Friday, Apr 23, 2021
Coming out of the Pandemic: Regulatory Expectations of Supervised Banks
As financial systems worldwide look forward to a post-pandemic environment, are bank supervisors setting clear expectations today for their supervised institutions? This Toronto Centre podcast reviews the importance of “Sticking to the Basics” of effective financial sector supervision. Bill Coen, Toronto Centre board member and former Secretary General of the Basel Committee on Banking Supervision, catches up with longtime colleague, Tom Dujenski, an experienced adjunct professor, financial services consultant and retired senior US bank regulator.
Listen to the podcast:
Read the full transcript:
Bill:
Hello everyone, and welcome to our Toronto Centre Podcast. My name is Bill Coen. I'm a member of the board of directors of the Toronto Centre, and I'm the former secretary general of the Basel Committee. I have the privilege of speaking today, with an an old friend of mine, Tom Duchensky. I've known Tom for going on 20 years. We met in Basel. Tom was appointed by the FDIC to come to Basel, to help with the project. Met back then, and we've kept in touch.
And during his long career at the U.S. Federal Deposit Insurance Corporation, Tom was the senior executive. And most recently was the regional director in the Southeast. And this was significant, particularly during the global financial crisis that began in 2008. He was a part of the U.S. that was most heavily impacted by the global financial crisis. Tom is also a managing director for a global consulting firm and a senior director at another consulting firm and is an adjunct professor at the State University of New York. Welcome Tom, pleased that you can join me today.
Tom:
Thank you, Bill. Looking forward to it and thank you for that kind introduction. It's a pleasure to be here and I'd like to thank you and the Toronto Center for allowing me this opportunity to participate today.
Bill:
Tom, what do you see as the biggest challenge in this really unusual environment? It's a challenging environment to begin with with low interest rates, with a FinTech competition, but now we've got the pandemic. So from your perspective, what are some of the biggest challenges facing bank regulators?
Tom:
Bill, in these times it continues to be the uncertainty that surrounds the economy and the continued impact of COVID on the institutions, credit quality, and so on. That's one of the main challenges that are there, the duration of this pandemic, it's really challenging for the regulators and supervisors to manage.
Also, I'd say from a regulatory standpoint, it's making sure that they have an effective supervisory program in place. For example, a lot of the examinations that are being conducted today around the world are being done remotely versus being done onsite. There is some onsite presence from the individuals that I've talked to in the regulatory environment, but most of it is occurring offsite and that presents some challenges.
And I just mentioned two more things. One is the communication. In an environment like this, where regulators are working offsite, bank personnel are offsite and given the volume of changes and the potential challenges from the standpoint of working remotely, communication continues to be an area where the regulators need to focus and make sure they're communicating, and also from the base, communicating that regarding. The last point I'll make, Bill, and response to your question would be, is that regulators are ensuring that board management and their supervised institutions are meeting the regulatory expectations for operating a bank in a safe and sound manner.
Bill:
Tom, on that last point, I kind of smile when I hear meeting regulatory expectations. My former career as the secretary general of the Basel Committee, this question came up quite often. I think people like you, and I know what regulators expectations are, but the banks, the trade associations, people on the other side of the table would always kind of scratch their head and they'd say, "Well, what do you mean by this?" So, Tom, what did you mean by that?
Tom:
Yeah, Bill, when I think about regulatory expectations, it's really the ability of the supervisors to remind the institutions, particularly in this environment of uncertainty, about what good governance and risk management practices are. I often refer to, Bill, as sticking to the basics. And when I say that, I mean to really the goal should be to help the supervised institutions navigate this environmental stress and the challenges they're facing.
In general, I'd recommend that the supervisors, again, remind their institutions, maintaining appropriate levels of capital that may have changed given the credit quality and some of the other issues that they're facing. Adequate liquidity during a crisis is always a challenge and needs to be monitored to make sure what was adequate liquidity before the event transpired may no longer be the case.
One of the fundamentals is good asset quality. Ensuring that the institutions do have good asset quality and that they have a good management team. And, I'd go one step further, Bill, and say that reminding organizations to continue their leadership as far as environmental, social, and governance and leadership in those areas.
Bill:
Yeah, Tom, I agree. The ESG topic is certainly here to stay. We hear so much about climate risk and transition risk and sustainability reporting. So I think you're right, but you just mentioned capital liquidity, maintaining a good asset quality. There are a lot of things here. What specific areas do you think regulators ought to stress to their banks?
Tom:
And, Bill, what I would do is encourage the regulators to maybe focus on what I consider some very important areas that go beyond the capital asset quality. Those would include things like reviewing and revising their strategic plan. We already mentioned about board and management assessing the quality of their team. It's really important at this stage of the game that institutions are assessing their international risk and cross border exposure and you know better than anybody, the core principles for effective supervision put out by the Basel Committee.
