Five Risks That Will Shape Banking’s Future

By Charlotte Birch

A little paranoia is a good thing as far as Richard Parsons is concerned. The 31-year veteran of Bank of America and author of Broke: America’s Banking System, shares former Intel chairman Andy Grove’s belief that only the paranoid survive “10x forces”—degrees of change that reshape an industry.

Judging from the number of banks that have folded or been acquired in the last 30 years—the industry has shrunk from 18,000 banks in 1984 to 6,500 in 2014—paranoia has perhaps been in short supply.

But Parsons, who spoke at the ABA Risk Management Forum in April, has studied the industry’s past and present, and he has identified five key trends—or 10x forces—that banks would do well to obsess over.

A war for talent

It is easy to overlook the impact that past bank failures can have on today’s talent pool. Parsons noted that the frenetic merger activity of the 1990s, when healthy banks were busy absorbing failing ones, led to overstaffing, which in turn inhibited hiring on college campuses and put bank training programs on the back burner.

Combine banks’ underdeveloped talent pipeline with the impending retirement of the baby boom generation and you have a talent shortfall that will challenge most banks, if it hasn’t already. This is especially true when it comes to commercial lenders. “As I travel around the country, this is the job we cannot find enough people for—the people who book the loans that we can make money off of long-term,” Parsons says.

To illustrate the potential impact a commercial lender talent shortage can have, Parsons notes that when four commercial lenders left a Raleigh, N.C., bank following its announcement that it was selling itself, the acquiring bank was able to negotiate a better exchange ratio.

Parsons, who monitors the expense structure of the industry, added that 52 to 56 percent of a typical bank’s noninterest expense today is in personnel—a line that is growing 6 percent annually at some of the largest banks as they seek to retain talent.

Shifting public policy

Parsons believes that banking entered the “public utility era” in 2008 when former Federal Reserve Chairman Alan Greenspan acknowledged a flaw in his free-market regulatory ideology. The Dodd-Frank Act soon followed, and the result has been the micro-supervision of banking, where examiners treat small decisions as significant and small banks as if they are large.

Less supervision is more, Parsons says, cautioning that policymakers should “major in the majors” and focus on asset growth rates and asset concentration.

But there are three macro-prudential policy outcomes from Dodd-Frank that Parsons doesn’t regret—and which he thinks will serve the industry in the long run: the new Financial Stability Oversight Council, which provides a formal way for federal regulators to talk through common issues; stress testing, which he strongly advocates all banks conduct in some form; and the increase in bank capital levels, which some politicians calling for more changes tend to overlook.

Economic uncertainty

A slow economic recovery and continued aversion to risk pose challenges for banks, which closed out 2014 with an all-time low loan-to-deposit ratio of 69 percent. “Banks are weather vanes of the overall economy,” Parsons says, noting the correlation between bank health and economic growth. “We depend on a solid economy and thrive at 3-plus percent GDP growth.”

Parsons encourages bankers to take time out to consider macroeconomic trends and their potential impact on their institutions. “I am a very strong advocate for banks to, on a monthly or quarterly basis, talk about emerging ‘10x’ risk,” he says. “Get together your best thinkers and talk about these macro issues, because they are getting crowded out by AML and other things. Make sure you are reserving enough time to talk about what could be on the horizon that could take your earnings down by half.”

Bank profitability

Just as Parsons believes regulators should “major in the majors,” bank leaders, too, should focus on the basic blocking and tackling of banking.

“Spend time ensuring that risk leaders and all personnel understand bank accounting and how banks make money,” he says. “I’m worried we are creating a generation of super specialists who actually are missing how banks make money.”

He says in his studies of bank failures and large dollar losses, he has found that the problems could have been detected three or more years earlier by reviewing the balance sheet and income statement. He urges bankers to keep a close eye on velocity and volume. “Go back and look at all your big losses, and I’ll bet you’ll find a consistent pattern that could have been detected years before in these two areas.”

“When you start seeing the velocity of earnings, compensation or revenue, the number of personnel working in a particular area, that’s your real watch item,” he says. “That’s why you need the finance partners to not just be cheerleaders helping out the first line get their job done but they’ve got to actually play their role as a control function.”

Parsons also stressed that bank efficiency ratios—which currently hover around 70 percent for most banks, but which are under 50 percent at the most efficient ones—will become increasingly important as banks are pressured on profitability.

“The average bank in the U.S. was worth less to its shareholders at the end of 2014 than it was in 2004,” Parsons says. “And while the S&P is up 70 percent over the past 10 years, the average bank in the U.S. is down 10 percent.”

All things digital

Nonbank competitors are turning banks’ cost disadvantages to their own advantage. Parsons suggests banks assess their vulnerability to emerging competitors like Lending Club by looking at their overhead ratios. “The best banks are at 2 or 2.25 percent, the average bank is 2.8 percent and laggards are over 3 percent,” he said. “Go back and look at yours and see if you need to drop your overhead costs.”

Suppliers, too, play a critical role. Parsons suggests that as banks rely on third parties for solutions to digital challenges, they must take stock of their vendors’ talent, the depth of their management and their scalability to ensure they can handle growth.

“I’m used to a supply chain management world where you try to hammer down the costs of your vendors,” he explains. “But I think the best banks are going to morph to seeing these as key partners in their business model and part of your risk assessment has to be about their talent.”

He added that while talent is important in all fields, it is especially so in cybersecurity, where it is rare, highly competitive and increasingly expensive.