5 issues financial institutions need to be thinking about now
INSIGHT ARTICLE |
There are a number of significant issues and emerging trends affecting U.S. middle market companies and the U.S. economy in general, both of which are crucial to the health and vibrancy of the financial institutions sector. Given this environment, it is imperative for financial institutions to be thinking about the following five issues in evaluating their strategic plans:
- The need to adopt the current expected credit loss (CECL) guidance which reflects fundamental changes to accounting for credit losses and related financial reporting.
- Congress and regulatory agencies in Washington and in states across the country are focusing on tax reform and regulatory reforms.
- Technology and data are creating opportunities to drive profitability.
- A tighter job market is challenging the ability of institutions to identify and hire qualified employees, particularly in technical areas such as compliance and information technology.
- Changes in consumer preferences are forcing banks to evaluate the products and services they offer and the related delivery channels.
Following are a few of the changes that have taken place or are on the verge of being implemented, and what actions financial institutions should be considering to address them.
1. Regulatory changes
The challenge for financial institutions is staying on top of a number of regulatory and accounting changes, including:
- Home Mortgage Disclosure Act (HDMA) data collection: Additional HMDA data fields are required for reporting. A new rule requires 48 new or modified data points and will allow regulators to determine if unfair lending practices could be occurring through the use of data analytics. The American Bankers Association noted that “The new HMDA rules are inherently complex and very expensive to implement.”
- CECL: With acquisition activity gaining traction in the banking industry, it is important for institutions that plan to grow via acquisition to consider how adoption of the CECL model will affect accounting for loans, securities and other affected instruments at the target institution.
- Revenue recognition: The new standard is complex and represents a fundamental and significant change in accounting. It may be more challenging than many companies and institutions realize.
2. Tax reform
In a challenging low-rate environment, banks are entering new markets and offering niche products in their efforts to generate loan growth. In the rush to market, many institutions have not considered what impact the loans being originated may have on nexus which may result in state and local tax liabilities outside of their physical footprint. To date, certain states have not rigorously enforced compliance0; however, as a number of cash-strapped states, counties and local governments across the country are facing significant revenue shortfalls, banks may now be on the radar. With more aggressive enforcement and collection activities by state and local governments to generate revenue, banks should actively evaluate and manage their nexus risk.
On the federal level, if Congress passes a tax reform bill that lowers the corporate tax rate, institutions in a net deferred tax asset position will need to realize the adverse effect the decrease in the corporate rate has on the value of the asset. The impairment of the value of the deferred tax asset would need to be recognized upon the effective date of the tax change resulting in a corresponding decrease in regulatory capital given the impairment of the deferred tax asset. Institutions may consider increasing their deferred tax liabilities as part of their year-end tax planning process to minimize the impact any rate decrease may have on the value of the deferred asset. Further, consideration of the impact should be factored into capital planning, and the evaluation of the sufficiency of regulatory capital should lower corporate tax rates become a reality.
Finally, institutions that have made a subchapter S election should also monitor the outcome of individual tax reform in combination with corporate tax reform to determine if the subchapter S election remains the most tax-efficient model for operations.
3. Technology and data
Financial technology, or fintech, is used in banking and financial services to deliver an array of products and services ranging from credit scoring to digital currency, and online lending to asset management. Fintech captures the same consumer data that community banks have access to—in fact, with the consumer’s permission, these entities scrape the data from consumer’s bank accounts to drive credit decisions—but fintech companies typically are more effective in their ability to leverage the data and capitalize on it.
Large banks are harnessing this data as well, but smaller banks may not have the resources to make the effort profitable. The data may be residing on multiple systems or it may be inaccurate or out of date. But the ability to efficiently capture and leverage data will fundamentally change how banks go to market and drive profitability. Banks that want to capitalize on the consumer data they already have will need to make a strategic decision to either ignore the data, imitate the fintech companies or partner with them.
Regulators are also leveraging data and, as a result, increasing reporting requirements for institutions as a way to conduct efficient, on-going monitoring. This is also fundamentally changing the way regulatory exams are conducted both for safety and soundness and compliance. Institutions that invest in their ability to leverage data for risk management purposes will see not only better regulatory outcomes but also improved profitability.
Cybersecurity remains an immediate and broad-based threat—and bank regulatory scrutiny in this area has ramped up accordingly. Banks need to have an effective data security plan in place to deal with the threats that come with gathering so much information.
4. Labor and workforce
Maintaining a skilled workforce is a challenge across industries. Banks are struggling to fill core functions where decisions are traditionally made by a person and not by artificial intelligence or automation. But changing demographics, and the demand for higher wages and a clear career path, have made it challenging to identify, attract and retain candidates in key roles across institutions. It has become particularly difficult to find qualified and well-trained credit analysts and compliance officers in such a tight labor market. Further, given most community and regional banks’ focus on commercial real estate lending, the projected shortage of qualified appraisers presents a significant challenge to the industry as a whole. Ultimately, this lack of qualified workers may constrain growth, service and innovation if not addressed from a strategic perspective.
Banks in smaller markets in particular face difficulty in attracting and retaining talent, but they can partially or completely outsource many responsibilities, such as those in information technology, asset liability management and regulatory compliance. A thoughtful approach to outsourcing can assist in maintaining core activities while allowing internal resources to focus on strategic activities.
5. Changing consumer preferences
As customers move towards non-branch, digital channels, acquiring new customers—and increasing wallet share of existing customers—should be top areas of strategic focus throughout 2018.
Customer expectations and needs are changing: Millennials prefer to go online for their banking transactions. While the importance of branches as the center of customer activity has diminished overall, they are hubs of activity in certain markets. Boomers are shifting from wealth accumulation to maintaining and preserving, and are migrating to warmer states. As a group they prefer a mix of in-person and digital interaction, particularly those that split time between cold and warm weather climates depending on the season. In an effort to retain these customers, many banks are not only modernizing branches into sleek, welcoming locations with a number of amenities but providing a sense of security in educating this demographic on the ability to leverage digital channels in a secure manner.
Banks need to find the balance between the digital and the personal, and be agile enough to respond to these changing preferences and customer demographics.