A Risk Professional's Survival Guide. Rossi Clifford
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The CEO believed in having a small management team reporting to him and this meant that only the presidents of SifiBank, SifiThrift, SifiFinancial, SifiInvestment Bank, SifiAsset Management, the CFO, General Counsel, General Auditor, and Head of Human Resources had direct access to the CEO. The CEO had handpicked the presidents as well and all had track records for achieving aggressive product objectives.
At this time the bank had only created the role of Chief Risk Officer two years before the crisis and this was largely a corporate oversight role. In fact at times, the role of the CRO and General Auditor seemed to overlap, creating significant confusion and concern by management that the bank was carrying too many risk oversight staff at a time when margins were thin. The CRO reported into the CFO, leaving an additional layer of management between the senior risk officer of the company and the board. The board did not hold executive sessions with the CRO separate from the CFO or CEO.
Furthermore, risk management activities were spread across the business, operations and audit functions in a decentralized model. As a result, the SifiBank board would pick up risk management issues in piecemeal fashion and only as management decided what was important to elevate to the board. A decentralized risk management function has its own merits over a risk management structure within the corporate center; however, it can lead to a number of governance issues that the firm must understand. In the case of SifiBank, the board of directors delegates development of credit and other major risk policies to the CRO. But since the CRO does not have any responsibility over managing the risk exposure of an individual line of business, a delegation of authority policy would need to be established by the CRO to allow business staff designated to manage risk at the unit level to operate within stated risk objectives. Such a policy would outline the size of deals, loans, and transactions that could be approved by employees, which is oftentimes based on seniority and expertise. By having a small corporate risk office and a large business risk function, it allows an independent review of risk management activities to be conducted by the corporate risk office while allowing the business risk units to be responsible for day-to-day implementation of risk management within each line of business. SifiBank had set up such a structure where each business unit had a CRO who reported directly to each division’s president and indirectly to the CRO. The presidents each created their own performance plans for their CROs with input from the corporate CRO (sometimes also referred to as the enterprise CRO). In the years preceding the crisis, SifiBank’s CEO gave clear direction to the heads of each business that they had to grow their businesses each year by at least 10 percent. As a result, these objectives were handed down to each executive in the operating units, including the business line CROs. For the business CROs, 85 percent of their performance was based on supporting product and sales within the division and only 15 percent was placed on managing the risk exposure of the unit. This executive compensation structure fueled significant risk-taking by SifiBank in the years leading up to the financial crisis.
Lines of Business
SifiBank operates along a complicated product and institutional structure as depicted in Table 1.1. Due largely to historical arrangements, several business lines cross corporate segments. While SifiBank remains the flagship entity with respect to consumer and commercial banking activities, its thrift and finance company divisions provide specialized consumer and commercial banking oriented in some measure to their unique charters.
Table 1.1 SifiBank Business Lines by Corporate Entity
Thrifts, or savings and loans (S&Ls) as they are sometimes known, are depository institutions like commercial banks and are granted operating charters from the state or federal government that allow them to access cheaper (federally subsidized) deposits. But a major differentiator between commercial banks and thrifts is that a thrift institution must maintain 65 percent of its assets in certain qualifying assets, much of which are mortgage-related. This specialization makes thrifts particularly vulnerable to mortgage market conditions. Moreover, thrifts are especially sensitive to interest rate risk, where losses can be realized due to mismatches between typically shorter-dated funding sources and mortgage loans that have long maturities. This will be examined in more detail in later chapters. SifiThrift Company is regulated by the Office of the Comptroller of the Currency (OCC).
SifiFinance Company had been an independent company prior to its purchase by SifiBank in 1999. As a finance company it did not hold a bank charter, which meant that it had to derive its funding via capital market debt issuance. The lack of subsidized deposits puts finance companies at a competitive disadvantage to commercial banks and thrifts. Balanced against that is the fact that unlike banks and thrifts, finance companies are not subject to safety and soundness regulations. They are subject to various state and federal consumer regulations such as those overseen by the Consumer Financial Protection Bureau (CFPB). However, by focusing on subprime borrowers, SifiFinance Company was able to earn substantial income by charging interest rates and fees significantly above that for prime borrowers. The company traditionally offered small ($500–$1,000) short-term (<1 year) unsecured (i.e., requiring no collateralization) personal loans realizing that the average loss rate on this business was between 12 and 18 percent. Borrowers could be graduated to larger loans, eventually after demonstrated payment ability over time, allowing them to obtain a mortgage loan from SifiFinance Company.
SifiBank, as mentioned earlier, is comprised of several commercial bank subsidiaries. SifiBank, having a federal charter, is technically a national bank, overseen from a safety and soundness perspective by the OCC. The Federal Reserve oversees banks that have state charters and are members of the Federal Reserve System (FRS) as well as bank holding companies. The Federal Deposit Insurance Corporation (FDIC) oversees state-chartered banks that are nonmembers of the FRS.
SifiBank’s lines of business are focused on consumer and commercial customers. The bank offers a full array of consumer loan products as shown in Table 1.1 with credit cards representing one of the larger consumer asset classes. SifiCards is one of the most recognized credit cards in the market, however, a rise in cyberattacks on large retailers and banks has placed the company on guard against this risk. But one of SifiBank’s greatest strengths is in its extensive branch network. It operates more than 10,000 retail branch offices across the country, although 75 percent of its network is on the East Coast. The cost of operating branches in an increasingly e-commerce environment has pressured the bank to find ways to reduce its operating efficiency ratio defined as the dollar amount of noninterest expense as a percent of operating revenues. To be more competitive with peer institutions, the bank has waged a cost-cutting campaign for three years and senior management has considered increasing its Internet banking model in an effort to combat higher costs.
Notwithstanding such costs, the branch network represents a significant source of revenue generated from cross-selling of bank products to its customers. On average SifiBank has found that its retail bank customers have about seven products that it obtained from branch operations. That means that when a customer opens up a retail checking or savings account they are marketed for loan and investment products. This compound effect of cross-selling products has boosted revenues even as operating expenses have risen with branch growth.
SifiInvestment Bank was formed to handle all of SifiBank’s vast trading and investment activities for its clients and for proprietary trading. The bank trades in virtually all investment types including equities, fixed income, derivatives such as options, futures and swaps, foreign exchange and commodities. When trading for clients it acts as a market maker, bringing buyers and sellers together without taking a position itself.7 The capital markets group has developed a robust structured finance offering, which features creating, underwriting and investing in various financial instruments with complex cash flow features. Examples of structured financial instruments include mortgage-backed securities and associated resecuritizations, collateralized debt obligations (CDOs),