Community financial institutions focus on the future by planning, forecasting, reforecasting, considering customer delivery preferences and assessing risks before they occur. Good thing … America is in the midst of the 2016 election cycle, and your institution should be planning now for possible exposure to a risk that’s lesser known and not often discussed—political risk.
Political risk refers to the adverse effects that could arise from political or governmental changes, including changes with policy makers, legislators and other elected officials. In such a turbulent election year as this, risk and strategic planning are critical.
But we should avoid defining political risk simply as effects from Dodd Frank, the CFPB or who controls the White House or Congress. Rather, consider it in broader, more comprehensive and integrated strokes. Political risk has a direct correlation to your financial institution. I’m not talking about individual federal agency or party affiliation. I’m talking about decisions made by the government that will affect your operations and performance.
I use the word “correlation” intentionally because it is familiar and also emphasizes something regulators ask you to consider today in your planning. They look for the correlation between the markets you serve and the employers in your trade area, as well as how outside influences might affect institution performance and create risk.
For example, consider the impact on commercial real estate loans, as with office space built to support expansion in the energy industry, with oil now at record lows. But we don’t have to look to the Middle East. Right here at home, consider the correlation between the impact of no state budget and the rumors of reduced services. Imagine how a bank or credit union could be affected if a local university closed, or even by the rumors of such?
When asked, community bankers almost unanimously agree that what happens in state capitols and in Washington, D.C. can result in substantial risk. In fact, a significant majority think political risk is equally important—or more so—than even credit or interest rate risk. And they are right.
But with strategic forethought, this threat is quite manageable. Successful mitigation of political risk requires deploying a forward-looking risk management effort emphasizing engagement with local, state and national government representatives. The following best practices offer direction:
Identify the Risks
It helps to separate political risk from regulatory compliance. While concentrating on compliance is a must, also accept the importance of working to influence legislation/regulations from their inception. Consider the remarks FDIC Vice-Chairman Thomas Hoenig recently made on regulatory relief: “While I would encourage useful regulatory relief from any source, my point remains that to achieve meaningful relief, it is necessary to change the statutes from which the burden flows.” Hoenig’s vital message is, regulators will be significantly constrained in the absence of enabling legislation. If you can positively affect the legislation on the front end, it will make your compliance with that regulation much easier on the back end.
Assign Responsibility, Become Involved and Engage Your Board
Mitigating political risk is a marathon, not a sprint, and it requires team effort—with less burden and lower costs as the result of this effort. Given its importance, someone high up in the food chain needs to take on the overall responsibility. You can also engage your senior management team to draw on their expertise.
The board must also be involved, as regulators consistently emphasize that boards be “informed and engaged” in risk management. And while you need to enlist the support of others and consistently keep the board looped-in to risk mitigation efforts, as a senior executive, you need to spearhead the effort as the person most familiar with your institution’s culture and all the risks it faces.
When providing valuable input to legislators and regulators, the information you share should consist of how you believe a law, rule or regulation that’s being considered will help or hurt your institution and your ability to serve your surrounding community. It is your constitutional right to provide that critical input, so take advantage of it. It is the government’s responsibility to listen and consider.
Be aware that legislators and regulators can construe silence as your consent. Did you consent to higher Basel III capital and liquidity requirements deserving only of the mega banks, or the potential doubling of your ALLL under FASB’s Current Expected Credit Loss model? If not, you need deliver your message to influence the legislative and regulatory process.
You may not think that your efforts can have an impact, but time and again, engagement has resulted in victories, exemptions and carve outs for community financial institutions. You won’t always get an immediate or positive result, but without effort there is no chance of success. In addition, you and your board will know that you played an important part of fighting for your community financial institution as well as your profession and your local community.
Incorporate Political Risk into Your Strategic Plan
Consider your SWOT Analysis for a moment. Your management and board undertake this particular exercise in an effort to identify strengths, weaknesses, opportunities and threats as they relate to the strategic plan. The question is, were government legislation and regulation considered or included as a “threat?” On the flip side, while the majority of bankers constantly identify compliance as a threat, they rarely mention their ability to influence these legislation or regulatory proposals through direct contact as an “opportunity.” Consider adding them into your strategic planning process, along with reasonable actions that you can take to help mitigate those risks.
Understand that the Regulators Agree
In a recent presentation to more than 100 bankers on ERM and the integration of risk efforts into risk management and strategic planning, several examiners were actually in the audience. I kept going back to them throughout the discussion to verify both the content and the premise of their regulations and guidance. And my interpretation of the content is that regulators are placing a heavy emphasis on business plans and the identification of the risks inherent in them. Notably, my analysis was confirmed repeatedly by this unofficial supervisory group.
Further, I brought up the potential for political risk to influence strategy. The response from the room was that governmental action can absolutely be a risk. While the regulators wouldn’t identify themselves as a threat—I didn’t expect them to—their meaning was clear: government actions should be considered in strategic planning.
While I have referred to political risk throughout this article, let me reiterate, this isn’t just about politics. It’s about promoting, defending, defining and implementing your strategic plan and mitigating the risks associated with it. There are outside influences that you must consider in order to accomplish that task, including the influence of politics and government actions.
Remember, there is no reason to take this task on alone, because you have valuable resources that can help. Use your membership in your state association as a starting point. But it isn’t enough to simply join—get involved. Working with an association amplifies your voice and provides opportunities to make a difference.
Not long ago, FDIC Chairman Gruenberg said, “It is important that the narrative about community banks be balanced and positive. The narrative should recognize the critical importance and substantial strengths of community banks in the United States …” There is strength in numbers. Be heard.
There’s an old saying: “Lead, follow or get out of the way.” You have fiduciary responsibilities to manage and mitigate all of the risks facing your institution and to lead its efforts in influencing the political and regulatory process.
Joe Wheeler serves as CSI’s strategic partnership manager. Joe has more than 20 years of senior management experience in the financial services industry. In his current role, he manages the strategic partnerships that are affiliated with CSI Regulatory Compliance. Throughout his career, he has worked with community banks and credit unions across the country to build strategic plans and business forecasts that fully incorporate risk management and compliance requirements.