Booking models in banking have traditionally been driven by a diverse set of factors–such as business priorities, legal and regulatory requirements, tax, and financial performance. When those models change, it usually happens incrementally over time in response to specific opportunities and business needs. It also usually happens without a holistic analysis that accounts for an integrated or big-picture view. But now, the regulatory environment and business strategy questions are driving rapid change.
Regulatory reform–both at home and abroad-is creating new and complex rules that are having a major impact on the way products are booked. As banking organizations comply with new regulatory requirements and supervisory expectations, they are overhauling business models and transforming how they operate. The need for transparency around booking models lies at the center of this change, since booking models determine how and where banking organizations transact. They also determine how the resulting risks are managed, both individually within a specific jurisdiction and together across multiple jurisdictions. Booking models are increasingly under scrutiny, and regulation and supervision are now key drivers of cross-border practices.
In the past, bank leaders didn’t really focus on where products were booked as long as the transactions got done. But in today’s regulatory environment, where you book, how you book, and what you book in legal entities are all very important issues with significant financial implications.
One key focus area is transparency. Management and the regulators today don’t just want to know what you’re doing and how you’re doing it; they want to know ,why you’re doing it that way. Many banks don’t have answers to these questions. We have seen supervisors ask direct and challenging questions about a number of banking organizations’ practices with respect to governance and controls, risk management and operational risk–and moving forward we expect them to become more systematic in their scrutiny of broader industry practices. In addition, efforts around structural reform are shining a spotlight on legal entity and business strategy decisions.
Another key focus area is how to treat cross-border revenue and cost agreements between US subsidiaries (consolidated under a US holding company) and other legal entities. This is often referred to as transfer pricing. These agreements are often opaque, poorly supported, and accompanied by little historical data. Bank organizations that operate in the US will need to understand these complex arrangements under a variety of scenarios (such as stress, recovery, and resolution) and be able to model, manage risk, and hold capital in compliance with various US regulatory requirements such as Recovery and Resolution Planning (RRP). Comprehensive Capital Analysis and Review (CCAR), and Enhanced Prudential Standards (EPS).
These changes and others are forcing banks to deploy their financial resources in more efficient ways.
A booking model plays a key role in positioning business for the future. So it’s important to get it right–aligning business strategy, legal entity strategy, and regulatory strategy. The process starts with transparency-and with clearly understanding and documenting your existing booking model. Improved transparency helps you understand where products are currently being booked so you can assess the associated returns, understand the pressure points, and make smart decisions that balance efficiency, strategy, and regulatory compliance.
Transparency lets you analyze changes, and then identify options and recommendations for redesigning your booking model. As part of this effort, it’s important to take a holistic, global view. Ask yourself, “What products are optimal, what do our clients demand, how do we manage risk and govern ourselves, what legal entities are deployed, and what kind of business do we want to be in the future?”
Also, when diving into the practical details, it’s important to realize you can’t view your booking model in isolation or focus only on the rules in one jurisdiction. By definition, every booking transaction has multiple sides, and all sides must satisfy their local regulators. Making changes to avoid a problem in one jurisdiction may create a problem somewhere else.
Reviewing and rethinking your booking model can be a daunting task, but at this point you really don’t have a choice. Regulators are demanding it, and your competitors are already doing it–or soon will be. Thus, much of the business case for booking model change is about cost avoidance: preventing supervisory interventions that could ultimately lead to forced and costly structural change. In our experience, some of the necessary components to clearly understand current practices are often absent–documentation is not robust, and there is limited high level understanding of booking practices as a whole.
Beyond the regulatory reform and cost reduction agendas, there are a number of other good reasons to review booking practices and look for efficiencies: Many banking groups will find room to allocate capital more efficiently, liberate trapped capital and liquidity by eliminating superfluous legal entities, make better use of shared back office infrastructure, and generate a clearer understanding of profit and loss across the banking group, among other benefits.
For all these reasons-and given everything that’s at stake-transparency and linkage to business strategy are key.
For more information, refer to our detailed global report here.
Banking and Securities
Banking & Securities