bank's presence in the Florida marketplace expands upon the formal and traditional definition of a bank by changing the frame of reference for his banking operation to be more aligned with the functions of a banking intermediary.  In a broad sense, a bank applies expertise (knowledge capital), technology, and, when necessary, their proprietary financial capital in a manner which meets the financial services needs of providers and users of funds in the marketplace.

The functions of banking can be exercised in several ways; first, by traditionally-defined bank financial intermediation where deposits are taken and bank credit is extended using the proprietary capital of the bank to absorb all risks; second, it can also be exercised via advisory or fiduciary services where the application of expertise is fee-compensated but non-operational risks are borne by the funds provider, or lastly, it could exercised through fee-compensated, customer-directed transaction services such as payments processing.

By changing the frame of reference about what is a bank, you, in essence, change how you view, plan, respond to marketplace developments like web-based crowdfunders, such as Prosper or Lending Club, or payments innovators, like PayPal, Bluebird, or virtual currency creators.

Certain observers of the peer-to-peer lending landscape, for example, have characterized the activity as a major threat to the banking industry - Too Big to Disintermediate? Peer-to-Peer Lending Takes on Traditional Consumer Lending   And as long as bankers consider this activity as separate from their existing preconceptions about the form of a bank, peer-to-peer lending could indeed be considered a growing threat.

But if bankers consider the activity consistent with the function of banking and treat it as a logical, technology-driven evolutionary development in the growth of banking itself, significant opportunities abound.  The opportunity to embrace it, subsume it, and add it to your menu of banking services is there.  

Some banks, like Titan Bank of Wells, Texas, BBVA Compass, and Congressional Bank of Bethesda, Maryland are dipping their toes in the water and are taking what are being characterized as small, calculated risks through partnerships with existing peer-to-peer lenders.

In an ideal government setting, however, the legal form of the banking charter granted by that government would slowly follow the evolving functions of banking in the financial services marketplace, so that proper and consistent prudential and consumer protection regulation can be applied to all providers of the same financial services.

In the United States, the powers granted by a bank charter are explicitly grounded in the Federal enabling legislation for federally-chartered banks.  Under the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), state-chartered banks are limited to the powers granted to federally-chartered banks, unless the FDIC approves exceptions on a case-by-case basis.

The time may be ripe for some bank charter reform.  While the political will is lacking, the mechanics of legislative bank charter reform could be as uncomplicated as changing the word "and" to "or" in a few places, and revisiting the corporate powers of national banks in 12 USC 24, including the incidental powers provision.

This would provide bank regulators a green light to cast the net wider and say to certain players in the shadow banking community, your activities are identical to, or closely resemble, what we have now legally defined as "banking".  You must now obtain a state or federal bank charter to conduct your business.  The result being, taking some of the "shadow" out of the new technology-driven shadow banking models.

There are some who have mused that shedding the traditional "strict constructionist" mindset of the existing national bank charter definitions and showing an innovative, well-reasoned and plucky application of administrative discretion, Tom Curry, the present Comptroller of the Currency and the chartering authority of federally-chartered banks, could obtain a roughly similar result.

Though he approached a similar issue from a completely opposite direction (deregulatory), does anyone still remember the feisty Comptroller C. Todd Conover and the "non-bank bank" controversy of the 1980's?

None of these new Web 2.X entrants into the shadow banking arena, at this point, present the kinds of macro-level financial stability concerns that would snare them into the orbit of the Financial Stability Oversight Council (FSOC) and thereby subject them to prudential supervision by the Board of Governors of the Federal Reserve System.

But their presence does undermine the concept of "competitive equality" in the marketplace for financial services.   Ideally, all providers of similar financial services should compete on as level a playing field as possible.  That includes all bearing the weight of their regulatory obligations equally.

The growing divergence between banking's legal form and de facto function, if left unchecked, will leave today's banking charter a slowly atrophying and increasingly irrelevant animal; condemned to living out its days in its own sad, dilapidated version of Jurassic Park.  Quaint specimens existing to help inform the world-view of historically-inquisitive visitors.

Monday, March 31, 2014

Stressed Out!

Credit: American Banker

The chart (above) comes from an engaging article by Victoria Finkle in the American Banker entitled Fed's Dodd-Frank Stress Test Results a Mixed Bag for Banks.  The chart lists the Dodd-Frank Act large bank stress test results under the Federal Reserve's most severe adverse macroeconomic and marketplace scenario.

A few observations... First, among these 30 large banks, the adverse scenario stress testing results vary widely.  Second, although almost all "passed" the adverse scenario stress test standard, you can see a significant variance in the degree of vulnerability among the players in the group.  Third, in an efficient market, (hopefully) those vulnerabilities would be reflected in the share prices of these banking giants.  Shares of banks with fortress balance sheets, relative to their peers, should command higher premiums.

