Bankers: Forget the Regulators, Focus on Risk

Last week there was a sell off of Wall Street and Banking stocks because the market fears that new Obama-administration regulation and oversight is going to reduce revenue and profits. The Wall Street Journal tells the sell-off story (New Bank Rules Sink Stocks) and the looming political battle (Obama vs. Wall Street) in case you missed all the fun.

With President Obama turning up the political heat on Wall Street, it’s clear that change is coming, one way or another. But predicting the exact form of that change is no easy task. Will it be new levies on big banks? Will it be forced break-ups? Will it be salary and bonus caps? Will it be some other cocktail of regulatory intervention designed to outlaw whatever high-risk activities are out of fashion with lawmakers from one month to the next?

Nobody really knows.

About the only thing you can bank on is that taxpayers won’t tolerate a system where public funds are used to underwrite the high risk activities of private banks. Which means politicians won’t stop meddling until this moral hazard is cured.

So what’s a banker to do in the meantime?

Despite all the regulatory uncertainty, there is one thing that all banks can do right now: improve risk management.

This can take many forms, but an obvious example is through a smarter approach to documentation. What can you do to improve visibility into your portfolio of derivatives contracts (ISDA Masters, CSAs, Structured Notes, and the like) so that you know more about where you might be exposed? If you don’t know which contracts are affected by a ratings downgrade trigger, and what the impact might be on your liquidity, how can you manage the risk? What can you do to ensure that future transactions include the best legal language for protecting the bank’s position in a liquidity crisis or where a counterparty fails to meet its obligations? What systems can you put in place to ensure that the contractual risks of a deal are not disproportionate to the revenue upside.

By implementing smarter systems for creating and managing derivatives, lending and securities documentation banks can benefit in three ways:

1. The risks buried in existing contracts are more visible, and thus can be managed before they become a problem.

2. A much tighter approach to risk management can be built into all future contracts.

3. As regulators demand more data and reporting on risk management, the cost of complying with those demands will be much lower.

For all these reasons, we think automated document creation or document assembly is a very smart investment for Wall Street firms right now. What’s not to love about cutting risk and cost at the same time?

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