Heightened banking regulation: Here’s a plan to turn reality into opportunity

Three bank failures that destabilized the sector in 2023 caused the Federal Deposit Insurance Corporation to sustain an estimated $30 billion in losses. The response by regulators was swift and substantial.

Bank regulatory agencies have accelerated two stabilizing rule proposals that apply to banks with more than $100 billion in assets. The first requires these institutions to follow Basel III final capital and risk framework components and to increase long-term debt requirements. In essence, regulators are expecting banks in this category to attain the risk-level readiness of Global Systemically Important Banks, or GSIBs.

This amounts to a new “systemic” tax that agencies estimate will result in an aggregate 16% increase in common equity tier 1 capital requirements for affected bank holding companies.

Non GSIB $100B-$700B asset banks along with those with $100B growth aspirations are facing a permanently hindered profitability landscape. This group of banks will be forced to either shrink or seek new growth synergies to justify the increased cost of coming regulations.

Only banks with less than $10 billion in assets will confidently continue to enjoy fewer regulations, protection from capital requirements, and most notably, the exemption from the next wave of Durbin amendments that have the potential to reduce debit and credit card interchange fees.

In this new reality, regulated banks of all sizes will struggle to find their new level set for cost, operations, capital and diversification while the “shadow banking system” — companies that operate outside the traditional banking system in private and embedded finance markets — is picking up steam.

Consumers will create added pressure as they seek better experiences and financing terms through specialty financing, fintechs and seamless embedded payments and lending solutions with their favourite everyday commerce partners.

Key action steps to become ratio, risk and growth ready

Whether at the top of the food chain, or anywhere below and beyond, all banking ecosystem players have an opportunity to capitalize on these converging factors to emerge ratio, risk and growth ready.

The ultimate winners will be defined by who:

• Demonstrates risk and capital readiness;
• Best delivers principle-based growth and synergy realization, strategy and operational execution frameworks; and
• Relentlessly delivers for the customer.

Traditional bank actions

Most institutions are well on their way in assessing and quantifying impacts from the new proposed capital rules and long-term debt requirements, including:

• Adapting processes and tools to analyze current asset mix and risk weights to model likely impacts of the Basel III proposed regulation and inform strategic decisions on the optimal future state business model.
• Building assumptions into their forecast to meet the unsecured long-term debt (LTD) requirements and quantifying structural balance sheet and net interest income impacts, including debt issuance volume, timing, tenor, and cost. In addition, they are developing and refining forecast scenarios based on higher expected rate path volatility, achievable deposit cost and balance forecast under each scenario and evaluating hedging programs to remain within interest rate risk (IRR) policy limits.

However, additional strategic activities and focus can position an institution on solid footing for continued growth under new regulatory expectations. Below is a checklist of additional action steps for banks to help meet the challenge. Banks and bank-like companies must:

• Renew focus on any existing regulatory remediation work to set the right tone with regulators and employees;
• Assess potential impacts from new proposed resolution and recovery planning requirements, including strategy, technology, data, documentation, reporting, training, forecasting and overall crisis management capabilities; and
• Develop well-supported hypotheses about types of actions and the scale of interventions required to get back to target levels of return on tangible equity. Meaningful business model changes may be required, including:
  • Opportunistically acquiring competitors to grow, diversifying assets and creating product, operational and geographic footprint synergies;
  • Double down on capital-light, highly profitable businesses (e.g., wealth management, fintech, BaaS, P2P lending, and cross-border payments); and
  • Spinning off or selling less profitable and higher risk business lines, such as non-core assets, to focus on core business lines, build capital and mitigate risk on the balance sheet.
• Evaluate enterprise risk, compliance programs, and second line risk functions to ensure risk programs meet or exceed an environment with increasing regulatory expectations.
• Enhance Finance and Treasury process and capabilities through technology to improve financial reporting detail, identify areas for expense savings, produce faster reporting and scenario analysis and build real-time financial reporting capabilities. Design business requirements around technology solutions that support the new regulatory requirements in addition to management’s information needs for running the business.
• Ensure operational, technology and security programs, such as cyber, anti-money laundering and mail fraud prevention plans, are in place and optimized.
• Assess and refine key health metrics and monitoring systems to provide leadership with near real-time access to internal bank and external market data and trends, to support the increasing frequency of regulatory reporting requirements, but more importantly the ability to adjust business strategies with the new agility this market demands.
• Be mindful of the rise of the shadowing banking ecosystem. Non-bank entities are capitalizing on less restrictive capital requirements for core lending activities and challengers are pursuing embedded finance solutions and superior customer experience tactics to win consumer and commercial share.

The reality of regulation can be a season of opportunity

Financial institutions should use the regulation phase-in period to take action to improve brand, business, growth and operational efficiency — and do so without regrets.

The timeframe for implementation is long enough for companies to strategically plan a vision for their business strategy, but leaders looking to get ahead of the curve should act immediately to position themselves to exploit opportunities in the market.

Farrell Hudzik is Managing Director with Alvarez & Marsal’s Banking & Payments Group.