It’s very easy to put yet another missive on better risk management at the bottom of the to-read pile. Don’t, though, miss the OCC’s new blast. As the in-depth analysis sent to you today makes clear, this blast isn’t from the past – the OCC is telling the banks it supervises that henceforth they must not only wear hazmat suits, but also keep themselves closely confined to the rubber room. Think utilities, think now.
I draw this conclusion from a close read of the proposed guidance. It demands that banks set forth “risk-appetite” statements – a cliché in regulatory parlance – but then goes on to make clear that, for the largest national banks and savings associations (and those owned by big parents like AIG) this appetite must conform to a macrobiotic diet or, maybe, a slim-shake every now and then. The appetite must keep the bank well within its capital and liquidity buffers, not use these as now allowed to cushion against unanticipated risk.
Further, every “front-line unit” – a term defined to include not just profit centers, but also critical operational units like Treasury and legal – must make compliance with the risk appetite their daily diet. No chocolate truffles unless breakfast, lunch, and dinner have been foresworn. Temptation to take a truffle now and then is to be forbidden by empowered risk managers and auditors, backed by a newly-formidable, independent board sworn to separate the bank from its parent should the parent breathe a word of risk.
Once you read the OCC’s proposal, the first thought you may well have is to find out fast about getting a state charter. But, it’s not just the Comptroller who’s putting big banks on notice. In Davos last week, big-bank CEOs got a very stern talking-to from a host of global central bankers. They were, I’m told, taken to task because of the revelations in recent investigations into one benchmark-rigging scandal after another – case after case, the central bankers said, in which high-level pronouncements about enterprise-wide “cultures” came crashing into the inability of traders to cut a quick deal if there’s something in it for them. The bankers promised to do better, but this time the regulators were having none of it. They put the banks on probation, although what might happen next was largely left unsaid.
Is this wrong? It’s certainly understandable given the excesses in many banks before the crisis and the continued ability of units nominally charged with prudence to take London-Whale size risks. The industry has brought itself to this place because the Comptroller – whose own agency has little credibility to spare – has concurred with widespread public opinion that big banks simply can’t be trusted on their own to balance risk and profit to ensure a sustainable, sound banking system.
I think regulators are right to err on the side of super-prudence if they are forced to choose between shareholder profit and financial-system stability. The trillions in economic output and all the other macroeconomic and personal hardships visited on the globe in the wake of the financial crisis – not to mention rumblings of new ones – show starkly why public policy has to demand top-down adherence to sound risk-management standards.
But, just as with dieting, there’s a balance to be considered. If regulators make banks safe at all costs, banks will be like anorexic teenagers who are thin at great cost. Non-banks will grow fat as banks are forced to push away from the table and grow weaker and weaker because they are confined to ever-less profitable businesses.
What is the new business model for sound banking? No one knows because strategic thinking has been largely confined since the crisis to commenting on proposal after proposal, with little thought to their total franchise impact. The OCC’s proposal may well be consigned to the low-level staff who ordinarily correspond, if anyone does, on proposals packed with demands for policies and procedures. Step back, though, and the real challenge for CEOs looms large.