They talk about identifying, monitoring and controlling both country and transfer risk. And that could be a real challenge in this, depending on how different countries and marketplaces have been impacted by COVID. I've mentioned three more areas that I think are really important for the regulators to stress is to make sure institutions have a good credit culture in place to revisit that in light of the current environment. There's no question concentration limits need to be reviewed both from a standpoint of loans, securities and off balance sheet items and funding.
What might have been in place, Bill, with respect to concentrations, as far as policy limits, those should be reviewed and revisited and make sure they're communicated to everybody. And the last area that I would say would be very important would be increased due diligence and oversight of third-party risk. The COVID and the crisis has impacted the individuals and companies that you've been dealing with, and the banks have been dealing with as far as their activities also.
Bill:
Yeah, Tom, thanks. I'm going to emphasize something you mentioned a moment ago and this is the strategic plan. You mentioned the strategic plan, you mentioned culture and a few other things. I can't emphasize enough how important that is. I spent most of my career in Basel working on Basel III and trying to find the right calibration or the right level of the output floor and things that are really important. And the banks know how important they are, because that's where there's a real financial impact. Do they have to maintain a high level of capital, they have to maintain a higher level of liquidity?
But when there's so much attention on those metrics, what's really easy to overlook things as basic and just as important, if not more important like strategy and like culture, how do we get banks as regulators, supervisors, how can you get banks to really focus on that? What's the best way to communicate, to supervise banks that banks really needs to pay more attention to this. Bank really needs to engage more deeply on something like for example its strategic plan.
Tom:
Yeah, Bill, one way to get institutions to really focus on it is to share with them the failures that have occurred, and based on my experience being really at the epicenter of the crisis here in the United States, as far as the downturn in 2008, I can tell you there's many examples for institutions who have not performed strategic planning properly. If you'd like, I would love to be able to share with you some of the things that they should do with respect to their strategic plan.
Bill:
Yeah. That'd be great. What do you think, Tom?
Tom:
I would say we all know that the strategic plan really lays out the foundation for an organization to move forward. Right now, Bill, too many people are busy with the day-to-day operations of their institutions and maybe distracted from this important area. And I'm saying it's always important to do strategic planning, but in light of the current circumstances, there's no question that an organization should be devoting the resources to strategic planning.
I would say it's a good opportunity to revisit their goals and objectives. Look at what's now their current operating landscape and look for opportunities and threats that are occurring. I would even get into looking at a specific industry if I was to pick two examples of what I mean by that. I mean that the institutions now really need to take a close look at the industries and the marketplaces they're dealing with. For example, I'm going to mention CRE and the hotel industry.
Bill:
What's CRE?
Tom:
The commercial real estate market. And as you well know, Bill, for example, we're seeing those with department stores, retail centers, and you see it in the headlines across the world. Department stores are significantly impacted. What we call malls or retail centers. A lot of the businesses have been impacted and are no longer paying rent in those locations. And many of the department stores themselves have gone bankrupt and it's impacting their ability to participate and pay rent and function in certain markets.
The hotel industry, let me shift to that a second. Somebody might come across as an institution say, "Well, the hotel industry has been significantly impacted." However, I would say that if you were to dig into the hotel industry, you might find that your luxurious towns have been impacted significantly during this last year, year and a half versus the budget hotels. And it might cause you to, through the strategic planning process to shift your lending programs and actually result in some underwriting changes in your organization.
Bill:
Thanks, Tom. During your career as an examiner and then as the guy in charge of an entire district. Let's say you go into a bank and you say, "You really need to update, you really need to revive your strategic plan," and the CEO or the board members, they start to roll their eyes because this is something at the FDIC told them that they should do, I don't know, a year ago, two years ago, three. And what's the right amount of time? How often would you advise banks to review and revise if necessary their strategic plan?
Tom:
The way I would approach that is first off to answer your questions as far as timing, it should be looked at every year. And if there's a significant event that occurs in between such as the pandemic, I would say that that is time to get your leadership team together and to revisit those areas. And the way I would stress it to them is there are cases of institutions that have appeared as problem banks and failures because their organization did not do proper strategic planning.
They did not allocate their resources properly as a result of a crisis or a downturn, and they didn't reprioritize goals and objectives. And if I could just have one more thing, Bill, on that, oftentimes there's an increase in problem assets. And by going through that strategic process, you need to identify where you want to allocate your resource and whether or not you need to shore up areas.
One of the most common areas that gets left behind is loan review. You should have a robust program in place now with proper staffing, not after the problem assets occur, but now so that you can get into risk identification. But the simple answer, Bill, is to share with them the many examples of, in generic terms, banks and institutions that ended up on the problem bank list or failed because they did not do proper strategic planning.
Bill:
Yeah. I completely agree. And I think it's so easy to fall into the trap of, when you're having this myopic approach worrying about the day-to-day operations or looking ahead no further than one quarter, and it always makes sense to remind senior management in boards that they continuously need to think about the direction which they're going and their strategic plan. I think that's a really important topic, Tom. Thanks for your views on that.
