This post is the second in a series discussing Open Banking, its implementations, and its implications. Part 1 is here.
APIs or “Application Programming Interfaces” are everywhere in ecommerce, and they provide the building blocks in the primordial soup of innovations that may stem from open banking.
Among other roles, APIs provide a protocol allowing one computer system to talk with another. For example, The Weather Channel (“TWC”) has invested heavily in providing detailed meteorological information and forecasts by region. TWC could conceivably require people to visit its website as the exclusive way to access this information. Instead, however, TWC permits some of its information to be accessed automatically across apps, websites, and services and in ways third-party developers can predictably map (e.g., certain tagged data reflects values like “75°F” or “Partly Cloudy”). TWC has determined such use advances the TWC business plan. Conversely, the developers of apps, websites, and services have determined using the TWC API is superior to reinventing what TWC has accomplished—or not offering weather information at all.
This post is the first in a series discussing open banking, its implementations, and its implications.
“Open banking” is a phrase that has been coined to capture a current theme in financial sector innovation – one that some say is going to revolutionize banking. For years, banks have given their customers increasing access to account information. Now, with open banking, the access is opening to the point where customers can potentially obtain financial services in entirely novel ways, and the customer’s expectations of their bank may shift.
The push to open consumers’ financial data goes back decades. In the 1990s and 2000s, financial institutions began giving customers online access to their accounts—and instantaneous access to information previously reserved for monthly statements. Card-based transactions gradually shifted away from signed papers with carbon copy receipts to electronic devices. With rapid access to financial information, debit cards that could immediately draw on bank accounts became more feasible. Meanwhile, third-party vendors, such as Intuit, Microsoft, and Checkfree, were among the providers who encouraged institutions to go even further by making financial data available in a format that could be imported into their software; their work led to the promulgation of the Open Financial Exchange (“OFX”) data stream format, among others.
In the past 10 years, the priorities in data exchange have incorporated the agenda of government proponents. Notably, in 2016, a U.K. regulatory authority required the country’s nine largest banks to allow certain registered third-party developers to access certain customer data. In 2018, the European Economic Area began implementing the Second Payment Services Directive (“PSD2”), including its goal to provide financial data through a central register. In the United States, the Consumer Financial Protection Bureau has expressed its view that consumers should have timely, secure, and transparent access to their financial account information and to data sharing opportunities. During this same time, digitization has accelerated to unprecedented levels in all facets of life and commerce, and data privacy risk awareness and regulation has emerged.
It is with a very heavy heart that I write to report that our longtime friend and retired Partner, Walt Moeling, passed away peacefully on Monday night. Walt was at home and surrounded by family, including his wife Nell who has become a friend to many throughout the firm. Nell was Walt’s lifelong best friend and true companion, and is almost as well-known as Walt within the banking community in the Southeast for always being by his side and helping to grow his practice. Walt was important to our group, to the firm and to every person whose path he crossed. He was an incredible mentor to many, including our entire banking team.
Walt spent his entire legal career with our firm, starting out in the late 1960s with Powell Goldstein, an Atlanta-based firm that merged with Bryan Cave in 2009. In Walt’s near 50 years of active practice, he represented banks, thrifts, insurance companies and securities firms nationwide. In recent years he was nicknamed “the Godfather of Banking in the South” by a very prominent banking industry commentator.
Walt was widely recognized for his accomplishments as a leader in the legal field and banking industry and appeared in Who’s Who in America, in the South; American Law; Business and Finance; and as one of America’s Leading Business Lawyers by Chambers and Partners.
Many of us who are native Southerners sat with mouths agape as we read the announcement of the $66 billion (!) all-stock merger of equals between super regional banks BB&T and SunTrust. Few of us who grew up in Georgia have not been personally impacted by these banks in some way or another. For me, my aunt worked at Trust Company Bank when I was a kid, and BB&T bought a local thrift (Carrollton Federal), making its way into our home market where it remains today. After college, law school barely beat out an offer to work in SunTrust’s commercial lending training program, and BB&T currently holds the mortgage on my home. With all of those ties, I feel somewhat nostalgic when reading that the bank will be rebranded as a part of the merger.
With that said, the real time business implications for all of us are even larger. The day before the merger, my friend Jeff Davis wrote a smart piece ($) detailing the virtues of merger of equals transactions in today’s world. BB&T recently discussed on its earnings call that it was accelerating cost savings initiatives in order to invest more in its digital offerings. With the announced merger, one can assume that the lab for digital innovation of the combined bank (to be based in Charlotte, a bit of a disappointment to the Atlanta community) will make a massive effort to transform the banking experience of the bank’s customers, a truly meaningful segment of the market. We have recently commented that the transformation of the Atlanta banking market is now a reality, and this combination promises to further evolve how many banking customers think of and interact with their banks.