Let's read the entrails of these large bank stress test results and talk about a "message within the message" as it relates to a totally different group of banks - community banks.  In particular, the role of stress testing in the context of the rapidly increasing pace of community bank merger and acquisition (M&A) activity over the last few months.

How many potential acquirors use adverse scenario stress testing to determine if a vulnerability discount needs to be included in the list of valuation "marks" when doing due diligence and determining an offering price?   ... particularly if folding in the target bank would weaken the pro-forma combined banking operation in an adverse scenario stress test.

How many potential community bank acquirees fail to include an adverse scenario stress test vulnerability premium  if the bank they are selling is contributing to the strengthening or fortification of the pro-forma combined banking operation in an adverse scenario stress test?  ... particularly if the purchase transaction involves an exchange-of-shares component.   Do you, as a seller, want to leave significant shareholder value potentially unaccounted for and left on the table?

How many potential community bank deal-makers are even looking at adverse scenario stress testing in the due diligence process?  How many model severe adverse scenarios through the balance sheet and P&L of the target bank or model those same scenarios through the pro-forma balance sheet and P&L of the proposed combined banking operation?

Sure, there's the loan, investment security, premises, etc. "markup/markdown" process on both sides of the target bank's balance (and off-balance) sheet, but those are generally in the context of conditions as they exist today.  Marks will likewise be adjusted for as-of date credit quality and possibly risk-adjusted so that those numbers account for required regulatory capital set-asides.  Interest rate risk given vaguely-defined directional assumptions about the term structure of interest rates might also be reflected.  But do the due diligence marks and external macroeconomic and marketplace variables come together in a structured, data-driven stress test?

If so, you wouldn't know it if you read the community bank M&A deal press releases.  These proclamations always seem to fit the same old M&A template - price-to-book value, price-times-earnings, earnings accretion timeframes, cost savings claims, the scope of the geographic footprint, leveraging talent, and, oh yeah, those deliciously vague "synergies".  Remember the definition of synergy from business school?  The whole is greater than the sum of its parts (e.g., 2 plus 2 equals 5).

In the fields of science and mathematics, the opposite of synergy is dysergy. Without solid adverse scenario stress testing in the due diligence process, a bank acquiror may be flirting with dysergy.  In the banking arithmetic we old-timers were taught, 2 minus 2 equals "you are now out of capital".   In dysergistic banking terms, the hole is deeper than the remainder of its parts (e.g., 2 minus 2 equals "a hole deeper than you ever imagined").

How do you integrate adverse scenario stress testing into the community bank M&A due diligence process?  Accept and internalize the fact that stress testing is more than a "best" or "helpful" practice, it is a core analytical competency for those community banks bent on acquisition or open to it.

Guidance and tools are available.  For example, the Office of the Comptroller of the Currency (OCC) provides excellent guidance to federally-chartered national banks and savings associations in two key guidance documents:  Community Bank Stress Testing:  Supervisory Guidance (OCC 2012-33) and Guidance for Evaluating Capital Planning and Adequacy (OCC 2012-16).  Though their requirements are targeted to federally-chartered depository institutions, the underlying concepts are fundamental, universal and generally applicable.

The OCC also provides national banks and federal savings associations access to specific stress testing tools for agricultural loans, acquisition & development loans, individual commercial real estate loans, and a portfolio commercial real estate stress test through its secure web site BankNet.  In addition, OCC's district and national experts are available for technical consultation and are only a phone call away.

Professional support is also available from other sources, including other bank regulatory agencies and trade associations.  There are professional services firms who use call report data to do rough, but reasonable, stress test modeling.  Others use defined data-sets from commonly-used vendor operating platforms.  Others offer true stress test customization at a higher price.

Adverse scenario stress testing should be part of your community bank M&A due diligence "to-do" list and part of your proforma combined operation modeling.  Wise buyers and sellers ought to be adding vulnerability premiums or a vulnerability discounts to pricing models to holistically account for risk, support capital planning objectives, and buttress strategic contingency management imperatives.

Sunday, March 9, 2014

Banks are Social Networks

You might wonder what went through the mind of James W. Marshall, who discovered a gold nugget in the American River on January 24, 1848.  It's doubtful that he fully realized that his discovery would set set off the great California gold rush and the hordes of "49-ers" who would jump start the fortunes of what would shortly become the great State of  California.

