In the banking industry, crossing the $1 billion asset threshold is a significant milestone, both regulatory and strategic. At this point banks are subjected to increased regulatory scrutiny at this level, including the requirements of the Federal Deposit Insurance Corporation Improvement Act (FDICIA). FDICIA compliance focuses on strengthening the safety and soundness of financial institutions, including requiring higher capital standards and holding more frequent audits and examinations. The $1bn threshold also opens new possibilities for raising capital and growth through acquisition. As such, it is important for banks to assess their readiness for this higher level of oversight and address key gaps in capabilities to prepare for future growth.
Our firm has worked with many institutions as they prepared for this evolution. Below I have summarized our learnings and the key areas for enhancement. These include strategic planning, governance, risk management and compliance, managing liquidity, digital capabilities and technology, commercial lending, and treasury management.
This milestone is an opportunity to set direction for the next few years with a well-established set of business objectives that are specific, measurable, attainable, relevant, and timebound. The plan should address operational improvements, new products and technologies as referenced in the following topics. Identify key goals that will build franchise value. An execution plan will help in aligning the Board, management, employees, and investors towards achieving goals and establish context for the many decisions which accompany growth. Coupling this with a thorough analysis of the bank's internal operations and the external market environment, technology, potential risks and opportunities will help management capitalize on strengths while addressing weaknesses. In today's environment additional attention must be paid to liquidity and funding for growth and unexpected contingencies.
Reviewing committees and committee charters, as well as streamlining and optimizing board presentations, can improve governance. It is critical to review policies at least annually to ensure alignment with regulations and internal controls. The bank should create an audit committee comprising independent directors to oversee the bank's financial reporting and internal control procedures. The Bank must have leaders assigned, and engaged, in overseeing risk and compliance, and the Board must receive reports on risk identification, mitigation, monitoring and any resulting corrective actions on at least a quarterly basis. The report must include a section on emerging risks and trends as well as ongoing, recent, and anticipated interactions with various regulatory agencies. Information technology is another area which deserves its own committee as the bank increases in size and complexity. Infrastructure performance statistics, vendor reviews and SLA performance, cybersecurity and disaster recovery are all areas which should be reported to the Board and a long-term strategy for technology established.
A well-defined risk management framework that includes identifying, assessing, mitigating, and monitoring risks helps the financial institution protect against potential losses or financial impacts.
A comprehensive and consistent enterprise risk approach, including a risk appetite statement supported by Key Risk Indicators (KRI) can help banks actively monitor risks, controls, and mitigation. Reviewing Liquidity Risk and Contingency Funding Plans, compliance assessments and insurance adequacy are also important steps in evolving risk management and compliance.
This is also the time to perform compliance testing of key systems and processes to ensure that they comply with FDICIA requirements. The bank should also appoint an experienced and qualified internal auditor to provide independent and objective assessments of the bank's internal controls and financial reporting.
Compliance monitoring should be recurring at an at least quarterly basis, preferably monthly, and should leverage proprietary and public data to the extent possible, while leveraging automation.
Key performance indicators such as profitability, liquidity, capital adequacy, efficiency, and asset quality are crucial for assessing a bank’s financial and operational performance. Effective use of analytical frameworks to measure and analyze changes in rates, volumes, and financial/liquidity stress tests are also important, particularly right now. Reviewing and improving resources for funding and liquidity can help banks better manage their resources and prepare for future growth opportunities and the occasional cliffs that can imperil the bank.
Banks have many levers to manage liquidity. In the low-rate environment of the last decade this function has often been relegated to obscure financial models. Given the volatility in today's markets, management this topic should be at the forefront. Maintaining adequate levels of cash and cash equivalents, diversifying funding sources (and adding new, unutilized lines of credit), and minimizing reliance on short-term borrowings are obvious.
Rethink your investment strategy; segment the securities between those that can be liquidated for immediate cash need, those that can be held longer term, those that are held for CRA purposes, and those that can be sold, and the portfolio rebalanced to reduce unrealized losses. The lower rate securities should be carefully reviewed and individual CUSIPS monitored for exit when prices hit a target that minimizes losses. Cash buffers should be increased, and as markets stabilize later this year, re-invested in short term securities. Strive to maintain a rate neutral portfolio, and study the stress tests carefully, adjusting assumptions. Models are only as good as their inputs, so look at the underlying components of the models to make sure that all dimensions are being varied.