Twenty venture capitalists gathered in Silicon Valley last week to discuss the impact of blockchain technology, including digital currency, on financial services and venture capital. The 20 VCs represent an equal number of funds, which invest–or are looking for investment opportunities–all over the world, including the third world. They represented a diverse group of perspectives, with some having regulatory experience, some having experience with conventional payment mechanisms and some with innovative mechanisms such as PayPal. Even their disagreements were instructive of the uncertain future of blockchain technology and its various potential applications.
The consensus is that digital currency is entering a nuclear winter. A majority of Initial Coin Offerings made in 2017–perhaps as much as 75%–turned out to be fraudulent and have no value today. Not coincidentally, the vast majority of Initial Coin Offerings originated in Eastern European countries that are home to spam and bot farms…and where there is little, if any, regulatory oversight.
To the extent bitcoins may become a viable, commercial technology for B2B transactions, it is likely to occur in a technology hub in the U.S. or Europe. Those hubs have the talent, the infrastructure and the robust regulatory structures that can be adapted to ICOs and create the trust necessary to make digital currency a positive, viable alternative to government currencies. In fact, the centralization of technology talent in the U.S. is depriving the rest of the world of talent.
The attempts of island states, like Bermuda, Malta, Cyprus, the Isle of Mann, and even Singapore to draft regulations that facilitate the creation of bitcoin issuers on their soil is unlikely to have a significant impact. Nobody who is experienced and seriously intends to build a global digital technology company and change the financial services industry on a global scale will think one can create the necessary large organization on these islands. These islands do not have an ecosystem of sophisticated VCs and do not have a critical mass of talented engineers. The island states are going for broke because they have so little to lose. When and if the technology matures, U.S. companies will step in and crush competitors based in these islands.
The U.S. depository industry has continued its path of consolidation, but as of the end of 2017, there are still over 5,600 banks chartered in the United States. This represents a decline of just under 3,000 charters from 10-years earlier, as mergers, receiverships and a near complete dearth of de novo activity have continued to shrink the number of banks.
As of December 31, 2017, we had 5,679 depository institutions with $17.5 trillion in total assets. That represents a decline of 243 institutions an increase of $600 million in assets since the end of 2016, and a decline of 2,865 institutions and an increase of $4.4 trillion since the end of 2007.
The four largest depository institutions by asset size (JPMorgan, Wells Fargo, Bank of America and Citi) hold $7.03 trillion (up slightly from $6.84 trillion at the end of 2016). Those four now represent 40.1% of the industry’s assets, down slightly from 40.5% at the end of 2016; but up from 34.8% ten years earlier.
There are 120 additional banks that have assets greater than $10 billion, holding $7.45 trillion. Both of those numbers are materially higher than one year earlier; at the end of 2016, there were 111 banks in this category with $6.98 trillion in assets. The 124 largest banks now hold 82.7% of the industry’s assets. Ten years ago, there were 119 institutions with more than $10 billion in assets, and they collectively held 77.6% of the industry’s assets.
Five years ago few legal departments were concerned with – let alone focused on – data privacy or security. Most of those that were aware of the terms assumed that these were issues being handled by IT, HR, or marketing departments.
The world has changed. Data privacy class action litigation has erupted and data security breaches dominate the headlines. It is now well accepted that data privacy and data security issues threaten the reputation, profitability, and, sometimes, the operational survival of organizations. It is therefore perhaps not surprising to find that in almost every survey conducted of boards and senior management, data issues rank as one of their three top concerns, if not their single greatest concern. With that backdrop, organizations increasingly look to general counsel to manage data privacy and security risks.
With the end of the year approaching, it is time to start looking forward to 2018 and putting together that list of New Year’s resolutions. This list of annual goals can be especially important for community banks because, let’s face it, times are a-changin’ and community banks cannot afford to ignore this, especially in the face of the ostensible juggernaut that is fintech. “New Year, New You” doesn’t have to be a mantra solely for individuals; it can also be a mantra for community banks who want to make 2018 a successful year. To get you started, we have provided some suggestions that may help you turn 2018 into a very positive year for your bank.
Don’t be Consciously Blind
With such a vast amount of information thrown at us every day, I think we are all guilty of becoming consciously blind. It’s true, all the information can overwhelm us, making us turn a blind eye and ignore what everyone has to say and assume if something really important happens, someone will tell us. As a banker, you cannot afford to do this. With the promulgation of new regulations and advances in technology, it is important for community banks to remain aware of the financial landscape and evolve. Whether this means meeting revised regulations or updating technology to meet your customer’s needs, make a resolution to stay abreast of information that may affect your bank.
As Jonathan and I mentioned on our podcast on succession planning a few weeks ago, our patriarch and founding father, Walt Moeling, formally retired at the end of 2016. However, his knowledge and influence continue to permeate almost everything we do (and he still has the same office down the hall). One of the ways that influence can be seen continues to be in our use of stories originally told to us by Walt. Of course, his storytelling ability has been noticed, including by the press. Several years ago, as part of our succession planning, we began chronicling some of those stories. What follows is what I wrote two years ago…
In early 2010, our clients were dropping like flies, with one or two clients failing every Friday. Even as one client entered receivership, we were each likely working with three or four others that were on the same path. (Each was a horror movie, and we knew exactly how it would play out, even if our clients held out optimism each time that, for whatever reason, their story would play out differently.)
Walt and I were on the phone with one such client who had just passed the 2% leverage ratio threshold, and was in discussions on next steps. The executives were worried about how their employees would handle the receivership. Walt, as usual, slipped into a story about another (former) client that had been a client for years. Whenever Walt called, the president’s administrative assistant, Nancy, would answer the phone and chat with Walt before tracking down the bank’s president. Walt shared how he had listened as Nancy became increasingly depressed as the bank’s condition had deteriorated.
In his best Southern belle, falsetto, voice, Walt would demonstrate the decreasing pep in Nancy’s voice. From an upbeat “Good Morning, Walt!” to more and more depressing “Oh, Walt, things are hard, but we’re trying.” In the weeks leading up to that client’s receivership, Walt himself became increasingly saddened by Nancy’s stress. Calls now usually started “Oh, Walter, things are rough.”
In this the new era of banking, our clients are continually looking for ways to enhance efficiency and effectiveness at all levels of their organizations. This line of thinking has led to the revolution of the bank branch and the adoption of many new technologies aimed at serving customers and automating or otherwise increasing process efficiency. Perhaps most importantly, however, banks have begun to focus on optimizing their governance structures and practices, particularly at the board level.
(A print version of this post if you’d like to print or share with others is available here.)
As we discuss this topic with our clients, the conversation quickly turns to the role and function of the bank’s director loan or credit committee, which we refer to herein as the “Loan Committee.” We continue to believe that Loan Committees should move away from the practice of making underwriting decisions on individual credits absent a specific legal requirement, and here we set forth the position that this change should be made in order to enhance Board effectiveness, not just to avoid potential liability.
Ensuring Board Effectiveness
Whenever we advise clients with regard to governance, our fundamental approach is to determine whether a given course of action helps or hinders the Board’s ability to carry out its core functions. Defining the core functions of a Board can be a difficult task. Fortunately, the staff of the Board of Governors of the Federal Reserve System recently outlined its view of the core functions of a bank Board. We agree with the Federal Reserve’s outline of these functions as set forth in its proposed guidance regarding Board Effectiveness applicable to large banks, which was based on a study of the practices of high-performing boards. Based on our experiences, many of the concepts expressed in that proposed guidance constitute board best practices for banks of any asset size. The proposed guidance indicates that a board should:
set clear, aligned, and consistent direction;
actively manage information flow and board discussions;
hold senior management accountable;
support the independence and stature of independent risk management and internal audit; and
maintain a capable board composition and governance structure.
We believe that an evaluation of the board’s oversight role relative to the credit function is a necessary part of the proper, ongoing evaluation of a bank’s governance structure. As it conducts this self-analysis, a board should evaluate whether the practice of underwriting and making credit decisions on a credit-by-credit basis supports its pursuit of the first four functions. We believe that it likely does not.
Considering Individual Credit Decisions May Hinder the Committee’s Ability to Set Overall Direction for the Credit Function.
We have observed time and time again Loan Committee discussions diving “into the weeds” and, in our experience, once they are there they tend to stay there. In most Loan Committee meetings, the presenting officer directs the committee’s attention to an individual credit package and discusses the merits and challenges related to the proposal. Committee members then typically ask detailed questions about the particular financial metrics, borrower, or the intended project, assuming that any discussion occurs at all prior to taking a vote.
While it may sometimes be healthy to quiz officers on their understanding of a credit package, focusing on this level of detail may deprive the Loan Committee of the ability to focus on setting direction for the bank’s overall loan portfolio. In fact, in many of the discussions of individual credits, detailed questions about the individual loan package may in fact distract from the strategic and policy questions that really should be asked at the board level, such as “What is the market able to absorb with regard to projects of this type?” and “What is our overall exposure to this segment of our market?”
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