By: John Ginovsky
November 26, 2002

The writing is on the wall: Banking will only get tougher, said former Comptroller of the Currency Eugene Ludwig.

Even as banks have embraced technology and increased their overall sophistication, and even as bank regulators have sought a balanced, risk-based approach to supervision, world events and a rapidly evolving economic situation are leading to a much more conservative and cautious banking environment.

“Even as good as the banks are doing [now], if we have very serious economic times brought on by a war situation, banks will have greater trouble getting earnings increases,” Ludwig said in an interview with ABA Bankers News. “They’ll have some loan losses and that, of course, brings on more regulations. There will be more scandals in the news, and that, of course, makes the regulators more regulatory.”

Ludwig, who served as comptroller of the currency from 1993-1998, now is managing partner of Promontory Financial Group in Washington, D.C. The firm advises community banks and complex financial institutions, specializing in investment banking, government regulation and monetary policy.

As such, he visits and talks with dozens of financial institutions of all sizes around the country while keeping tabs on banking-related developments in the nation’s capital.
“The decade we’re embarking on is a riskier time than the decade of the ‘90s,” Ludwig said. “It’s been an evolving situation, evolving because of technological changes and globalization and the war and terrorists. It’s a [much] riskier time. For bankers it means that we have to manage risk very aggressively. We have to be very cautious and do the right thing.”

The focus on corporate governance, for example, as exemplified by the Oxley-Sarbanes bill, highlights new combinations of risks and new ways risks are presented, he said. Reputation risk, in particular, is surging in seriousness.

“I’m thinking of one banking organization where they had a director who turned out to not have done anything wrong with the bank, but turned out to be an unsavory character…The bank took a hit because of it, a genuine hit in the community. The competitor said, `Look, why do you want to bank with that bank over there? I hear they have some unsavory things going on.’ So those kinds of things are real issues, real risk issues.”

Much of banks’ new vulnerability comes from indirect reputational risk, he noted. For example, “When we have clients such as Enron or Worldcom, you can see it in the papers. Who lent to these folks? Who is involved?”
What can banks do? “Banks can’t set the economy right,” Ludwig said. “But banks can help. Banks are the shock absorbers in the economy. In my view they’ve always maintained higher integrity standards than other industries…Bank behavior can teach corporate America how to behave.”

At the same time, banks will have to deal with the increasingly conservative focus of regulators.

“In community banks every day you have people who are really unsung heroes making very tough decisions, life-or-death decisions for small businesses, and that is where the jobs are, that’s where the growth is…It’s one of the reasons I’m so worried about the regulatory pendulum swinging back too hard. If we’re going to re-ignite the economy it’s really going to come out of what community bankers are doing in terms of lending to small businesses. What we don’t need is to have over-reaction [by regulators},” he said.
Nevertheless, that pendulum already has started to swing. “[The regulators] have shown, I think, admirable, admirable efforts thus far to continue to be thoughtful and balanced…But in terms of tougher exams, I think we’re going to see it,” Ludwig said.
Technological advancement is a parallel force affecting banking going forward, Ludwig said.

“There are many opportunities that are going to present themselves where community banks will be able to utilize technology to level the playing field with their larger brethren. This is a very exciting thing. At the same time, like all the changes in finance, they bring management issues and risk issues,” he said.

“Finance is not going to become easier. Think about the risk mitigation tools we now take for granted in derivatives. [At one time] it was a subsegment of a subsegment. Today, for larger institutions, you can’t be in business without using credit derivatives, interest rate derivatives and currency derivatives. This is percolating down to smaller institutions. The time will come when everybody will use these instruments,” he said.

“The bottom line is that banking will become more technologically sophisticated and more complex. It also means …there are real opportunities here. This is not something to be afraid of. It’s something to be taken advantage of,” Ludwig said.