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Superintendent Richard H. Neiman Addresses the Institute of International Bankers at the Risk Management and Regulatory Examination Seminar



Institute of International Bankers
  Risk Management and Regulatory Examination Seminar

October 19, 2010

A.  Introduction

Thank you for that kind introduction and for the invitation to speak here today.   I am pleased to help kick off this seminar, which is always an outstanding gathering of risk management and compliance leaders.   I hope to provide you with an overview of emerging issues, from my perspective as a state Superintendent and as a member of the TARP Congressional Oversight Panel.

I am also proud that the Department’s Deputy Superintendent for Foreign and Wholesale Banks, Regina Stone, will be participating in a panel dialogue tomorrow on examination issues.   The Department supervises the vast majority of foreign banking organizations that are active in the U.S., representing over 80% of these foreign bank assets in the United States.  This is in addition to overseeing a wide range of domestic banks, including some of the nation’s largest such as Bank of New York Mellon and our newest, Goldman Sachs Bank, and non-banks, including thousands of mortgage bankers, brokers, and check cashers.   So you will find that Regina brings a deep and diverse set of insights to the table as well.

In my introductory remarks, I would like to share my thoughts on some of the changes coming out of Basel III, the Financial Stability Board, and the Dodd-Frank financial reform legislation in the U.S.   In particular, I would like to look at this evolving compliance landscape from two perspectives:

While an exhaustive laundry list of new rules is beyond the scope of these brief remarks, I know that you will be exploring the nuts and bolts throughout the course of this conference.  So what I hope to add is a framework for effectively dealing with this expected level of change.  After all, there are scores of studies and hundreds of rules yet to be written, with those relating to systemically significant institutions among the most prominent still outstanding.  But I believe that both industry and regulators can take concrete steps to prepare for new supervisory regimes, even if all the details remain to be seen.

B. Action steps for risk managers

Starting from the industry perspective, here are three action steps to consider in assessments, contingency planning, and corporate governance.

1. The first step is to digest the new rules and effectively assess the impact on your organization and control functions.

A great deal of information will need to be analyzed and disseminated across your organization.   This means it is essential to prevent information overload and to ensure that mere information is translated into practical institutional knowledge.  Silos will need to be broken down.  Risk assessments will need to identify which reforms are most germane to your business model. Trying to appropriate the whole scope of regulatory reform in one swallow is impossible.   Rather, as the Chinese proverb goes, a long journey begins with one small step.  Creating a formal process to communicate internally on reform issues is the first step to effective implementation.

From a practical standpoint, this means first of all deciphering what the law actually says.  Legislation and rules are unfortunately not always written in language that is easily understood, even by experienced professionals.   Seek clarification when needed to ensure you can assess the impact of the changes on your bank and develop a compliance and implementation strategy, whether it relates to capital or personnel resources.  To facilitate this whole process, it can be advantageous to create teams from business lines and support divisions, such as human resources, training, and audit that include a mix of operational as well as policy staff.  The use of outside consultants can also be appropriate.  Risk managers’ familiarity with the changes would ideally enable the industry to participate in the rulemaking process by offering constructive feedback.  Consider which changes could benefit from comment by your institution or by the entire industry, and don’t hesitate to participate in the rulemaking process.

2. The second step is to engage in robust contingency planning.

This is a consistent theme in both domestic and international reform efforts.  We don’t need to wait for every rule to be written to know that serious risks can be hidden in places such as off-balance sheet items or counterparty exposures.  Plan for the rainy day- and do it today.  Don’t wait for regulators to come in and assess your models and risk management approach.

This can mean enhanced internal stress testing, as well as preparing for the capital buffers that are an integral part of Basel III.  In Europe especially, market pressures may drive a faster pace in raising capital than the formal implementation schedule.

Contingency planning can also mean taking a closer look at your funding plans, to ensure that you would have sufficient liquidity if markets are disrupted.  Even firms that are adequately capitalized can experience liquidity runs practically overnight. 

