Tightening the Screws

The Wall Street Journal reported today that regulators are increasing the scrutiny over U.S. financial institutions as Congress debates the future of the regulatory system.  This certainly comes as no surprise given the state of the economy, but many of the banks are not comfortable with the new pressure.  Here is what the WSJ had to say.

Federal regulators have escalated the number of wounded banks they have essentially put on probation, with some of the targeted banks complaining that the action is too harsh. The Federal Reserve and the Office of the Comptroller of the Currency, two of the primary U.S. banking regulators, have issued more of the so-called memorandums of understanding so far this year than they did for all of 2008, according to data obtained from the agencies under Freedom of Information Act requests. The sharp increase comes as Congress considers changes proposed by the Obama administration that would overhaul the way the U.S. government oversees banks. Many bankers and analysts believe those changes would result in an even more assertive regulatory apparatus. Regulators have been criticized for going too easy on banks and securities firms.

Regulations and their associated risk will continue to rise into the foreseeable future.  How banks respond and proactively adjust to the risk will determine who thrives, who just survives, and who fails.

Alphabet Soup of Agencies

A recent op-ed article in the Wall Street Journal by professors from Columbia and Harvard Business Schools provides a view on the political impact on financial regulatory reform in the United States.  Here what they had to say about the missed opportunity in the current proposal by the Obama administration.

For political reasons the administration has decided not to upend the current system. Instead it proposes four federal entities—Financial Services Oversight Council, the Office of National Insurance, the Federal Consumer Coordinating Council, and the Consumer Financial Protection Agency—on top of the current alphabet soup of regulatory agencies. This is a shame. We need fewer, not more, regulators. The Committee on Capital Markets Regulation, a private, nonpartisan organization on which we serve, recommended in its May report that serious consideration should be given to the creation of a unified supervisor, such as a U.S. Financial Services Authority, modeled on the approach of the United Kingdom. Our financial system has had a complete meltdown and our outmoded regulatory structure is partially responsible. This is the time to redesign the system for the future, not for politics as usual.

Reduced complexity and more accountability will result from a streamlined regulatory system.  The professors should take their case to Capitol Hill.

S&P ERM Criteria to be Released Soon

A recent article in Treasury & Risk Magazine discusses the incorporation of ERM reviews in credit ratings by Standard & Poors.  These reviews have been a part of ratings reviews in the financial services industry, but now are being extended to non-financial companies.  Criteria for these reviews will be released soon as discussed in the excerpt below.

“Most companies these days recognize the value of risk management,” says Dale Hall, vice president and chief actuary at Bloomington, Ill., insurer Country Financial. But he says for a lot of them, it’s still mostly in the “should do” category.  Steve Dreyer, an S&P managing director who heads the ERM global integration project, says, “This is something we’re doing very deliberately and carefully.”

The plan is not for some kind of “big bang,” Dreyer says. Rather, S&P’s analysts, in the normal process of their reviews, are talking with corporate managers about risk management and developing criteria and a methodology, which will be published before ERM ratings are actually offered. “We’re getting the lay of the land,” he says. The target date for publishing the criteria to be used for risk management ratings is the third quarter of 2009.

Is your company prepared for these reviews?  If not, Wheelhouse Advisors can help.  To learn more, visit www.WheelhouseAdvisors.com.

The Middle Path to Financial Regulatory Reform

Last week, a high-profile group of investor advocates published a report that provides practical recommendations on how to reform the U.S. financial regulatory system.  Known as the Investors' Working Group (IWG), this independent, non‐partisan panel was formed to provide an investor perspective on ways to improve the regulation of U.S. financial markets.  The group is led by former SEC chairmen William Donaldson and Arthur Levitt and, among other things, recommends establishing a Systemic Risk Oversight Board rather than placing this responsibility in the hands of the Federal Reserve.  Here is a summary of their proposals.

1. Designating a systemic risk regulator, with appropriate scope and powers. One option would be for the Systemic Risk Oversight Board to evolve into a full‐fledged regulator.


2. Adopting new regulations for financial services that will prevent the sector from becoming dominated by a few giant and unwieldy institutions. New rules are needed to address and balance concerns about concentration and competitiveness.


3. Strengthening capital adequacy standards for all financial institutions. Too many financial institutions have weak capital underpinnings and excessive leverage.


4. Imposing careful constraints on proprietary trading at depository institutions and their holding companies. Proprietary trading creates potentially hazardous exposures and conflicts of interest, especially at institutions that operate with explicit or implicit government guarantees. Ultimately, banks should focus on their primary purposes, taking deposits and making loans.


