A Risk Professional's Survival Guide. Rossi Clifford

SifiBank is the Corporate Division. This group comprises the nonbusiness-oriented activities of the entire company such as finance, accounting, treasury management services, corporate risk management, legal, IT and operations, and human resources. The company over the years adopted a center of excellence model where these activities would emanate from the corporate center for purposes of maintaining consistency and adherence with applicable laws, regulations and accounting rules as well as promoting best practices across the company. Each operating division of SifiBank maintains a cadre of staff performing these functions for its specific business, but these resources have a direct reporting line to their respective corporate offices.

      An important function within the Corporate Division is the Treasury Office. This group is responsible for ensuring that SifiBank and its operating subsidiaries have the right mix and level of funding required to meet its activities, on a day-to-day as well as longer term basis. Each day the Corporate Treasurer and her staff face a complex and well-choreographed exercise of determining how much funding is available from its retail deposit network, wholesale deposits, and short-term funding markets, including asset-backed commercial paper (ABCP), and overnight repurchases (repos), which amount to interbank borrowings. It balances its needs for short-term funds with an ability to issue debt and equity at regular intervals in order to best match its asset and liability structure while maintaining a safe cushion of liquidity on hand to meet uncertain events such as unexpected deposit outflows or other disruptions. Thus, one of the Treasury Office’s major risks is from liquidity risk. In reporting directly to the Chief Financial Officer (CFO), the Treasurer also has responsibilities for asset-liability management within SifiBank. The CFO and Treasurer also work closely with each business unit CFO to maintain the right level of assets in each subsidiary’s portfolio.

      For SifiBank and SifiThrift, for example, the bank maintains large held-for-investment (HFI) mortgage positions. These are portfolios that the bank and thrift subsidiaries plan on holding for long periods of time. Some mortgages that are originated, however, are designated as available-for-sale (AFS). These assets, for example, might be formed into a pool to be packaged into a mortgage-backed security (MBS) and sold to investors. Different accounting rules apply for assets held for sale than HFI. Accounting principles, for example, require fair value treatment for assets intended for sale. Depending on a number of factors, including how liquid the market is for an asset, fair value could be assessed based on observable market prices, inferences drawn from closely related assets, or even models if no market pricing is available. During the financial crisis SifiBank saw the fair value of their AFS mortgage securities positions fall 50 percent as investors retreated from the market. Meanwhile, the bank’s HFI portfolios experienced a much smaller decline limited to its expectation of credit losses forming in the portfolio. In originating loans, the bank engages in a “best execution” assessment that determines the highest price it would be able to obtain for a loan whether that is an HFS or AFS disposition. A detailed financial analysis of the value from retaining or selling the asset is performed.

       SifiBank Balance Sheet Composition

At an aggregate level, the variety and composition of SifiBank’s balance sheet at the holding company level is illustrated in Tables 1.2 and 1.3. At a glance, Sifibank holds nearly a quarter of its assets in consumer loans, 50 percent of which are in mortgages, with credit cards accounting for another 44 percent. As mentioned before, trends in the economy and housing market will feature prominently in SifiBank’s assessment of the credit and interest rate risk profile of this portfolio. Commercial lending represents about half the size of the consumer business with commercial and industrial loans (C&I) and commercial real estate (CRE) lending evenly split. The consumer and commercial lending businesses couldn’t be more different in many respects. Consumer lending such as the credit card business tends to rely on relatively homogeneous populations to assess risk, which lends itself to intensive data mining analysis. Underwriting for a credit card is more heavily automated than commercial lending which, due to large differences in client, loan size and purpose, among other factors, makes commercial lending a much more manual underwriting process.

Table 1.2 SifiBank Asset Composition

      Note: Subcategory percents add up to 100 percent for each category.

Table 1.3 SifiBank Liabilities and Equity

      Note: Subcategory percents add up to 100 percent for each category.

      The bulk of SifiBank’s remaining assets are distributed across its trading and investment units. More than one-fifth of the bank’s assets are in a variety of derivatives positions. The bank faces significant risk in the fluctuations of prices in these assets known as market risk. In addition, the vast fixed income and MBS holdings are subject to fluctuations in the value of these securities due to interest rate movements, which expose the firm to considerable interest rate risk. Finally, the bank retains 11 percent of its assets in liquid positions such as cash, and a variety of short-term positions. The bank faces the risk that it does not have sufficient assets that could be sold quickly with little or no price effect in the event of an unforeseen problem such as a bank run. Alternatively it must balance that risk against the reduction in income that it realizes for allocating a sizable portion of its assets to no or low earnings investments.

      Turning to the other side of the balance sheet, SifiBank shows liabilities totaling $900 billion against $1 trillion in assets. The difference is the amount of equity in SifiBank, or $100 billion. As will be explained in a later section, not all forms of equity (for example, common and preferred stock, loan loss reserves, and subordinated debt instruments) are created equal in the eyes of the regulator. As a result, SifiBank must comply with a variety of different capital requirements as a regulated depository institution.

      The liability structure of SifiBank broadly speaking comprises deposits and nondeposits. Just over half of the bank’s liabilities are in deposits and these are evenly split between retail (branch-sourced) and wholesale deposits. Retail deposits are cheapest since federal deposit insurance backs up each account to a significant level which helps hold funding costs down at banks and thrifts. However, as banks grow, their ability to grow deposits from retail branches may not be able to keep pace with asset generation and so bank treasurers may seek out wholesale deposits that can be procured in open markets. Brokered deposits are one such type of wholesale deposit, which allows banks to buy deposits from intermediaries at higher costs than would be the case for retail deposits. Bank regulators for many years have looked at brokered deposits as a source for fueling aggressive risk-taking at some banks that ultimately led to their failure. While such funding sources do need to be carefully evaluated, they can be an important way to augment funding when gaps exist. SifiBank also uses a wide variety of debt instruments of various terms (tenors). As previously mentioned, the bank must manage the composition of both its assets and liabilities in order to reduce exposure to interest rate risk. The weighted average life, or better yet the duration of its assets and liabilities, must be in relative balance for the bank to avoid major declines in the bank’s market value of equity (MVE). Since SifiBank has a large portion of its portfolio in mortgages and other longer-dated investments, it needs to extend the life of its liabilities in an effort to accomplish its asset-liability management (ALM) objectives.

       Industry Structure and Competition

      Since SifiBank operates in nearly every corner of the traditional banking sector, its competition comes from a variety of different entities. Banking in the United States has undergone significant consolidation for decades as economic forces have driven a large number of banks and thrifts into insolvency or merger precipitated either by economic downturns or weak performance at individual institutions. The nature of bank competition directly influences the risk exposure of SifiBank since its profitability and growth depend on how effectively it can compete in different businesses. To provide some perspective on the overall banking sector, at the end of 2013, there were nearly 7,000 commercial banks and thrift institutions operating