It’s increasingly expensive for big banks to maintain their size, especially while they face growing data management challenges, increased capital reserve requirements and regulatory surcharges.
Conventional wisdom used to hold that a bigger bank could better spread its risk. With more assets under its control, a big bank can diversify to the point of almost absolute security. Sounds pretty safe, but eroding confidence in too-big-to-fail institutions has upended this model.
Increasing public, government and regulatory pressure have driven a corresponding increase in capital reserve requirements. Two U.S. legislators on the Senate Banking Committee sent a letter to Federal Reserve Chairman Ben Bernanke on Monday advocating higher surcharges for systemically important financial institutions (SIFIs).
Managing data is expensive too. But not managing data correctly also has its price, as Knight Capital demonstrated last week, when it held about $7 billion in stocks as its software broke down.
If You Botch It, They Will Come
“The likely truth of the matter is that Knight had no idea how much it could lose if its trading went awry,” Peter Eavis wrote in The New York Times DealBook Tuesday, exploring the limits of what data can actually tell us today. “Predicting the losses from a rogue algorithm is like predicting the losses from a tornado that turns into a hurricane.”
And if you think the market hates uncertainty, the public has steadily lost patience with these scandals since the financial crisis began in 2008. It’s no surprise that last week’s debacle prompted the SEC to step in as well, with new proposals that would require trading firms to disclose system failures and test changes in computer code — invariably increasing the cost of compliance.
“Greater capital, stronger rules … [and] more liquidity” are key to a more robust financial industry, Bernanke said at a town hall meeting in the U.S. capital recently. Regulatory regimes such as Dodd-Frank and the Basel accords could provide greater transparency to the financial services industry, preventing future financial crises, according to the Fed head.
But the kind of transparency that Dodd-Frank, the Basel accords and other regimes offer to regulators is pie-in-the-sky. That’s because the large institutions cannot provide it for themselves.
Illusion of Transparency
Pressure on banks isn’t going away any time soon. One of electronic trading’s first black eyes was the Flash Crash of 2010. Now, in addition to Knight Capital’s incident last week, experts are looking at potential faults in the foreign exchange market, as well as possible software glitches on three exchanges.
Banks will have to become more efficient at managing unstructured data if they want to have a better picture of what’s happening within their domains — and especially if they want to get regulators off their backs. But there are at least three obstacles to banks getting their act together, according to my fellow Trading & Risk Technology blogger Neil McGovern of SAP:
- Executives are reluctant to allocate funds for the necessary technology.
- Banks lack the viability to bring together all of their data together, including counterparty exposure.
- Data management architectures take a long time to build.
And let’s face it: Patience is a virtue that too few possess.
It Ain’t Easy Being Big
Big banks face another hurdle to total transparency, aside from money, time and patience. As big banks acquire other institutions, especially other big institutions (e.g., JPMorgan Chase & Co.), they typically encounter problems integrating internal systems. Streamlining these systems can be a lot work.
“A world in which technology, product strategy and business models evolve faster than language may be a poor place to apply regulation based on participant silos,” as ITG’s Ian Domowitz noted in TABB Group on Wednesday.
Look to the Future
The financial services industry must regulate itself, but for more than just satiating the prying eyes of regulators, politicians and angry voters. Individual institutions — and colossal conglomerates — must do so for their own sake.
For four years, governments around the world have made it increasingly clear that there will be no more tax payer-funded bailouts. Spending the money and investing the time in effective data management and streamlining internal systems will help the bottom line and secure the future of financial services firms.
I’ll end with a tribute to someone who thought a lot about the future. Former NYSE Chairman John J. Phelan Jr. brought computer technology to his exchange in the 1980s. He passed away on Saturday at the age of 81.
“After the 1987 crash, which shook investors’ confidence in financial markets, Mr. Phelan coolly resisted calls to close the exchange, fearing that it would breed further panic,” William Alden wrote in Phelan’s obituary on Monday. “He rang the closing bell himself.”
“Two Senators Urge Raising Large-Bank Capital Demand” by Cheyenne Hopkins
“The Dread of the Unknown” by Peter Eavis
“SEC to Tighten Rules Following Knight Bailout” by Kara Scannell