5. Consolidating federal bank regulators and market regulators. Regulation of banks and other depository institutions may be streamlined through the appropriate consolidation of prudential regulators. Similarly, efficiencies may be obtained through the merger of the SEC and the Commodity Futures Trading Commission (CFTC).


6. Studying a federal role in the oversight of insurance companies. The current state‐based regulation makes for patchwork supervision that has proven inadequate to the task.

This report offers a middle path on many issues under debate today and may prove to be the best way forward for all involved.

Key Risk Indicators Provide a Full View

Over the past few years, companies have become enamored with key performance indicators ("KPIs") as a method for improving their operations and bottom-lines.  However, when viewed in the short-term, KPIs are only one side of the coin.  To have a full view, companies must understand their key risk indicators ("KRIs") as well.  Here is a recent viewpoint from Ventana Research.

Key Risk Indicators (KRIs) are emerging as an important element of performance management. This reflects the times, since corporations tend to pay closer attention to understanding and mitigating risk during a crisis or a tough business environment. In a challenging business environment, KRIs are becoming increasingly important because they are an important complement to Key Performance Indicators (KPIs). KPIs are related to the most important business objectives. They indicate the degree to which individuals, business units or companies are achieving them. KRIs are specific events or root causes that prevent achievement of performance goals.

Does your company have a full view through KPIs and KRIs?  If not, Wheelhouse Advisors can help.  Visit www.WheelhouseAdvisors.com.

Holes in Risk Management & Compliance Programs

As the current recession continues into its seventh quarter, many companies are living on the edge when it comes to risk management and compliance.  To conserve cash in the short term, a company will often forego investments in risk management and compliance because it does not bear an immediate return to the bottom line.  While this may be true, the ultimate value of solid risk management and compliance  is in its ability to avoid catastrophic losses or major impacts to a company's reputation.

Southwest Airlines is a case in point this week as its weak compliance practices have been brought to light through a faulty fuselage that imperiled a flight and its passengers.  On a flight from Nashville to Baltimore, the airplane suddenly developed a hole in its fuselage that caused the cabin to lose pressure and forced an immediate emergency landing.  Here is what was reported in the New York Times about the incident and subsequent investigation.

The National Transportation Safety Board has sent an investigator to the airport in Charleston, W.Va., where the 15-year-old plane landed, to inspect it and determine what caused the failure in the fuselage at cruising altitude. Representatives from Boeing and the Federal Aviation Administration are helping in the investigation. The event could have been catastrophic, and an F.A.A. spokesman, Les Dorr, said Southwest was being prudent to examine its airliners immediately. More sophisticated analysis will have to wait for details to emerge from the investigation, he said. “In the absence of any identified problem in the top of the airplane, that’s all you can do,” Mr. Dorr said.

In March, the agency ordered Southwest to pay a $7.5 million fine for a series of safety violations in which its jets were flying with undiagnosed fatigue cracks. The investigation against the airline, based in Texas, also uncovered efforts by managers at the F.A.A. to cover up reports of maintenance problems at Southwest.

As companies continue to sacrifice safety and reputation to protect the bottom line, more reports such as these will surface.  However, a proactive, cost-effective risk management and compliance program can help companies avoid "holes" in their approach and maintain a significant competitive advantage over the long-term.

Early Preparation is Critical

An article in Wall Street Technology this week emphasizes the need for financial institutions to prepare for the coming wave of new rules and regulations.  Here is a sample of their view.

The Obama administration's new proposals to regulate the financial industry, which respond to calls for greater transparency and oversight, will completely overhaul the way Wall Street firms operate. But even while specific regulations still are being mapped out, it is vital for financial institutions to prepare now to comply with any new rules that may be coming down the road.

Brian Cummings, director of information risk management, Tata Consultancy Services, North America, agrees that it is more essential than ever for firms to consolidate their risk and compliance efforts, rather than to just bolt on new tools. "You can't have IT doing its own thing and accounting doing its own thing too," he insists. "You need to take an enterprise view of risk management and consolidate your efforts." Then firms can use the appropriate tools to analyze their risk exposure, Cummings continues. "That's powerful, as trying to do it on an ad hoc basis makes it very difficult to get a grand view of where you are," he says.

A streamlined, efficient approach to enterprise risk management can yield great cost savings and provide firms with a true competitive advantage over rival institutions.  Wheelhouse Advisors can help craft a cost-effective plan for your company to implement an integrated enterprise risk management program.  Learn more at www.WheelhouseAdvisors.com.