Superintendent Neiman Addresses the Conference of State Bank Supervisors
and The Institute of International Bankers
July 16, 2007
Thank you, Larry, for that kind introduction.
I also want to thank CSBS and the IIB for inviting me. Both have a special meaning to me. For my first day of work on March 5, I had the choice of coming to the office for the first time or attending the annual meeting in Washington of the IIB. Due to Larry Uhlick’s persuasiveness and the importance of international bank issues, I felt it was important to invest the time with the IIB in my first few days. I also used the visit to meet with senior staff of the Conference of State Bank Supervisors.
I know that like me, many of you are new, or relatively new, to your current positions, so I’d like to congratulate you on your roles. And for those of you moving to the US, I’d like to welcome you to New York. If you have never lived here before, you are in for the time of your life. Living here is much better than being a tourist. You will feel like a “New Yawker” in no time!
During the time I have with you this morning, I’d like to provide an overview of our Department from both an historical perspective as well as current priorities --- particularly those focused on risk management. Which I think you will find very much aligned with your own priorities.
Before I begin, I want to share some personal information about my background and experience, so you can better understand my approach and the perspectives I bring to the Department.
I started my career as a lawyer with the Comptroller of the Currency in Washington, DC. After four years, I joined Citibank as Counsel and Compliance Officer in their Money Market Trading Division, where they traded government, municipal and money market instruments. My final position at Citibank was as General Counsel to its Global Equities Group – their effort to expand brokerage and trading activities in the UK and Far East.
I spent a lot of time in London in the late ‘80’s during the time of Big Bang, when the UK was following the US with the elimination of fixed commissions and the adoption of brokerage rules along the lines of our NASD structure.
In 1989, I returned to DC and joined some former colleagues who had established a regulatory consulting practice at Price Waterhouse. Most of my time there was spent developing a compliance practice to support US and foreign banks. I conducted numerous regulatory reviews and drafted several compliance manuals for New York branches of foreign banks.
One of my clients was Larry Waterhouse, founder of Waterhouse Securities, one of the nation’s first discount brokerage firms. I worked with him to establish a national bank to support his retail customer base. In 1994 I left Price Waterhouse to join Larry as his first General Counsel and participated in the introduction of internet trading. In 1996, Waterhouse was sold to The Toronto-Dominion Bank and my role as General Counsel expanded to include assisting TD increase its brokerage business globally, as well as develop its Global Compliance and AML Program. After TD Waterhouse was sold to Ameritrade in 2006, I remained with TD as President and CEO of TD Bank USA, the bank I had helped create back in the early 90’s.
History of NY as Financial Hub and Banking Department
That’s my history, but for the history of New York and the Department, we need to look back just a bit farther- although I promise not to go quite as far back as 1624, when the Dutch West India Co. established the colony of New York!
But I do think a meaningful consideration of our future goals should start with an appreciation of where we’ve been. To operate successfully in the current financial environment, I feel it’s important to first understand how it evolved, so that we can contribute to that ongoing process.
The Banking Department has a long and distinguished record of supervising foreign banks. Canadian banks (and I know several who are here today) entered the New York market shortly after the establishment of the Department in 1851, and laws incorporating agencies of foreign banks were introduced in 1910. Then in 1961, when full branches were authorized, the foreign banking presence in New York really began to take off. And throughout the 1960’s, the increased appeal of overseas markets, combined with the restrictions on the financing of foreign transactions using domestic funds, led U.S. banks to aggressively expand their worldwide operations.
The further dramatic expansion of U.S. banks in the decades that followed changed the character of banking markets around the world and compelled major European and Japanese banks to increase their international activity. As the U.S. dollar became the dominant currency in world trade and international corporations turned to the United States for expansion, their home-country banks recognized the need to follow. As the principal financial center in the United States, New York was the logical entry point for many international banks.
Today, our Department is the primary regulator of U.S. branches and agencies of foreign banking organizations, supervising more than 80% of the nationwide assets held by these entities. We supervise a total of 148 branches, agencies, and representative offices of foreign banks from more than 40 countries, holding more than $1 trillion in assets. As the oldest bank regulatory agency in the nation, the Department also oversees a wide range of domestic financial institutions. These include approximately 300 state-chartered banks and 3,300 state-licensed non-depository institutions, such as mortgage brokers and bankers, sales and premium finance companies, cash checkers, money transmitters and budget planners. The aggregate assets of the depository institutions supervised by the Banking Department are more than $1.8 trillion.
Beyond our traditional regulatory role, the Department also has other unique responsibilities as part of our mission. For example, we operate a Holocaust Claims Processing Office that is dedicated to assisting individuals recover Holocaust-looted or forced sale-assets. From restoring recovered deposits to stolen works of art, the Department has played an integral role in helping to obtain a just resolution for Holocaust survivors and their heirs.So with both an expanded mission and growing assets under supervision, we’ve come a long way since our establishment as a regulatory body over a hundred and fifty years ago.
