Lessons from the subprime crisis

The recent turmoil caused by problems in the subprime market has far-reaching consequences, and only time will tell how the economy will be impacted. We’ve seen an entire industry take a major hit. But banks can learn from this situation.

Just as it was clear before the subprime meltdown that there were issues that should have been addressed, I still talk to bankers who are postponing improvement of their compliance risk management systems. What I tell them is this: Now, more than ever, financial institutions need to devote more resources to ensuring their risk management and compliance systems are bulletproof. Here’s why:

Investment in risk management and compliance will see returns.
As a former banker too frequently I hear from current executives that they have a hard time convincing the board that investment in compliance will positively impact the bottom line. Other upgrades are easier ‘sells’, it seems. Online banking, bill paying, promotions – these are things visible to the customer. No one ever says, “we need to beef up our compliance program to keep up with our competitors”.

But I also hear another view from bankers: “Investing in comprehensive risk management technology has saved us money by preventing regulatory penalties and keeping staff costs down.” At the very least, it buys peace of mind.

Reputational risk is as real as credit risk.
Many of the institutions caught up in the subprime lending crisis may close their doors – others may spend years repairing the damage done by negative media attention. Reputational risk can result in a decline in your customer base, costly litigation and revenue reductions. Similarly, regulatory action against a financial institution which exhibits noncompliance with laws/regulations can result in costly fines, burdensome reporting and negative attention that could keep customers away for years – or in the severest of cases, results in a total collapse of your institution.

Financial institutions can’t afford to be shortsighted.
Unfortunately, I’ve seen too many financial institutions neglect their compliance risk management system until after they have suffered a system breakdown that resulted in regulatory penalties. At that point, the damage is done and the cost of responding to formal regulatory actions is significant.

Achieving a good compliance system ultimately is a mandate, so doesn’t it make sense to deal with it before the damage has been done? Just as the subprime lenders have played ‘hot potato’ with mortgages, someone will always be left holding the potato when the music stops. It’s not a matter of if, but when.

New technology means automation keeps things from falling through the cracks.
Once a good system is in place, financial institutions will actually find that they are spending less time focusing on compliance. They work smarter, not harder. With a good system in place, regulatory reporting becomes easier, less effort is required on the part of individuals, and control of enterprise compliance risk is achieved. A good system will automatically adapt to regulatory changes, making it much easier on the staff. A recent American Bankers Association report documented how compliance officers wear many different hats, and are expected to keep track of more than just compliance. It helps to have safety nets in place and automate as much of the process as possible.

Following the spirit, not just the letter of the law, pays in the long run.
On paper, perhaps subprime lenders did nothing wrong – after all the loans were collateralized. But in losing sight of the big picture, they made tactical and ethical errors that, in the end, cost them. The same truth can be said of compliance management.

The subprime loan crisis is not the end of the world, but it does remind us that the best of times sometimes can be the worst of times. So, nothing is certain. The banking crisis of the 1980s was not that long ago, and financial institutions remember the lesson that came from that: only the strongest – and best-prepared – survive.