With President-elect Barack Obama reasserting he will reform a "weak and outdated regulatory system," and the FDIC calling for more information about how the 5,000 banks it regulates are using billions of dollars in government aid to help struggling homeowners avoid foreclosure, banks face a larger regulatory challenge: answering to their new government and taxpayer shareholders without creating a vast and costly bureaucracy.
According to a new report from Diamond Management & Technology Consultants (NASDAQ:DTPI), banks that are participating in the $700 billion Troubled Asset Relief Program (TARP) need to be proactive about adding capabilities to cope with a new regulatory environment. For starters, Diamond suggests establishing a Regulated Market Office, a nimble, cross-disciplinary SWAT team that can help banks address new issues beyond their traditional compliance efforts.
"A bank's response to TARP should include widespread initiatives that will need to be closely coordinated in a transformed regulatory environment," says Rachel Parker, an author of the report and a partner in Diamond's Financial Services practice. "Setting up a Regulated Market Office (RMO) can leverage the strengths of earlier compliance investments while avoiding expensive pitfalls. In most cases, existing compliance structures will not be sufficient to manage the new set of shareholder requirements."
John Erik Garr, an author of the report and a partner in Diamond's Public Sector practice, added: "The only certainty in Washington about financial services regulation is that more is coming. A Regulated Market Office is a first step for banks to get ahead of emerging regulatory issues and help participate in future legislation, determine what data regulators will need, and what different types of reporting will be necessary."
To obtain a free copy of the complete copy of Diamond's report, "When Taxpayers Become Bank Shareholders," send an email to TARP@diamondconsultants.com.
"Our problems are rooted in past mistakes, not our capacity for future greatness."
This quote, a broad statement from Mr. Obama's Jan. 8 speech at George Mason University, can also be applied to specific problems in the banking sector. In its new report, Diamond recommends an RMO approach that utilizes lessons learned from the corporate response to the Sarbanes-Oxley Act earlier in the decade. While the purpose of Sarbanes-Oxley was to establish a more uniform set of rules for corporate accountability and disclosure, execution was too often hasty and overly expensive.
"In the RMO setup, a 'regulatory controller' would lead a relatively small, nimble team with deep finance, analytical, and technology skills-and this would go over and above the traditional compliance function," says Jeff Hesse, the managing partner of Diamond's Financial Services practice. "This group's leadership must be capable of maintaining high-profile relationships with C-level executives and a new breed of regulators."
An RMO would act as a central point of contact with government supervisors and maintain constant communication with the regulatory, compliance, and legal communities, according to Diamond's report. The office would also be responsible for coordinating multiple internal business unit functions to ensure compliance with all regulations and reporting requirements. It should have significant influence on a bank's technical architecture due to the need for consistent and clean data to evidence compliance.
Proactively Navigating a New Framework
The Government Accountability Office (GAO) weighed in on regulatory reform with a Jan. 8 report that reinforces the reality that banks require the means to address operational, policy, reporting, and technology issues raised by TARP-and to keep ahead of problems.
The GAO cites nine characteristics that should be reflected in a revamped regulatory system. In other words, the current requirements for TARP are only the beginning, and banks will need to meet these regulatory challenges without hindering operations or hurting profitability. But assuming a constantly evolving financial landscape, smart institutions will develop RMOs and call upon them to regularly monitor the following areas to gain greater insight into what the future will hold:
- Upcoming guidelines, rules, and procedures of pending programs - The Capital Purchase Program is now in flight. The RMO must constantly adjust to TARP guidelines for this program, and must also monitor evaluation criteria and explanations for other programs that will continue to evolve.
- The new administration's transition team - The Obama administration will demand a high level of transparency. As more formal documentation of the administration's plans is promulgated, banks need to evaluate comments by Timothy Geithner, Lawrence H. Summers, and the rest of the new economic team as a way of anticipating new demands.
- Regulations in other markets and industries - The financial crisis is now a global predicament and other countries will inevitably establish their own national compliance policies. The RMO will need to monitor conditions abroad, their impact on U.S. markets, and the implications for global institutions.
- Public Perceptions - The attitudes of the media and public interest groups toward re-regulation, corporate citizenship, and perceived abuses of taxpayer-funded support can have a profound impact on company performance. Monitoring attitudes and avoiding perception problems can help banks maintain healthy relationships with customers, investors, and regulators.
Parker emphasizes that the RMO is a single piece of a much larger puzzle. "But it's an element that will likely play a significant role in maintaining a bank's financial health."