Everyone is fully aware that our country is in the midst of the deepest economic recession in more than 80 years. Banks have been hit hard by the collapse, and as a result many have eliminated thousands of jobs and slashed IT budgets. For many, however, these cutbacks may turn out to be unwise, because -- as Emanual rightly suggested -- the slowdown presents an excellent opportunity to make long-overdue changes to core systems, prepare for compliance with new regulations and increase capabilities to respond to ever-increasing customer demands.
Fueling the Recession
The recession was caused in large part by the failure of large financial institutions to appropriately calculate the risks associated with complex investment vehicles such as collateralized debt obligations (CDOs), essentially pools of mortgages, and credit default swaps (CDSs), which effectively provide insurance against borrower default. CDOs, a product of the subprime lending market, were sold to corporate and institutional investors as highly rated debt based on the assumption that the underlying property values would never decrease, providing protection in the event of a default on the associated mortgage. When the housing market collapsed, CDOs plummeted in value while CDSs, originally just low-risk hedges against default, skyrocketed in price.
The complex financial structures created by CDOs and CDSs, coupled with instability in the housing market, left banks unable to calculate the risk of default. As a result, they tightened the credit market, ultimately fueling the recession.
In response to the crisis, the federal government stepped in and bailed out failing banks at a great cost to taxpayers. To address the problems that gave rise to the crisis, the government is expected to issue a series of new regulations aimed at curbing excessive risk taking, specifically in regard to high-risk financial derivatives such as CDOs and CDSs, which to this point have been largely unregulated.
Even in the down economy, banks must begin ramping up their compliance teams now. Those that have recently completed compliance initiatives surrounding Basel II, Sarbanes-Oxley (SOX), the Payment Card Industry Data Security Standard (PCI DSS) and the Fair and Accurate Credit Transactions Act (FACTA) will have an easier time adapting to the new regulations than those that have not. For those banks that have not already ventured down the road toward compliance, now is clearly the time to start.
While this all creates a challenging time for many banks, it also offers great opportunity to make improvements to information technology. Banks willing to use the economic slowdown to upgrade and standardize their core systems -- which have long been deemed too risky to replace -- will have the ability to respond to both new regulations and changing customer demands, positioning themselves for a fast recovery when the economy turns around.
Banks looking to reduce costs now should consider the rapidly maturing outsourcing and cloud computing markets. In cloud computing, often referred to as software as a service (SaaS), organizations outsource a single function or business process and are charged based on usage rather than at flat, monthly rates.
Financial institutions can also consider implementing or improving their enterprise risk management (ERM) systems to help avoid risky behavior in the future. Over the past 18 months, ERM technology has made great strides in its ability to interface with different data sources and calculate risks for new financial products. Banks that implement or upgrade these systems now may avoid the impact of the next major market meltdown.
While the present is decidedly dreary, for the banks that are willing to face the day's challenges head on and have the courage to embrace change, the future looks bright.