Let me shift gears a little bit. I want to pick up on something you said earlier, and that's, you mentioned a review of the board and management qualifications. You also mentioned the Basel Committee core principles. Of the 29 core principles, there's one specifically on licensing that talks about, in Basel Committee parlance that's fit and proper. So what are your views and during your long career, thinking about the fitness and the propriety of the board and senior management, how should we think about this and how do regulators get a point across to the bank about the qualifications of the board and management?
Tom:
Bill, that's a very good question with respect to assessing the qualifications of board and management. As you go through that strategic planning process that we talked about earlier, one of those things that will become self-evident is do I have the right expertise for where our organization is heading as a result of this crisis and what expertise do we need? And I would say this, self identification is what I would stress as regulator to my institution is much better than having the supervisors come in and find weaknesses or shortcomings to the management team. I know it's a sensitive issue, but it's certainly better to self identify, and that is where I would sell it to the institutions.
Bill:
So in other words, better to point out your own weaknesses rather than have the examiners, the supervisors come in and do it for you. Yeah, I completely agree.
Tom:
And, Bill, if I may add on that, I'd say that resoundingly it's much better and it comes across much better to the regulators when an institution says, "Hey, look, here's where we are. We're in process of staffing this area. We understand that our back room operations loan review workout staff needs to be increased and we're in process of doing that." But the other advantage of doing that, Bill, is as a result of this crisis and the pandemic, there might be some things that have triggered in succession management and contingency planning that have really become evident to management. And this would be a good time to visit that as part of your review of board management qualifications.
Bill:
I like these topics about assessing board and management qualifications, encouraging the board and management to look at the strategic plan on a regular basis. Something else you mentioned, Tom, credit culture. I chaired a group when I was in Basel that revised the Basel committees corporate governance guidance for banks. And that this was a really interesting discussion. First of all, as a supervisor, trying to make an assessment of culture and then comparing culture across a range of banks. And there were some organizations around the world, I think of the Dutch, they do a fantastic job at trying to assess culture. How about you, Tom, from your perspective, what are your views on trying to make an assessment of credit culture within an organization?
Tom:
You know, Bill, the credit culture of an organization and looking through some of the stuff that you've done from the Basel Committee and so on, it really starts at the top of the organization. There is no question in the quality of the team that an organization has in place. Whether or not an organization has good underwriting in place and they're adapting that underwriting for the changes that are occurring in the marketplace. Not just that, but we've had two really important things happen. I mean, they're obvious, but they deserve repeating.
That is we've had a downturn in the economy which has impacted lending. And I'm not sure the full extent of the problems have been realized yet because of various government systems programs, et cetera. But also we have a lot of people in financial institutions working in a remote environment. And as a result of that, it's really important how an institution communicates and makes sure that its people are understanding the risk appetite and the culture of the organization.
And that may have changed pre-crisis to now. There's no question in the organization the risk appetite has changed at various marketplaces in various areas. And there's no changes, tweaks, and the training program need to be done. What was taken for granted, Bill, in an organization prior to the crisis, as far as their training program, for example, well, if I'm a regulator around going look at the credit card, I'm going to look into training program. Have they adapted it so that people are being reinforced on what the policy changes are? These new government programs, any new regulations and any new lending areas that you have. And you have to adapt the banks' training programs in order to maintain that strong credit culture.
Bill:
Thanks, Tom. I said earlier, we're in an unusually challenging environment for banks. And of course, if the environment is challenging for banks, it's equally challenging for bank supervisors. As the world, hopefully very soon comes out of this pandemic, then we'll really start to see the effects on economies, on local economies and on banks. Tom, we're almost out of time. I'm going to give you the last word, give us some closing thoughts, please.
Tom:
I'll give you three last thoughts, I would say that are important. First off, I can't stress enough the importance of reminding the institutions to review their credit culture and the risk appetite and to perform good strategic planning. The second point I have is I would tell institutions, please take a look at the partnerships that you have. What do I mean by that? Make sure you're participating in peer group analysis, looking for best practices amongst institutions that are your peers.
The benefits to that I hear time and time again, really help organizations move forward. Take advantage of your trade association and professional organizations as far as the training. And I would say, don't forget to communicate with your regulators. Nobody likes surprises, and during a crisis that goes both ways. The regulators should be communicating what their expectations are on the banks should be communicating with regulators any issues or concerns they have.
And the very last thing I would say from a regulatory standpoint, I'd be encouraging my banks to start preparing again for onsite examinations, getting their contacts in order. And from a regulatory standpoint, I may have changed some expectations or formatting of things of what's required on examination. I would really encourage my institutions to start preparing and communicating with the regulators prepared for those examinations.
Bill:
Excellent, Tom. Thank you very much for your time today. It's always good to speak with me. I appreciate, Tom. We'll talk again.
Tom:
Bill, always a pleasure. Thank you, sir.
Bill:
Bye.