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How to ensure transparency and credibility in banking

The foundation of trust created by banks such as JP Morgan and Goldman Sachs, has taken a real battering lately as a result of sub-prime loans, collateralised debt obligations and credit default swaps. 

The last two years especially, have taken their toll on consumer faith in the banking system. This is entirely understandable given the fact that we have seen whole countries descend into financial chaos and even bankruptcy, with some even having their sovereignty rating downgraded – as has been the case with Spain, Greece and very nearly the UK.  

As such, now more than ever banks need to act to regain and bolster trust, and to do this they need to be transparent. There are a number of ways they can go about doing this. 

Be proactive in communication to stakeholders:

The culture of keeping their cards close to their chest is no longer acceptable when it comes to a banks finances. Given what has happened recently, banks need to be completely transparent and keep stakeholders apprised of their finances to re-assure them that they are in the best fiscal health possible. Furthermore, stakeholders are keener than ever to be made aware of the key business decisions being made which could impact this, so that they know what is going on and be reassured that the business is being competently run.

Publish financial information and make it easily accessible:

In keeping with the spirit of openness, banks need to make their liquidity, credit and market risk information available to consumers, regulators and stakeholders – as well as to various banking partners who will want to know how beneficial a partnership with an organisation is, and what the counterparty risks are likely to be. Only by being completely open can banks start rebuilding this trust, but more importantly the system-wide trust, which is essential for the financial eco-system to succeed and regain its former solidarity and strength.

Support the business with the right infrastructure:

Ultimately, the success of a transparency initiative hinges largely on technology. Real time liquidity and management systems are a must, as are systems which can effectively measure systemic and interbank risk. As more banks participate and release their information, such risk will be easier to calculate and track online. The development of a reporting system and information dissemination process would be the final piece in this transparency puzzle, allowing information to be easily reported and interpreted in a consumer friendly format.

Confidence in the banking industry takes years to build and seconds to destroy.  As such, now more than ever, banks need to act to regain market confidence and re-build lost trust.  Not only should they publish these results but they need to make sure they are continually re-enforcing the positive messages and communicating them to the market. Banks need to shout their successes from the rooftops and discuss their results and financial standings, so stakeholders and consumers know that the industry is in good shape and in no danger of falling victim to another financial crisis. 

In today’s world a handshake from a leading financial institution is no longer enough, information needs to be harnessed and used to drive the transparency and credibility required to sustain trust; and this can only be done by having the right systems in place to provide the necessary insight.

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Comments: (4)

A Finextra member
A Finextra member 15 July, 2010, 16:07Be the first to give this comment the thumbs up 0 likes

I don't fully subscribe to this, in that any commercial organisation would never be this transparent, nor should it be.  It wouldn't be in the stakeholders' interests either for an organisation to be so open about its position, strategy, etc., as it would be giving up their competitive advantage.

However, what should happen is that the institutions should be completely open with the regulator - as used to be the case with UK clearing banks being accountable to the Bank of England.  we need to get back to that situation, so that someone, somewhere, can exercise restraint on these organisations.  If people could have faith that they were being controlled by a central, competent and powerful organising body, then that should be enough.

Oh, and we need to see the end to these exotic financial instruments.  I think it is absurd, for example, that a bank can buy insurance against the default of a loan that they granted.  They did the credit assessment in the first instance, and it must be their responsibility to manage that loan (or overdraft) to successful conclusion.  I can't see how an insuring organisation can agree to take on that risk without the kind of credit analysis that the bank should do (or should have done).

Similarly, it must not be possible for them to seel on those loans, packaged up with others in an opaque wrapper.

The availability of both these instruments enables the shifting of liability away from those making the initial decision, to someone else, with all that implies for expanding the business without proper controls.

Get rid of these things, and restore the authority of competent central banks over the banking systems, and confidence should come back.

Ketharaman Swaminathan
Ketharaman Swaminathan - GTM360 Marketing Solutions - Pune 16 July, 2010, 14:56Be the first to give this comment the thumbs up 0 likes

Credit appraisals, based on which a bank grants mortgages, are based on facts from the past / present and assumptions about the future. e.g. borrower's employment status, income. Like anyone else, banks are not perfect crystalball gazers all the time and therefore carry the risk that their assumptions about the future prove wrong. Insurance helps them mitigate that risk. To that extent, I fail to see any basic disconnect between granting a mortgage on the one hand and taking an insurance against default of that mortgage on the other.

Besides, if banks are able to buy insurance, it means someone is willing to sell it to them. By itself, this should suggest that there is nothing fundamentally wrong about this process.

We hear so much buzz around how regulators should stop banks from repackaging dubious assets and selling them off as Triple-A securities. How about some regulations to prevent corporates and financial institutions (e.g. pension funds) from buying such securities, and to ensure that rating agencies really understand what they are rating and don't grant anything better than junk-bond status to them?

 

A Finextra member
A Finextra member 21 July, 2010, 09:47Be the first to give this comment the thumbs up 0 likes

Roger, thanks for bringing in a different perspective. I understand your argument and reasoning behind it however, it is important to remember that in addition to the shareholders; banks and other financial institutions are also trustees of their depositors. Some of whom are small and some big, and also constitute the public at large who have a right to know how their funds are being managed and secured. In addition, considering that when things do take a turn for the worst, and public funds are relied upon to bail out the banks – then it only seems fair that this safety net provided by the public should come with a degree of transparency. As well as ensuring that the depositors’ money is kept safe and that the banks are able to provide them with the best returns possible, it will also provide peace of mind to the investors and public at large.

Furthermore, while exotic and OTC derivatives may not necessarily be bad, there is a need to bring in more transparency in how the risk is assessed on these and how this risk is priced. Similarly, Asset Backed Securities serve a useful purpose, but there is a need to ensure that there is greater diligence in packaging and pricing them, and that this diligence is made transparent to all the stakeholders.

While I agree that compliance to a regulatory framework is a must-have, there is a need to go a step further. That is the need for the whole banking system to win back the trust of all the stakeholders including the public at large. Many people, albeit misguidedly, lay the blame for the ongoing financial crisis entirely at the feet of the banks and weather true or not, this is a PR issue that they need to win at all costs to retain their customers and secure their future.

What is more, this is all very easy to achieve simply by having the right systems in place, and ensuring the data these systems capture is the same data that is reported to the regulators.

A Finextra member
A Finextra member 21 July, 2010, 09:53Be the first to give this comment the thumbs up 0 likes

Ketharaman, thanks for echoing the sentiments expressed in my original write-up. As you rightly pointed out – if there is a demand for an instrument, it will be supplied and hence, it is not possible to wish away Mortgage Backed Securities, CDS’s and CDO’s. I whole heartedly agree that the need of the hour is to ensure that trust is brought back to the system by ensuring greater transparency backed by the appropriate system support.

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