Dodging the next recession- Technology in play

Original article was published on Artificial Intelligence on Medium

Dodging the next recession- Technology in play

Lessons learned from past recession

In 2008 the financial crisis lead to a sharp downfall in the banking sector when banks lost money on mortgages with freeze in inter bank lending and drought in credit lending. When looking beyond the immediate outcomes, the financial crisis gave birth to new regulatory directives through Basel III globally & by way of the Dodd-Frank Wall Street Reform and Consumer Protection Act in the U.S.

The deregulation of financial industry in early 2000 permitted the banks to engage in exotic derivative products like mortgage back securities, collateralized debt obligations and other similar products. This along with availability of cheap credit in U.S boosted the subprime mortgage market creating an asset bubble in real estate. However with the increase in Fed rates from 2004 ,the interest rates were reset on mortgages leading to higher payments & decline in housing prices thereby causing default trap for subprime borrowers. Since the mortgages were tied to exotic derivative products, the crash in housing industry in 2007 crippled the U.S financial industry leading to liquidity & credit meltdown in the global financial market.

Regulations to Avert Further Crisis

In order to avert another banking emergency, in December 2009, the Basel Committee presented recommendations for new capital and liquidity standards for the worldwide financial and banking sector through Basel III. The regulators in the U.S also put forth a substantial number of new strengthened laws to regulate the financial markets & protect consumers through the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) in 2010.

The Dodd-Frank Act requires bank holding organizations with more than $50 million in resources to follow strict capital and liquidity models, and it set new limits on incentive compensation.

The provisions of Dodd Frank include creation of Financial Stability Oversight Council which had a clear mandate to identify risks that affect the financial industry & to monitor the stability of large “systematically important” banks whose failure woud negatively impact the economy. Another Key provision, the Volcker Rule aimed at preventing commercial banks from taking part in speculative activities and proprietary trading for profit.

Government across the world spent billions of dollars to bailout banks from crises in order to revive the economy. While US Congress approved a $700 billion bank bailout in October 2008 through the Emergency Economic Stabilisation Act of 2008, the UK treasury spent more than $1000 billion to bailout the economy.

After the regulatory reform in 2010, The Financial Accounting Standards Board(FASB) in 2016 reformed the allowance for loan and lease losses (ALLL) calculation through the current expected credit loss model(CECL). Currently, the impairment model is based on incurred losses, and investments are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms.

Under CECL, financial institutions will be required to use historical information, current conditions and reasonable forecasts to estimate the expected loss over the life of the loan. The transition to the CECL model will bring with it significantly greater data requirements and changes to methodologies to accurately account for expected losses under the new parameters.

Post the financial crisis,larger banks actively started investing in data and technology capabilities specifically in disruptive technologies to comply with post-recession regulations like BASEL, CCAR, CECL, etc.They made significant progress in Risk, