Question

The redbrick bank in Weir, Kan., in a building cater-corner from the mortuary on Main Street, does not look much like a candidate for the bank of the future.

Inside, an Emerson boombox with a fully extended silver antenna is tuned to KJMK, Classic Hits. The huge steel vault, from the Mosler Safe Company, was used to lock up former owners of the bank overnight during an armed heist in 1959. And the storage room in the back contains an old, unlabeled bottle of brown moonshine.

Beneath these holdovers, though, the Citizens Bank of Weir—or CBW, as it was renamed—has been taken apart and rebuilt, from its fiber optic cables up, so it can offer services not available at even the nation’s largest banks.

The creation of the new bank, and the maintenance of the old one, are the work of a couple who were born in India and ended up in Kansas after living in Silicon Valley and passing through jobs at Google and Lehman Brothers.

Suresh Ramamurthi, 46, and his wife, Suchitra Padmanabhan, 44, bought CBW largely with their savings in 2009, just after the financial crisis….

Their work is an unusual experiment: a new kind of mom-and-pop business trying to reshape a highly regulated and innovation-resistant industry. The new services that CBW is providing, like instant payments to any bank in the United States, direct remittance transfers abroad and specialized debit cards, might seem as if they should be painless upgrades in an age of high-frequency trading and interplanetary space missions. But with most banks, it still takes longer to send money to another country or even to another state than it does to travel the same distance.

The slowness of current methods of moving money is a widely acknowledged problem in the financial industry. The Federal Reserve has been holding meetings for its initiative, called Faster Payments, which has the goal of devising safe and speedy payment methods.

But hastening the movement of money creates risk for banks, because it generally means less time to catch fraudulent transactions. Having paid fines and penalties for the outsize risks they took before the financial crisis, banks are loath to take on new risks. They have been occupied with “getting their house in order,” rather than introducing products, according to Steve Kenneally, the payment systems specialist at the American Bankers Association….

The most obvious problem to attack was the difficulty of making instant money transfers from one bank account to another. This is already possible in many countries, including Mexico and Britain, but in the United States the primary option that consumers have to transfer money is still the A.C.H. payment. Requests for A.C.H. transfers are collected by banks and submitted in batches, once a day, and the banks receiving the transfers also process the payments once a day, leading to long waits. Wire transfers move faster, with some being settled in hours, but they cost significantly more, and are still not instant.

Last year, big banks helped scuttle a plan that would have expedited the A.C.H. system, in part because it would have jeopardized the fees they earn from wire transfers. Large banks are experimenting with faster transfer systems, like QuickPay from JPMorgan Chase, but these are generally instant only between customers of certain banks….

1. The article describes a trade-off in two risks banks face: liquidity risk and operational risk. By speeding up payments, banks will be able to turn deposits into cash more quickly, thus increasing liquidity, but at the risk for more potential fraud. Is it worth it? Why or why not?

2. The article also points out that it may not be risks the banks are really concerned with. Why do you think a change in risk management has been so slow to come about?

Answer 1

Question 1

To understand this question, let us first understand the two terms. Liquidity risk is the risk that the banks' short term liquid assets (cash, government bonds etc.) may not be sufficient to meet its short term liabilities (call money, interbank loans etc.).

Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or external events.

While banks are required to keep aside some part of their capital for operational risk, liquidity risks are monitored through liquidity ratios or NSFR (Net stable funding ratio).

Over the years specially after the financial crisis, availability of capital at banks have taken a major hit with regulators tightening the screws by raising the capital norms and requirements. Banks have come under increasing margin and profit pressures trying to manage the two levers.

In the given case, instant payments do create operational risks for a bank which may require them to reserve more capital and ultimately impacting their profitability. However, liquidity risks are lower. While it does seem that banks may be hurt by activating instant transfers due to higher operational risk and lower fees on the same, they make lose out in the long run, specially due to the new age and fintech companies crowding the marketplace. So banks are better advised to keep up the changing competitive dynamics and adopting these new age technologies.

Question 2

There are various reasons due to which banks have been slow at changing their risk management practices. Some of the them are:

a. Some of the largest banks have been in existence for decades with legacy systems, people and processes in place. Immediately after the financial crisis, there were remarkable changes in the norms and regulations. Banks were naturally not able to keep pace with the same.

b. Profits and margins of the banks have come under huge pressure due to changing regulatory landscape and emerging new technological players. These have forced them to focus more on cutting costs, leaving less room for making the required IT spends.