New Institutional Models Follow Changes in Risk

MBA (10/6/2008 ) Murray, Michael
A new adminstration in January, $810 billion legislation and accelerated consolidation all add up to increased fiscal conservatism and reduced risks for a new model of financial institutions moving forward, based on analysis from Deloitte Consulting LLP, New York.

In the past month, Charlotte, N.C.-based Bank of America acquired Merrill Lynch, JPMorgan Chase, New York, acquired Washington Mutual Bank and Des Moines-based Wells Fargo or Citigroup, New York, will likely acquire Wachovia.

With a new administration in January, Deloitte said it expects current regulatory proposals to focus and coordinate a structure geared toward reducing levels of systemic risk. The $810 billion Emergency Economic Stability Act—at a minimum—could add liquidity to surviving financial institutions while taking “toxic” assets off of its balance sheets, Deloitte said.

“When you look at some of the banks and the concentration right now, the question comes up whether they are too big to fall,” said Scott Baret, partner in regulatory and capital markets at Deloitte. “The fundamentals should be high in that the risk management areas can no longer fail going forward.”

“This crisis is fundamentally redefining the structure of the industry, the nature of the industry and material change going forward,” said Adam Schneider, principal at Deloitte.

Schneider said active trading banks—name-brand, global, capital markets-focused financial institutions—rather than retail institutions would likely find substantial changes based on greater risk. He said the subprime market—an “originate and distribute” model of packaged loans sold for investment—would likely change based on lack of investor trust in the securitization market.

“We expect to see much more ‘originate and retain.’ Part of that is the consolidation of the industry—three institutions with about 10 percent of American financial deposits—can, in fact originate and hold those mortgages that they may have originated,” Schneider said. “We expect, on average, the balance is swinging in the other direction [with] much less distribution of products, much more originating and retaining them and a very significant premium on safety, a very significant premium on getting money back and a very significant premium on safe and sound lending practices.”

Schneider noted that securitization would survive, but it remains unclear as to levels of transparency and guarantees investment banking divisions—or firms that securitize mortgages—would provide to restore levels of trust for investors.

“Some of the changes in the regulatory regime, in the attention span of the regulators, have some things they are clearly trying to go do before the election, allows those issues to resolve faster than they would otherwise,” Schneider said. “We’ve seen other economies—Japan in the 1990s—take five or 10 years to work through issues of this magnitude.”

Based on Deloitte's analysis, a regulatory system would need to focus on systemic risk, market stability, business conduct and consumer protections with regulators that have “fundamental sets of market-based responsibilities as opposed to a panel of industry-based responsibilities.”

“There are many regulatory agencies and many regulations, but somehow this particular set of activities still managed to happen,” Schneider said. “The reform of the regulatory marketplace is likely to happen, and we believe there is going to be a lot of change in the new administration going forward.”