Deposits should be tracked with the same details and diligence as the loan portfolio. Minimize liquidity surprises through robust reporting and analysis. Balances over $250k should be identified and tracked daily (if possible), and account balance changes of $1mm isolated by depositor. Track new accounts and closed accounts and wire transfer/ACH volumes. We also recommend segmenting deposits into commercial, small business, retail, and public funds, and setting liquidity guidelines for each category that can help guide the banks’ investment strategy. Commercial deposits over $250k should behave the highest ratio of liquid securities, with the shorted duration investments, while small business and retail deposits under $250k can be allocated to longer term investments and lending activities. Public funds accounts should be reviewed in the context of their collateral requirements. We also recommend proactively marketing CDARs products to larger clients to reduce future volatility.
Finally, a Funds Transfer Pricing mechanism should be developed to guide decision making. Too many banks make tactical decisions on a client or product basis without considering the bigger strategic picture of business segment profitability, capital utilization, liquidity, and resource management.
Banks have spent much of the last five years building online banking and digital "on-ramps", but the industry and consumer expectations continue to evolve. Growing banks should conduct a gap analysis of current digital capabilities compared to local competitors and industry leaders, particularly in the retail channel. Consumer checking and money market accounts can be hard to obtain and will be prized as larger sources of liquidity come under scrutiny. Optimizing capabilities through partnerships with existing core platforms and new vendors or FinTech’s is critical. Platforms like Pinwheel Deposit Switch, which can help banks increase deposit by becoming the primary bank of existing customers. Reviewing the banks website, social media, and digital marketing, focusing on what isn't delivering results, can help identify areas for improvements.
In addition to digital banking the technology infrastructure should be reviewed and a course set. New real time core systems, such as FinXact, are emerging which link payment systems, transaction data and client information through APIs, allowing banks to create products on demand, and rendering many core systems obsolete. Banks must proactively develop a strategy to upgrade core systems and not simply expect existing vendors to keep up. The vendor landscape will face unexpected upheaval as the new technology, as well as artificial intelligence, move into the mainstream in the next few years.
Banks generate huge amounts of data from their operations, such as customer transactions, loan applications, market data, and more. A strong Data Management Framework that focuses on data integrity, security and privacy can help banks extract valuable insights, such as predicting customer behavior, identifying fraud, reducing risk, improving product sales, tracking liquidity movements, and optimizing business operations. A well-managed dataset can help Banks detect emerging and hard to find patterns such as in case of UDAAP and Fair Lending, by enabling advanced Data Science techniques such as Natural Language Processing and Artificial Intelligence.
In turn, banks can use these insights to improve their service to customers and make better decisions. Data will be crucial to effective digital marketing and implementation of artificial intelligence. Banks should invest in partnerships that help it explore its data using data visualization, predictive modeling, machine learning, and other techniques. Data science helps make better decisions by providing insights into customer behavior, business operations, and market trends. Data science can also help organizations identify new opportunities and improve their overall performance.
This is a good time to review key lending activities and clients. Stratifying clients by importance to the bank can help tailor service, staffing and decision making. Improved pricing discipline and refined capital allocation models can help managers and the board make better decisions. Consider diversifying the commercial portfolio through participations/syndications. Also, now would be a good time to improve collection processes and ensure the banks special asset capabilities and governance routines are current and in place. Finally, adopt a pricing model that fully captures all banking activity of a client, and allocate capital based on risk, to arrive at a Risk Adjusted Return on Capital for each relationship.
Most banks have good commercial checking platforms, and online capabilities for wires, advanced ACH, and B2B payments are a must. Areas for improvement are automated payables and receivables services such as Strongroom. Strongroom provides an API driven suite of purchase-to-pay solutions purpose-built for industries like real estate, homeowners associations, construction, financial services, media and healthcare and social services as well as some of the most widely used accounting systems. Other areas to consider are add on systems, such as Autobooks, that support cash and liquidity forecasting, screening, and reconciliations. Supply chain collaboration tools such as Ariba can also be very effective. The key to a successful strategy is to build a suite of capabilities that share data and allow customers to use these tools to streamline their internal processes, and thus tie their business closer to your bank.
Treasury product sales are also critical to review. Ensure you have a dedicated team marketing these products that can 1) partner with clients to ensure that clients know how to use these capabilities, and 2) understands how the clients actually use these capabilities. The feedback loop is critical. The sales team should be partnered with commercial lenders, but separately target clients where deposits are the key product, such as title companies, foundations, homeowners associations and others.
Making the transition to the next level in banking can be challenging- whether it is the $250mm, $500mm, $1bn or $10bn threshold, each milestone requires evolution of governance, risk, compliance, technology, and management practices. Change needs to be owned by internal management with resources and insights provided by a consulting firm. The first step is to complete an assessment to identify areas that may need improvement to comply with FDICIA requirements, investor expectations and the unique challenges of managing a financial institution in the 21st century. Balancing these upgrades with the day to day demands on staff can be challenging, so establish a plan with the expectation that this effort will take a full year.
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