The cost of emerging from the perfect storm

If you were writing a drama about the financial system, then you could not have asked for more material over the past few years. A major and potentially catastrophic financial crisis, the after-shocks of which are still with us, the rise of cyber-crime, geopolitics getting out of control, wave after wave of regulation, and on top of that, the rise of new market challengers in the form of the financial technology sector. It’s something of a cliché, but you could not make it up!

Let’s be very frank, however. Tighter regulation was long overdue and has largely been a reaction to a collapse in risk management controls and some market ethics. The financial crisis revealed some huge problems and behaviours that just could not be tolerated any longer. Since 2008, regulators have had to ensure there is no systemic risk in the market, that banks are stable and robust to withstand shocks and that investors and savers have an appropriate level of protection.

The crisis, and its fall-out, have placed compliance very much in the front-line as banks and other financial institutions deal with the new, developing business paradigm. While the compliance officers and their teams represent the public face of the commitment to regulatory best practice, there is a growing feeling that compliance is the responsibility of everyone.

The regulators set the rules, but it is the job of the practitioners to ensure that individual organizations implement and monitor the business and ensure they are complying with laws, regulations, standards, codes of conduct and accepted market behaviour.

. The result of this is that banks are spending increasing amounts of money on ensuring their compliance regimes are robust, appropriately skilled and right-sized. Consequently, the cost of compliance is rising at a time when the financial burden of pursuing traditional business models, such as correspondent banking, are also climbing substantially, to such an extent that banks are scaling-back correspondent banking networks. The implications of this growing trend are significant – some banks will find it impossible to maintain US dollar and euro clearing accounts or confirm letters of credit. This not only impacts the banks themselves but also the economies of the countries in which they are located. The old correspondent banking model, so long part of the lifeblood of banks, is also under threat from new ideas and new competitors from outside of the industry.

It’s not just compliance that is seeing a rise in costs and headcount. Supporting functions, such as business control offices, audit and risk, are also in the ascendancy. Statistics from the European Central Bank (ECB) provide evidence of the shift in expenditure to ensure bank infrastructure is safe and sound – in 2015, the ECB said that the appropriate size of an audit department, for example, was approximately 0.9% of the total global workforce. Indeed, from a business perspective there is no longer a single compliance officer, but specialists in anti-bribery and corruption, anti-financial crime, sanctions and embargoes and antimoney laundering.

The involvement of an ever-increasing number of compliance gatekeepers, while a necessity, can add weeks to the lifecycle of a deal. Furthermore, the prolonged process around client onboarding is costing time and resources. The industry is currently working on utility type systems that can introduce standardization, notably through instruments like legal entity identifiers, and consistency to the act of client adoption, but these are still in their nascent stages. The effect of delayed indicative offers and credit approval, for example, can be frustrating for clients. As we move out of a huge transitionary phase, the industry has to balance the need for a more responsible regulatory environment with commercial requirements.

A lot of banks and financial institutions have become more selective in the deals, clients and counterparties they engage with, often deterred by the regulatory ask or the practical hurdles in meeting all requirements. The huge growth in control functions across the industry has simply made it that much harder to do business. Some banks have trimmed back their client lists or retracted in certain areas because of a reduced risk appetite or simply through cost restrictions.

There are broader considerations other than those affecting banks, however. While banks’ reluctance to get involved in certain deals, for a variety of reasons, undoubtedly impacts the clients, alternative investors have started to fill the void left by the banks. Financial technology companies are providing payment services or FX services by matching buyers and sellers online without the need for extensive KYC procedures. This brings a new dimension to a system that has been in place for decades.

Where does this leave us as we look back eight years since the onset of the financial crisis? Cost is not just measured in money, but also in terms of time and opportunity. Much of banks’ capacity is now being absorbed in developing more stringent antimoney laundering and anti-financial crime techniques and processes. We all agree that there are legitimate reasons for a more rigorous approach, but there is also a need to ensure that these additional layers of scrutiny are correctly calibrated to do their job: ensure the safety and stability of the financial system. In the coming years, I believe it is the shared responsibility of industry leaders and global regulators to work together to create a more safe and sound financial system. But this resiliency and this trust will have to be rebuilt over time, and can only come from dialogue which is candid and open. And I invite each of you to join us as we begin this journey towards greater resiliency and openness.

Daniel Schmand

Chairman, ICC Banking Commission Advisory Board