Roll the clock forward to early 21st century Silicon Valley, California and what Wikipedia calls Web 2.0 - the second stage of the development of the World Wide Web - characterized especially by the change from static web pages to dynamic or user-generated content and the growth of social networking.  Today, we are living through Web 2.0's own evolution: Mobile Web 2.0 - services that integrate the social web with the core components of mobility - personal, localized, always-on, and ever-present.

The list of these Web-based social networks, though presently dominated by the likes of Facebook, Twitter, and LinkedIn, is growing continuously.  Each is seeking to add value (and riches to their founders) by metaphorically finding gold nuggets in attractive niches within our global social geography.  In the management consultant lexicon, the sponsors of Mobile Web 2.0 are sorting themselves into well-known commercial categories - scale players, niche players, and the occasionally successful "all-in" risk-takers - the disruptors.

Bankers have not been silent about the rising competitive threats to their industry. The trade publications have long been running warning pieces of the Paul Revere genre ("The British are coming! the British are coming!").  Most pointing out that the banking industry may soon be caught in the middle of a classic military pincer movement... with peer-to-peer lending and crowdfunding threatening the asset side of the balance sheet and the numerous nonbank-sponsored online payments alternatives laying siege to the liability side.

Other authors, like Francisco Gonzalez, Chairman and Chief Executive of the global Spanish bank BBVA, recently raised the starkest of choices:  Banks need to take on Amazon and Google or die He warns that banks need to turn to their vast array of accumulated customer data and leverage it to provide customers "exactly what they want, precisely how and when they need it."

Even others, like the recent article, The Next Big Thing You Missed:  How Starbucks Could Replace Your Bank, focus on the creeping encroachment of bank-like services like prepaid card channels and Lego-like snap-together banks, like Simple.

Almost everyone in the industry is raising red or yellow flags about what I'll call an emerging synthetic banking system.  Don't even bother to paint the emerging competition as "shadow banks", these "synthetic banks" are perfectly prepared to fight hand-to-hand combat in the bright sunshine of both Main Street and Wall Street.

Unfortunately, the odds may favor the invaders over time, as they have neither the ponderous weight of government banking regulation, nor high sunk-costs in legacy operations.  Akin to that of ancient Rome, the invaders may also be aided by the inertia of our industry's business culture - where, inevitably, denial always precedes defense.

What's a classic bank to do?  The famous general Sun Tzu, in his classic The Art of War, advised "Know yourself and you will win all battles".  That self-knowledge should begin with the fact that fundamentally:  All banks are social networks.  Your customers are to you, like "followers" are to Twitter, or  "connections" are to LinkedIn, or "users" are to Facebook.  Your customers are networked to your bank because they have chosen you as a trusted advisor and provider of needed financial services.

In the present stage of the banking industry's Mobile Web 2.0 development, the bulk of the emphasis has been on non-social, vertical networking (bank customer-to-bank).  Because we are talking about confidential financial affairs, this vertical communications channel is both "armored" and "hardened" to provide the requisite account privacy, security and other safeguards.  Within the armored and hardened vertical communication channels, many banks are making great strides in improving customer engagement and loyalty to the bank.

There is also a non-armored and non-hardened part of the vertical (bank customer-to-bank) communication channel that passes for social networking by many banks - the Twitter, LinkedIn, and Facebook fluffy marketing stuff, non-specific customer assistance, financial literacy education, public service announcements, and those happy, giggly posts like "It's Friday, we here at AnyBank want you to have a terrifically enjoyable weekend!"

That's a centralized customer communications model that talks "at" people and not really "with" people.  There is an audience lurking, but unfortunately not interacting among themselves, within 'the social network that is a bank'.

Where is the horizontal (bank customer-to-bank customer) networking?  I'm talking about the kind of horizontal networking that makes the social networks (like Twitter, LinkedIn, and Facebook) so popular and highly-used?  Where is the bank customer-to-bank customer horizontal communication interactions on financial or business topics of mutual or common interest?

If you don't think it is possible to have business-like social networking, just look at the success (and soaring stock price) of  Horizontal social interaction is where 'the social network that is a bank' is not being profitably leveraged enough to check the competitive pressures from both banks and nonbank/synthetic banks.

How can a bank build revenue from these horizontal social interactions?  Consider the power of lightly-moderated online forums.  Let's take for instance, and for the sake of discussion, your neo-entrepreneur customers who run innovative internet-based or "brick-and-click" businesses.  They share a common social bond as far as the operations of their businesses are concerned.

In a lightly-moderated online forum, you would have customers sharing thoughts, ideas, and problem-solving among other people with common business interests and who also share a common financial product provider (remember they are already your bank customers).  This pool of horizontal online social interactions provides an avenue to promote the availability of the bank's credit, payments, treasury, and investment/wealth management services opportunistically in the context of the shared business needs of a specific customer segment.