Contingency planning also relates to the resolution authority under Dodd-Frank that is so critical to addressing TBTF and moral hazard.  Such planning would include preparing for a potential wind-down phase, if a bank had to exit certain business lines or even prepare for an orderly transition to receivership.  So I see the concept of living wills applying in this area as well.  Some express skepticism that a living will could ever capture the essentials of what would inevitably be a dynamic situation.  It is important to remember that a living will is not a precise blueprint for receivership- but it is a useful guidepost.   And perhaps living wills’ greatest value will be as a compliance tool in quantifying risks such as counterparty concentrations.   

By engaging in robust contingency planning, banks will be thinking constructively about risks such as counterparty concentrations and funding costs.   This type of scenario mapping, coupled with appropriate follow-up actions, should dramatically reduce the risk of ever needing to implement a living will.   And it is an excellent early step to take in identifying areas for improvement and preparing for new and heightened prudential standards.

3. The third step for risk managers is to strengthen corporate governance.

This is another area where banks can take immediate action to get their house in order, without waiting for regulators to identify specific deficiencies.  I do expect that both state and federal regulators will be looking much more closely at this area going forward, particularly in assessment of management under the CAMELS rating.  

Ask yourself whether the bank has effective board oversight, including meaningful and measurable standards for setting risk appetite and a process for evaluating execution.  Activities with wider margins or higher yields merit heightened scrutiny by risk managers, to ensure that models and assessments capture the true risk profile and are clearly understood.  Higher required capital and liquidity ratios are no excuse to perversely seek out higher-risk activities just to maintain historic returns. 

This leads directly to a related point, that of the misaligned incentives which contributed to the financial crisis.   For instance, compensation structures should be designed to better align performance goals with the institution’s risk profile.  Risk managers should be relating to a variety of Board committees, beyond traditional areas of interaction such as compliance and new product approval.  Risk managers should also interact with the executive compensation committee of the Board, to ensure that the relationship between incentives and risk are understood and properly gauged.

These are just three examples of core areas where a proactive approach will generate valuable results for the bottom line as well as the compliance effort.   

C. Action steps for regulators

I said at the outset that it isn’t just the industry that will need to adapt to regulatory reforms.   Regulators also face a sea change, particularly with the immense operational task of merging the OTS with the OCC and the creation of the new consumer protection bureau.  There are no structural shortcuts to effective oversight, however.   Countries with diverse regulatory frameworks were all deeply impacted by the current financial crisis.  Beyond these structural adjustments, there are deeper substantive issues that require regulators to be every bit as proactive as industry. Here there are also three actions steps that I would note as examples of how regulators also need to be proactive: in assessments, interagency cooperation, and restoring public confidence.

1. The first step for regulators is also to assess and communicate the impact of changes across the supervisory landscape.

This is the same item that I identified as a priority for the industry, and it is true for regulators as well.   In fact, digesting and communicating the impact of reforms may even be a larger task for regulators, as agencies are being consolidated and functions transferred.   In the Banking Department, we have developed internal task forces and information share drives centered on six major reform themes: financial stability oversight; domestic banks and bank holding companies; foreign banks;  derivatives and clearing systems; consumer protection; and mortgage issues.  The purpose is threefold- to assess the impact on the Department, including whether additional state laws, regulations or other resources are needed; to assess the impact on the institutions we supervise; and, to provide appropriate feedback at the federal level.

Part of this assimilation process will be to avoid regulatory arbitrage and ensure a level playing field in the implementation of new standards, especially where responsibility for a given function crosses agency lines.  On the international front, this means placing greater emphasis on harmonization coupled with a continuing dialogue on the appropriate degree of latitude in national implementation.  In the U.S., that debate goes one step farther, as we also coordinate between the state and federal levels.  This will be of particular importance in the relationship between the states and the consumer financial protection bureau, on both the bank and non-bank sides.