Regulatory Models and Principles
But New York’s position as the hub for global finance, and the Banking Department’s role as the charter of choice for international banks, would not have developed or endured without the right regulatory models and underlying principles in place.
A. Importance of risk management in a global marketplace
And a key part of the historic regulatory formula behind the market successes in New York is our constant vision to assess and contain risk. I strongly believe that a proactive risk-management posture is precisely the right approach to take because effective bank supervision and profitable business operations is largely about ensuring effective risk management, especially in today’s global marketplace.
This shared concern for risk means that our interests are significantly, although admittedly not perfectly, aligned with yours. Both government and industry want to stimulate an environment of responsible and sustainable market growth - but a major obstacle to this is unidentified or mismanaged risk.
B. Elements of successful risk management: Therefore, our regulatory model is designed to encourage successful risk management through balancing four strategic elements:
- Independence and Experience. The compliance function needs to be insulated from the competitive pressures of business lines. The independence and level of expertise of your compliance and internal audit staffs is a critical component of any successful risk management system. The independence and experience of our examinations also adds significant value here. Perhaps the examination process looks more inviting if you think of us a “free” - but not optional - external audit.
- Sound general principles. The bank’s general operating framework should be specific enough to ensure compliance, and flexible enough to foster innovation. We realize that industry needs guidelines that are clear. Uncertainty in managing compliance-related risk is an understandable concern. We want to encourage banks to step out and design creative solutions that meet their own unique needs. The space to innovate, within the supportive structure of a sound compliance framework, is vital to remaining competitive.
- Targeted specific standards. Even within the context of sound general principles, there may be areas of heightened risk, such as AML, that warrant more precise internal controls and regulatory standards. I’m not talking about a general standard of zero tolerance in all cases - I simply mean that elevated risks deserve specific standards and oversight. Such specific rules can function as familiar signposts in an increasingly diverse regulatory landscape, and compliance shouldn’t be merely a mechanical exercise. The goal isn’t to jump through hoops just to satisfy the letter of the law. Banks can benefit from precision-crafted rules: they can level the playing field and help ensure that banks voluntarily adopting best practices are not disadvantaged when compared to less scrupulous competitors.
- Management of conflicts. The final piece of a sound risk management program involves the identification and management of conflicts of interest. These conflicts can occur on many levels: some are between the institution and its clients, while others may exist between various clients. For example, compensation structures that increase production may at the same time encourage sales staff to steer clients into inappropriate products that benefit the firm or benefit one client over another client. Vigilant monitoring and self-assessment by the institution is needed to identify and manage these emerging concerns.
When we at the Banking Department design our regulatory strategy, we focus on these same four ingredients of risk containment that you as bank officers face on the front lines every day. However, your task is especially complex, because it involves coordination and compliance with the laws of more than one country.
C. The role of supervisory dialogue in risk management
Support from your home office is critical to both your success and our success as regulators. We rely on your home regulators to partner with us, and I’m pleased to say that we enjoy a significant level of cooperation, through memorandums of understanding, sharing agreements, and other policy statements, with authorities in 17 countries that have diverse regulatory structures. But this cooperation also depends upon meaningful communications between you and your home office. Your home office needs to be supplied with sufficient information to understand and monitor the risks that may be unique to your expanded activities in the United States.
One facet of doing business in this country that may be new for some of you is the dual banking system. While this system is somewhat unique, it is far from being a regulatory dinosaur and it shouldn’t be viewed as a hindrance. Rather, the system has spurred innovation by encouraging a healthy form of competition among U.S. regulators. The New York charter continues to compare favorably because we genuinely want to assist you and be a resource - the presence of so many of our staff today is a sign of our accessibility and willingness to help.
D. High standards and market success
We also want to encourage innovation. Progress can be achieved without sacrificing the integrity and high standards New York has always cherished and promoted. Much of our success as a global financial center is attributable to those high standards, and the security and confidence they have built into our market. We shouldn’t take that security for granted: it is the product of the complex interplay between innovation through principles and protection through tailored rules.
However, when industry begins to operate outside these lines, this finely tuned balance becomes misaligned and risk is not effectively contained. The repercussions can be enormous and can have far-reaching effects. One timely example of negative consequences of unidentified risk is the subprime crisis.
