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This article appears in the March 2, 2016 issue of Forbes
Two of my favorite things are talking about the future of financial services and having a good laugh. Some would like them to go hand in hand. At a recent panel discussion to launch our latest report — entitled “Restructuring for Profitability” and jointly sponsored by Broadridge and Institutional Investor — former Securities and Exchange Commission (SEC) Chairman Harvey Pitt did exactly that when he managed to mix banking with humor in just the right combination.
The report revealed some good news in that the financial world is a less risky place today than it has been since the 2008 financial crisis. There are real challenges for banks as they still face severe headwinds, including from new regulation that is making it difficult for capital markets and financial institutions to beat their cost of equity capital. Pitt brought great insight, mixed with unique humor, to these serious topics. Pitt knows financial services as well as anyone — as chairman of the SEC from 2001 to 2003, he oversaw the commission’s response to 9/11 and created its real-time enforcement program. Pitt, now head of the consultant firm Kalorama Partners and a senior advisor at global advisory firm Teneo Intelligence, was among the panelists at the launch of our report in December. Chris Perry, president of Global Sales, Marketing and Client Solutions at Broadridge, interviewed Pitt and a number of other industry experts. Here are some key highlights from Pitt’s remarks, which have been condensed to highlight some key themes.
QUESTION: Most of the nearly 150 analysts that were surveyed in the report believe post-crisis regulation has made the financial system safer. Is it safe enough?
HARVEY PITT: Since crises never replicate themselves, the likelihood that we are prepared for the next crisis is small to nonexistent. Congress had a good opportunity to change the approach to regulation and start thinking not just about solving the problems that occurred but how to anticipate and deal with the next crisis. It failed. I’d like to say Congress labored mightily and brought forth a mouse.
QUESTION: Are we seeing regulatory creep?
PITT: The real issue is that we need smart regulation. We didn’t have it in 2007 and 2008 and, to be blunt, we still don’t have it. I’m really concerned that when these regulations come out, they’re a thousand pages long. The Dodd-Frank Act was 2,313 pages long, and nobody understands everything that’s in it. Juxtapose that with the fact that when God wanted to regulate the human race, there were only Ten Commandments on two tablets. The disparity is enormous.
QUESTION: As a former regulator, what advice would you offer the SEC and U.S. Federal Reserve?
PITT: We never want government bureaucrats effectively determining the business plans of financial services organizations, but that is precisely what we have. We also have concerns about shadow banking, but shadow banking is sort of a nasty pejorative for what the current regulatory system is engendering. The real needs for capital aren’t being met by our banks because the risks are too high, so you’ve got others who are raising capital in different ways, and that’s not a bad thing, as long as there are appropriate regulations.
You have to start by thinking about what types of problems could you have, where are the places where risks occur and which kinds of risks are increasing? Political risk is now gargantuan. We’ve got personality risk, which many firms don’t spend a lot of time on, which is, who are the people who are providing advice to the board? If you’ve got members of senior management who are unduly aggressive, people have to know that when they receive their advice, but most people don’t try to figure that out. If people are too conservative, they’re going to miss opportunities. And then the next thing people have to do is figure out how to become much more efficient in offering their services. The problem we have is that this layering upon layering of regulation increases the costs of doing business.
QUESTION: Should banks and regulators try to engage in a different way with each other?
PITT: I’m a big movie buff, and one of my favorites was a fairly raunchy one called Wedding Crashers. At one point, Owen Wilson wants Vince Vaughn to hang around while he tries to get a young lady interested in him and Vaughn says, “I’m not going to do that. Why would I do it?” And Owen Wilson says, “Because you’re my friend.” And Vaughn utters what I think is incredible wisdom. He says, “A friend in need is a pest.”
If you think about it, it’s absolutely true. If the first time you’re talking to the government is when you need them, it’s already too late. So the regulators need to have an understanding of the culture of the bank, what the board is about, and it can’t just be the CEO — you also need the lead director, somebody who’s also independent but understands the firm’s business, to help the regulators develop a sense of trust. The acknowledgement that you’ll shoot straight with us. You’ll tell us what the real issues are. What banks need to do is become investors — in new technologies, in new markets, in new businesses that don’t pose a threat to the security and safety of the bank but that give them a shot at making a better level of profits. Because the truth is, with more and more regulations, the profit margin on traditional bank activities is definitely starting to take a hit.
QUESTION: How can we try to ensure that regulations will work effectively on a global level?
PITT: It would be helpful if the U.S., instead of trying to define final rules that run thousands of pages, tried to work more with pilot programs. Regulators should find firms that are willing to volunteer, perhaps in exchange for some modest inducements with regulatory retreat, to follow a pilot program project. The U.S. can provide a laboratory and then, with actual experience, can go to other regulators and work out solutions.
You could see how these requirements work in practice and that’s something that could be done globally without anybody giving up any sovereignty. Those are the kinds of creative solutions that regulators have to start embracing. But the problem is, at least in this country, regulators are understandably worried about being criticized. And they don’t realize that if they take action, they’ll be criticized and if they don’t take action, they’ll be criticized. So the solution is, do what you think is right.
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While I don’t advocate taking investment advice from Vince Vaughn, many of Pitt’s points are worthy of consideration. I do trust that we are safer than we were in 2008, if for no other reason than that financial institutions were forced to deleverage.
Nevertheless, there are a number of areas where the industry should work together to ensure a safe and vibrant global capital markets ecosystem. One example is through “living wills” — where big banks demonstrate to regulators how they would plan for an orderly recovery and resolution process in the event of a failure. Living wills should include a mechanism to protect customers by quickly moving remaining assets to a “safe haven” amid a bank failure. Multiple banks using an industry-standard technology platform capable of transferring and protecting assets in the event of a crisis would make living wills more robust.
Markets would also benefit from shorter settlement times, moving to a two- or even one-day standard from the existing three-day cycle, to free up capital in financial markets and allow banks to employ that money more efficiently.
With the industry working together, there are steps that can be taken today to protect investors and strengthen our financial system before the next crisis.
From Forbes.com, March 2, 2016 © 2016 Forbes. All rights reserved.
