People all around the world rely on banks to get paid, obtain loans, purchase goods online, take out mortgages, and access other services that they rely on to be full participants in the global economy.
Banks are such a common feature of our everyday lives – running out to the ATM to draw some cash or whipping out a credit card to pay for goods are activities we take for granted, never imagining that we could get cut off from our money. But banks do fail, and history has shown that when they do, the effects can be catastrophic for individuals, businesses, and the economy as a whole.
Fortunately, it is clear that strong regulatory frameworks and monitoring are effective at reducing the number of banks that fail. Over three hundred banks were shut down in the US during 2009 and 2010 in the aftermath of the 2008 economic crisis. But as regulatory bodies tightened the reins, ushered in stricter rules, and heightened supervision, that number steadily dropped. In the last five years, there have been only twelve bank failures in the US.
In this blog, we will look at the banking compliance landscape and some of the factors that contribute to banking failures. To understand how compliance is a critical part of preventing bank failures, keep reading.
Overview of Banking Regulatory Compliance
Banking activities are governed by a complex web of laws and regulations set in place by a range of government and self-regulatory bodies. Each of these bodies aims to achieve the same thing – the safeguarding of financial systems for all stakeholders. Understanding key statutory bodies in the US, along with other global authorities, helps clarify how the banking compliance environment is set up:
- Securities and Exchange Commission (SEC): The SEC holds a critical mandate in overseeing the securities industry in the US. It establishes rules and regulations designed to ensure fair and transparent market practices and monitors financial institutions to make sure they are compliant.
- Federal Reserve System (the Fed): As the linchpin of the US central banking system, the Fed wields a lot of influence over US monetary policy. It is the orchestrator of, among other things, capital adequacy standards for US banks. The Fed’s role is to ensure that US banks are resilient and able to cope with economic fluctuations.
- Financial Crimes Enforcement Network (FinCEN): Operating under the US Department of the Treasury, FinCEN focuses on combating financial crimes. It also sets out strict regulations that banks have to follow in relation to anti-money laundering (AML) and counter-terrorism financing (CTF).
- Consumer Financial Protection Bureau (CFPB): The CFPB protects consumer interests within the financial sector, enforcing regulations related to responsible lending and the selling of financial products such as mortgages and credit cards.
- Basel Committee on Banking Supervision (BCBS): The BCBS is a global organization that works to get international agreement on banking standards. It sets directives for banks in relation to capital requisites, liquidity standards, and risk management protocols.
- Financial Action Task Force (FATF): FATF is an international organization focused on combating money laundering and terrorist financing. It provides guidelines and standards for AML and CTF activities and promotes international cooperation to prevent financial crimes.
Regulatory Requirements in the Banking Industry
While there are a lot of regulatory bodies with different regulations, there are a number of key principles that set the background for compliance requirements for banks, including:
- Data Privacy and Protection: Requirements related to the collection, processing, storage, and sharing of personal information. Some global principles include getting consent before collecting or processing information, ensuring data is kept securely, and only using the data for its intended purposes.
- Consumer Protection: These requirements include measures to prevent predatory lending, unfair fees, and discriminatory practices.
- Capital Adequacy: Banks must make sure they have enough money set aside as a buffer that can help them handle unexpected losses and keep them financially stable if something goes wrong.
- Risk Management: Banks have to make sure that they are continuously assessing and identifying potential risks, including credit, market, and operational risks. They also have to put plans and processes in place to mitigate these risks.
- Reporting and Disclosure: Banks have to report on their financial health and risk exposure to regulatory authorities on a regular basis.
At the heart of all compliance requirements is the mandate for banks to keep clear, accurate, and comprehensive records of their operations, transactions, and communications. These records provide concrete evidence that they are complying with the rules. Proper recordkeeping creates a comprehensive audit trail that shows that a bank is both adhering to regulatory requirements and is able to demonstrate its compliance.
Analysis of Major Bank Failures and Their Underlying Reasons
Despite thorough regulatory oversight, banks do still fail. And even though this has become much less common, even one bank closing can have serious repercussions for individuals and economic systems. This is evidenced by the failure of Silicon Valley Bank, the 16th largest bank in the US, in March 2023. At the time of its closure, it was holding $209 billion of assets. According to the FDIC, $90 billion of these assets will remain in receivership and the total loss from the bank’s collapse to the Deposit Insurance Fund is estimated at $20 billion.
Silicon Valley Bank largely serviced venture-backed start-ups who are now struggling to pay their bills and meet payroll and loan commitments. This has severely impacted the start-up ecosystem in the US, with many ventures going under.
What causes banks to fail? While it is often due to a complex number of interrelated issues, these factors usually come into play:
- Poor Risk Management: Failure to identify and address emerging risks can lead to catastrophic consequences during economic downturns.
- Overly Aggressive Lending Practices: These practices often involve lending to borrowers with weak credit profiles or expanding into high-risk markets without proper due diligence.
- Inadequate Capital Reserves: If a bank doesn’t have enough money set aside to handle unexpected losses or financial shocks, it can cause insolvency.
- Economic Downturns: If the economy suddenly gets worse, the value of assets drops, more people can’t pay back their loans, and banks might not have enough money available. Even banks that are well-managed can struggle.
- Corporate Governance Failures: Weak corporate governance structures can contribute to bank failures. Conflicts of interest, lack of transparency, and inadequate internal controls can all undermine a bank’s stability.
The Impact of Bank Failures on the Economy
Bank failures can have far-reaching consequences for customers and the general public. When a bank fails, customers often lose immediate access to their money. This can have devastating effects on individuals who rely on their money to keep themselves and their families housed, clothed, and fed. For businesses, this can lead to operational crises, and can even cause them to close down. Bank failures also mean that customers can’t access essential financial services like mortgages, loans, or credit cards. This disrupts other economic activity, causing a ripple effect.
Because financial systems are so interconnected with one another, the failure of a major bank can affect other financial institutions, including those in different countries. Banks rely on partnerships to do global business, and they conduct a lot of different transactions with other financial institutions. If a major bank fails, its partners will face sudden losses, and this will lead to their financial instability.
A clear example of this was the collapse of Lehman Brothers in 2008. Lehman’s bankruptcy sent shockwaves through the financial system, leading to a severe loss of confidence, disruptions in interbank lending, and a sharp decline in asset prices. The resulting crisis triggered a global recession and required massive government interventions to stabilize the financial sector.
Compliance is the Path to Reducing Banking Failure
The regulatory framework that has been put in place for the banking industry is successful at protecting stakeholders’ interests and preventing banking failures. Compliance should be the top priority for banks globally, particularly given the extensive damage and disruption even one bank failure can have on entire financial systems.
It can be an overwhelming thought when you consider the sheer volume of rules and regulations to be followed. Compliance activities can take on a life of their own and run the risk of distracting the business from considering bigger-picture risk issues. It’s important to automate as many of the routine, administrative tasks as possible, creating a system that ensures compliance with as little human intervention as possible. Building the right tech stack will allow banks to take care of a big chunk of compliance considerations.
LeapXpert is the ideal tool to add to your compliance tech stack. LeapXpert offers a fully integrated platform that helps you monitor professional communication between employees and customers across personal and work devices and different messaging applications. Ensure regulatory compliance and protect your data across communication channels – book a demo today.
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