In order to meet these heightened responsibilities, all regulators need to view staffing as integral to their core mandates.  The financial markets have become so complex, with a pace of development that has even outstripped the industry’s own capacity to see all the interconnections.   It is that much more difficult for regulators to effectively supervise large and complex firms from the outside.  Training and retaining experienced staff to keep abreast of these legal and regulatory changes is a top priority.  This is also a time when the choice of public service should be respected and encouraged, if we want government to be best equipped to avoid future crises.  Experience from the private sector- whether in business, risk, or audit- is especially relevant today.  There is a healthy transfer of knowledge and skills set between the private and public sectors, different from a revolving door, which contributes to the success of both.

2.  The next step for regulators is to exponentially increase their level of coordination and cooperation.

Because of the globalization of financial institutions and the risk of regulatory arbitrage, there is clear recognition that international supervisors need to increase our cooperation and reinforce mutual accountability.   Whether it is in fighting terrorist financing or ensuring prudential standards are met, supervisors need to have clear expectations of each other.   The Basel III process and work of the Financial Stability Board provide critical guideposts.  The same type of cooperation that the G-20 is striving for on the macro level needs to hold true on the front lines of bank examination as well.

This need for effective supervision highlights the role of supervisory colleges, to strengthen home-host sharing and collaboration.  This supervisory cooperation is increasingly important as banks continue to organize their operations by business lines, with the result that risk management for a New York activity may be located in the home office.  In New York, we have close to twenty agreements in place with regulators from around the world, and have developed very strong supervisory relationships with those home countries. In fact, supervisory colleges may be formed as an outgrowth of such bilateral agreements.  The college then creates an additional forum in which subgroups of core supervisors can form new international connections and focus on concerns common to their markets. This flexibility is one of the benefits to the supervisory college structure.

Supervisory colleges are also the appropriate approach for coordination among jurisdictions with disparate legal and supervisory structures that would hinder more formal and binding approaches to cross-border supervision. For example, I considered it critical to attend the recent supervisory college in China sponsored by the China Banking Regulatory Commission.  New York has recently licensed the first branches of banks from mainland China to open in the US in over 17 years, which reflects the growing trade between our countries and New York’s role as a hub for global finance.  The nonbinding but still effective mechanism of the supervisory college is the best practical fit for engaging with supervisors from jurisdictions with legal systems and other dynamics that are very different from those in the US.

3. Finally, regulators need to restore public confidence while managing expectations.

In many ways, this financial crisis was about confidence- confidence in the financial system, in individual institutions, as well as confidence in our legal and regulatory framework.   I believe the significant progress being made with Basel III and Dodd-Frank will go a long way to restoring that confidence.  But there is a flip side.  We must also manage expectations.  Regulation was certainly part of the problem, but it is not the only solution.   There is no panacea for financial stability. 

Perhaps it is only through ongoing dialogue with all stakeholders- borrowers, taxpayers, investors, consumer advocates, and industry- that this confidence in the regulatory process will ultimately be regained.   In terms of the dialogue with industry, we need your input as these new higher prudential standards on capital, leverage, and liquidity are phased in.   During this rulemaking, implementation, and observation period, it is critical that standards are calibrated properly.  There are twin goals to achieve- namely, enhancing stability and supporting the real economy with appropriate credit access.  We need to get both prongs right, and you as risk and compliance officers will play a critical role.

D. Conclusion

In conclusion, my hope is that the industry remains as engaged in the implementation phase of regulatory reform as it was in its passage.  The work of building a more resilient financial sector has really just begun.  True regulatory reform is not about creating a longer laundry list for a “check the box” compliance mindset.  The changes we are undertaking will only succeed if they are embraced in the corporate culture of financial firms, and I see your attendance at this conference as risk managers as a positive sign.  Thank you again for the invitation to speak today, and I look forward to answering any questions you may have.


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