Financial Institutions: to propel the economy
The US financial system is the largest, most advanced and one of the most open in the world. Foreign financial entities are allowed a level playing field alongside domestic financial institutions as long as they abide by the US regulations after gaining prior approval. Customers are free to deal with any financial institution they choose and may negotiate at will.
Perhaps this sounds a bit too utopian, considering the American financial system has taken a severe beating. This has raised a great deal of concern. Christopher Dodd, chairman of the Senate Banking Committee, due to retire next year, is making his second attempt in a new plan to plug loopholes in financial regulation to prevent a repeat of the crisis of 2008. However, his first attempt last year was aborted by his Senate colleagues. The American Bankers Association claims that the new plan imposes too much regulation, while the consumer groups say it imposes too little. So while the new plan also faces criticism, the sense of urgency to pass the reforms is palpable all around us. Dodd’s bill aims to clarify the regulatory apparatus, making the Federal Reserve responsible for bank holding companies with assets exceeding $50 billion and for policing the entire financial system for risk. The Fed would also house a new consumer financial protection bureau.
The Securities and Exchange Committee has recently charged Goldman Sachs, the blue-eyed boy of Wall Street, with betting aggressively against the nation’s housing market. There are opinions for and against the allegations that are pressing the senior-most executives of the beleaguered company. However, the fact that the financial industry operated in a lightly regulated world is what disturbs those affected by the economic collapse. Nonetheless, Goldman’s profile had steadily risen over the past two years. The firm was propped up with taxpayer dollars in the fall of 2008, enjoyed a windfall from the collapse of insurer AIG and was poised to pay large bonuses to its employees for last fiscal year. However, the company’s shares have plummeted as a result of the recent allegations.
Financial Institutions such as banks, lenders, credit unions, and insurance companies directly affect a country’s economy. When problems arise in this sector, the economy-at-large becomes unstable and uncertain, here at home and internationally. But with problems come innumerable opportunities. Just as individual businesses seek to manage risk by improving liquidity and profitability to ensure stability, so shall financial institutions. Financial regulation, however, needs to ensure that the financial sector doesn’t have the incentive to make risky bets that may ultimately become toxic debts. It has become a game of risk for high return, forecasting which debts will become toxic, and selling the risk off before they actualize. These toxic debts have increased to such a degree that the economy suffered the resulting downfall. Now, lending institutions that traditionally extend finance to small businesses have become extremely conservative.
At a time when confidence in American financial institutions is wearing thin, their contribution to the economy cannot be ignored. Financial institutions that service the middle and small business sectors with commercial loans have a crucial contribution to make. However, identifying low-risk customers, minimizing exposure to bad loans and effectively pricing the risk of each applicant is a challenging and an exhaustive exercise.
Toxic debts are to be avoided, yet traditional methods of evaluating loan risks have not been entirely reliable. Struggling or growing businesses remain in need of additional capital, yet lenders and business owners aren’t entirely confident they know what loan amount is serviceable before a business experiences major cash shortages. Creditors need to better delineate which loans will be serviceable, and business owners should know with certainty, how much lending their firm could sustain.
Likewise, a firm needs to ensure that its internal measurement of financial performance is measured against the larger industry standard, to uncover trends in effort to stay efficient, stable, and competitive. This is true whether it involves a lending institution which benchmarks its own performance against other financial institutions, or a company analyzing its own financial health in relation to its peers.
The truth of financial health remains embedded in the numbers. No matter which analytical methodology or financial tools are used, sound financial decisions should be a priority over extensive risk. Business owners should manage their own financial risk to avoid unserviceable debts, lending institutions need to better delineate safe from potentially toxic loans, and financial regulation needs to address the issues that arise from an unchecked system of risky bets, which ultimately lead to a toxic-debt shell game. Although our economy will continue to recover slowly, it will only maintain stability when a better balance has been achieved between financial regulation, the banking industry, and business leaders.
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Tags: American financial system, Financial Institution, Lending Institution