E. Lax standards at the root of mortgage market turmoil
Today we are facing unprecedented turmoil in the mortgage market precisely because risk was misread or underappreciated by certain market players, in four critical respects:
- Underwriting risk. This type of risk was grossly underappreciated- the lack of discipline in underwriting standards, particularly in regard to the borrower’s ability to pay, is at the root of much of the trouble. Lenders were quick to rely on stated incomes (without verification) and qualifying information provided by third-parties such as mortgage brokers. In their haste to capitalize on the boom in real estate, quality control measures may have been relaxed. As a result, traditional underwriting standards were largely jettisoned in favor of a more asset-based approach. But as housing price appreciation trends began to cool, there was no longer a ready source of equity to support repeated refinancings. Investment banks eager to satisfy investor demand for higher yielding investments did not appreciate the risk of utilizing third party bankers and brokers to originate these higher yielding subprime products without maintaining sufficient discipline over the underwriting process.
- Over-reliance on statistical modeling. Credit tools are designed to increase objectivity in the loan decision process, and thereby reduce risk, but they come with their own unique limitations that lenders can easily fail to appreciate. Statistical models are intended to aid in sound decision-making, but there is a potential danger of over-reliance. While there is a proper role for credit modeling, the question remains as to whether the various credit risk models were sufficiently tested, or were even designed to forecast default rates when income and payment capacity were de-emphasized.
- Over-reliance on ratings. Lenders and investors also may have underestimated the true nature of the risk in loan pools, by relying passively on the estimations given by ratings agencies. This over-reliance on ratings may even have been accompanied by a misunderstanding of the rating agencies’ role. Rating agencies make crucial assessments as to credit quality, but they are not regulators. The use of ratings does not replace the purchasing investor’s own due diligence.
- Indeterminate dispersal of risk. Here is a risk factor that may have gone largely unidentified, precisely because dispersion is traditionally a risk containment device. While securitization has increased liquidity and profitability, the accompanying compartmentalization of risk has been a partial detriment. The distribution of risk, in itself, is a positive- certainly no one is looking to concentrate risk. But risk dispersal can have the negative effect of fostering complacency in the absence of vigorous risk management. If the risk is so widely spread that no one really knows where all of the interests lie, then no one has the motivation to invest in a sufficiently robust risk containment infrastructure.
F. Future strategies to manage risk and remain competitive
The regulatory models and underlying principles we promote are designed to foster sound risk management. As I said, the interests of regulators and industry experience significant convergence on this point - we are both seeking the best strategies to assess and contain risk, although our motivations may differ. Banks want to reduce risk in order to enhance returns and protect their business reputation. Regulators are primarily concerned with ensuring the safety and soundness of the financial system, and protecting consumers and investors. But in order for both of our goal sets to be met, we need to listen to each other in designing appropriate solutions. Regulators need to remain open to new industry-designed risk management models and stay sensitive to industry’s operational constraints. Industry in turn needs to respond positively to constructive regulatory input and solutions needed to realign inefficiencies and ensure healthy competition.
I believe that New York consistently strives to strike the right balance in this delicate task - that’s why we continue to be a leader in international finance. And we want to remain in the lead by continuing to assess our regulatory perspective, to ensure that it is optimal. There is often great debate over the appropriate weightings of principle-based regulation versus rule-based regulation, and we want to find the right balance so that we offer industry, investors, and consumers the best approach.
And therefore we don’t have the luxury of resting on our laurels.
Other markets abroad are maturing and the New York capital markets are under increasing pressure. Pressure that can be channeled creatively. We see this as a perfect time to reevaluate our regulatory models to ensure they are calibrated to respond to the emerging challenges of an increasingly global marketplace.
Blue Ribbon Commission
With that in mind, in May, Governor Spitzer created a Blue Ribbon Commission to “Modernize the Regulation of Financial Services.” The Commission is charged with identifying ways for New York to retain and enhance its status as a world financial center and bring our regulatory structure into the 21 st Century.
This panel brings together a prestigious group of executives of financial institutions, consumer organizations, elected officials, and the heads of state agencies overseeing the industry. As a member of the Commission, I look forward to your input and toward working on promoting continued economic innovation.
I want to emphasize that this commission is no mere think tank; although the complexities of the issues require deep analysis, the goal is to produce tangible results in the form of an action plan. While the commission has just been announced, there are several areas that are likely to merit review:
- Developing a holistic review of how all financial institutions and products are regulated at the state level and whether the existing structure is effective and optimal;
- Identifying regulatory hurdles in bringing new products to market;
- Eliminating redundancies, gaps and inefficiencies between and among agencies; and
- Assessing whether a more “principles based” or “prescriptive based” approach to regulations – is most effective.
The goal is to identify ways in which regulatory powers can be integrated, rationalized and changed in order to promote economic innovation, while protecting consumers. I am quite excited about the prospects for the Commission and expect that you will be hearing a lot more about it during the next several months.
Thank you for the opportunity to speak with you today. I wish you all success in your new roles and I encourage you to reach out to me directly as well as to the Banking Department staff if you have questions or need further clarification on anything I addressed today.
I would now be happy now to take any questions.