Moreover, it's also an excellent opportunity to refer customers to vetted outside professional services providers... some of whom may also be (now very grateful) bank customers.  Lastly, it also provides valuable customer feedback on the quality of your own banking products or may reveal gaps in your menu of financial product offerings.  Therein lies the untapped potential of a true social network.

Add a high-touch component to the high-tech approach with occasional physical social events over coffee and snacks, luncheons with guest speakers, or wine-and-cheese evenings to further cement a sense of affiliation and relationship with the bank.

By verticalizing confidential personal financial matters in armored and hardened channels and horizontalizing social interactions among bank customer segments with common interests, both virtually and physically, you have the potential to capture some share of that person-to-person networking allure that the Facebooks, Twitters, and LinkedIns presently offer.

Thinking about your bank as a social network is not a cure for the constant competitive pressures coming from the emerging synthetic banking system, but not losing yardage (and hopefully gaining yardage) can keep you in the game.

Tuesday, February 18, 2014

Officially Distorted


Recent controversy about the officiating at the Sochi Winter Olympics sparked a thought about how the 2008 financial crisis, and the aftermath we are living in today, have, hopefully, only temporarily distorted the traditional role of bank regulators in the marketplace for banking services.

Historically, as a bank regulator and bank examiner, your job was to calmly officiate in the marketplace for banking services.   As a member of a rulemaking body, subject to statutory guidance and notice-and-comment rulemaking, you helped establish the dimensions of the ball field and rules for player behavior.   In your day-to-day job as a bank examiner, you were also an umpire or referee on the field who monitored player behavior, called out-of-bounds play, and penalized some for personal fouls.  And as a corollary part of the job of officiating, you sometimes had to sideline someone from play or, in grave situations, ask the Federal Deposit Insurance Corporation (FDIC) to carry an ailing player off the field on a stretcher.

The game itself, though, was played by teams of bankers, doing what bankers do well - making a visible contribution to a safe, sound,and prosperous banking system that is earnestly attending to the legitimate credit needs of the most powerful economy on Earth.

Like any sports competition, the fans show up to the game to applaud the performance of the players on the field and appreciate the quality of the game play. None of the fans came specifically to see the game officials... except maybe the spouses, kids, or significant others of the officials themselves.

But you pick up any national or banking trade media publication these days and there are tons of copy tilted toward the topics of regulation, compliance, and policing unsavory banking behavior and only a smattering of news coverage about trends, tools, and techniques for scoring the game's goals.

Every fan knows that when the game's center of attention becomes the officiating, there is something grossly wrong with the game.  The game should be about the bankers and not the officials.  Hell, even the officials on the field, diligently doing their jobs, would  prefer the spotlight shine on the players and the goals of the game itself.   How many bank regulators relish the prospect of being summoned up to Capitol Hill for congressional video replays of every close call they make (or should  have made) in the scrum down on the playing field?

Like the Polar Vortex that brought us one of the chilliest winters in recent memory, the regulatory "Big Chill" on the banking marketplace seems to be showing small signs of a Spring thaw.  Although there do seem to be a couple of exceptions to this hypothesis.... the activities of the Consumer Financial Protection Bureau and the continuing gang-beating of the global megabanks.

First, while there is still much to do on the Dodd-Frank Act implementation, the outlines of major unfinished rules are generally visible, and there are signs that the rulemaking process is beginning to slowly wind down.  Regulators appear to be just as fatigued with this seemingly endless process as the banking community.

Second, bank enforcement actions are being terminated by regulators at a rapid clip as the level, and direction, of bank prudential risk metrics are improving as banks have finally worked through most of their legacy problems.

Third, bank merger and acquisitions (M&A) activity has been popping in the last few months.  Acquisitive-minded  banks have emerged from their financial storm shelters as the climate seems to be more hospitable.  In 2013, the average unasssisted community bank acquisition crept out of the discount-to-book zone and rose to around 1.2X book value and 25X earnings.

Lastly, based on my unscientific poll, bank consultants, on the community bank beat, who practice in the regulatory relations arena are getting fewer phone calls from bankers desirous of those specific services.  Inquiries now tend to tilt towards corporate governance, regulation implementation, expert witness, and due diligence work.

I think if this "Washington Spring" is real, the roles of the players and the officials should start normalizing over the next three years or so.

Like sports officiating, banking regulation and supervision was not meant to be a public limelight and celebrity status area of professional practice.  The public attention should deservedly go to the competitors in the marketplace.  And again like sports officials, their professional satisfaction should come from being tacitly appreciated for the fair, dedicated, and quietly professional execution of their official responsibilities.