In her final hours in charge at the Federal Reserve, Janet Yellen raised an issue central to the health of the U.S. financial system: And it isn’t alone.
The world’s biggest financial institutions run myriad lines of business, with hundreds of thousands of employees spread across the globe. This involves two kinds of risk. One is the danger of losses so large that they burn through capital and upset the broader financial system. The other arises from failing to apply controls and standards aimed at curbing misbehavior and maintaining confidence.
In dealing with that second risk, Wells Fargo is an example of what can go wrong. Top management set aggressive sales targets but paid little attention to how they were met. Over several years, employees opened millions of fake bank and credit-card accounts, and charged hundreds of thousands of customers for auto insurance they didn’t need - contributing to loan delinquencies and repossessions. Executives were slow to act as evidence of the misdeeds mounted. The board, charged with overseeing executives on shareholders’ behalf, did little until public outrage forced it to sanction the CEO.
In response, the Fed has devised a new approach. The bank will be prohibited from growing until it can demonstrate - in detail - exactly how it will avoid this mistake in future. It’s an unprecedented move, and a mark of how frustrated officials have become with the pace of change.
The Fed is right to be forceful - and should be no less diligent in policing the other kind of risk as well. To guard against systemic financial breakdown, it’s crucial, for example, that banks’ top executives have timely and reliable information on their exposures to major counterparties. Without it, they may find themselves as much in the dark as they were when Lehman Brothers and AIG nearly brought down the financial system in 2008. Last year, global regulators reported that only one of 33 large global banks fully met the necessary standard.
These failings have one thing in common: They show that managers and directors of the world’s largest banks need a much better grasp of what their institutions are doing. With luck, Yellen’s closing act will finally get this message across.