Apparity Updates: April 2023
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Bank Crisis & Capital Requirements
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The banking industry has seen a lot of activity recently. SVB and Signature Bank have collapsed, Credit Suisse was taken over by UBS and there are worries about First Republic Bank. This activity has been explosive. Calling the current banking stresses a crisis is hopefully hyperbole, but the unease is apparent.
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In this edition of the newsletter, we'll share why banks should consider anticipating more rigorous liquidity/ capital requirements. The focus is mainly on the US banking industry. However, this may also apply to other countries. The current financial contagion is spreading beyond US borders.
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Financial Crises 101
To begin, we'll take a look at historical events to identify regulatory outcomes of key financial crises. The US has experienced many financial crises throughout its history. Each one has led to the implementation of new regulations aimed at preventing future ones. Here are the most prominent examples:
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The Great Depression (1929-1939)
This was one of the most severe financial crises in US history. In addition to the Wall Street Crash of 1929, it led to the passage of several major pieces of legislation. This includes the Securities Act of 1933, the Securities Exchange Act of 1934 and the Banking Act of 1933 (Glass-Steagall).
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These measures established the Securities and Exchange Commission (SEC) and imposed new disclosure and registration requirements on securities issuers and exchanges. Additionally, Glass-Steagall separated commercial banking and investment banking activities. It also created the Federal Deposit Insurance Corporation (FDIC) to insure bank deposits.
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Savings and Loan (S&L) Crisis (1980s-1990s)
This crisis was caused by the failure of many savings and loan institutions. The crisis led to the passage of the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA).
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FIRREA saw the creation of the Resolution Trust Corporation to oversee the liquidation of failed savings and loans. The act also established new regulatory requirements for savings and loans and expanded the regulatory powers of the FDIC.
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Enron & WorldCom Scandals; Dot-com Crash (late 1990s-early 2000s)
The Sarbanes-Oxley Act of 2002 was passed because of these crises. This act put in place new accounting and reporting requirements for publicly traded companies. Furthermore, it required CEOs and CFOs to certify financial statements. Lastly, it established the Public Company Accounting Oversight Board to supervise accounting firms.
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The Great Recession (2007-2009)
This crisis was caused by a variety of factors. The housing market collapse, risky lending practices and the failure of many financial institutions all contributed. It led to the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. This created new regulatory agencies, established new rules and requirements for banks and financial institutions, and implemented new consumer protections.
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Each crisis has had unique causes and consequences. Policymakers responded with a variety of regulatory measures aimed at preventing future crises and protecting the stability of the financial system.
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Dodd-Frank
In context of recent events, Dodd-Frank is perhaps the most relevant regulation in two ways:
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Dodd-Frank Act originally targeted banks with at least $50 billion in assets. In 2018 the asset requirement was rolled back to $250 billion. This placed a greater impact on the largest banks and financial institutions, while having less impact on midsize banks.
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However, today's concerns of bank runs are very real for small and midsize banks. A bank run occurs when many customers withdraw their deposits from a bank within a short period of time. The reason for the bank run usually stems from concerns about the bank's solvency or liquidity. This can lead to a rapid depletion of the bank's reserves and potentially even insolvency.
Chart: Google search queries for 'bank run' in the last 5 years
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Capital requirements and bank runs are connected. Capital requirements can help prevent or mitigate the impact of bank runs.
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If a bank has adequate capital, it can absorb losses and continue to operate even if many customers withdraw their deposits. This can help prevent a bank run or limit its impact. On the other hand, if a bank does not have sufficient capital, it may be more vulnerable to a bank run. The bank may be forced to close its doors or seek assistance from the government or other sources.
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Therefore, a bank's capital position is a key factor in its ability to withstand a bank run. Those working at small and midsize banks should begin taking notice. Should Dodd-Frank requirements change again or new legislation passes, they may have to implement more rigorous processes.
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A Pragmatic Approach
The level of effort to address capital requirements and stress testing, especially at smaller banks, must seem monumental. However, banks can pragmatically address these areas with a readily available tool— Microsoft Excel. Many banks already use spreadsheets to enable and support these activities. Others have moved on to other end user computing (EUC) tools such as Python, BI tools and others.
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End-user computing tools, or EUCs, are software applications. They are used by individuals or small groups of users to support specific business processes or analysis needs.?Examples include data analysis, financial modeling and report generation. These tools are often developed outside of the formal IT organization.
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Using EUCs for Capital Requirements
For capital requirements, banks can use end-user computing tools for a variety of purposes.
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Calculate and analyze bank capital requirements
By inputting data into a spreadsheet, banks can calculate risk-weighted assets and determine the corresponding capital requirements.
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Perform risk assessments
Banks need to determine the level of risk associated with their activities and assets. EUCs can be used to calculate the amount of capital required to cover those risks.
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Track and monitor capital levels
EUCs can be used to track capital levels over time and calculate the amount of capital needed to meet regulatory requirements.
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Using EUCs for Stress Testing
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Additionally, EUCs can be used to conduct stress tests. Stress testing helps assess the potential impact of adverse economic scenarios on the bank's financial condition.
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Banks collect and store vast amounts of financial data, which can be difficult to analyze without the use of EUCs. By inputting financial data into a spreadsheet, for example, banks can easily manipulate the data to perform various stress tests.
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Another use of EUCs in bank stress testing is to model different economic scenarios. Models are created to simulate the effects of economic shocks on a bank's financial condition. These models can be used to test the bank's resilience to adverse economic conditions and identify potential areas of weakness.
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EUCs can also be used to perform sensitivity analysis. This involves changing different inputs in a model to see how it affects the output. By performing sensitivity analysis on bank stress testing models, banks can identify the most important risk factors. It can also help determine which scenarios are most likely to cause financial distress.
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Overall, EUCs are a valuable, pragmatic tool in bank stress testing. They help banks organize and analyze financial data, model different economic scenarios and perform sensitivity analysis to identify potential risks. By using EUCs, banks can better assess their resilience to adverse economic conditions and take steps to mitigate potential risks.
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Associated Risks
As explained, EUCs can help banks enable and support their capital requirement activities and stress testing. However, the use of EUCs can also pose risks to banks. The issues range from data integrity, errors and inconsistencies. All of which can impact the accuracy and reliability of the information produced by these tools.
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As a result, banks must have?policies and procedures?in place to manage the risks associated with EUCs. This includes governance, documentation, testing and controls.
2023 EUC Solution of the Year
Insurance ERM Awards
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We are thrilled to announce that Apparity has been named the End-User Computing Risk Management Solution of the Year by InsuranceERM for 2023. This award recognizes our commitment to product innovation and customer prioritization in the development of our end-user computing risk management solution.
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InsuranceERM’s end-user computing (EUC) risk management solution of the year award recognizes a software provider that has demonstrated excellence in creating solutions to manage the risks associated with EUC applications. The award is given to a company that has shown innovation in addressing the challenges of identifying and mitigating risks in end-user applications such as spreadsheets, databases, and programming languages. The winner of the award is chosen based on their ability to provide a comprehensive solution that automates the EUC lifecycle and prioritizes customer needs, while also being able to meet specific regulatory requirements.
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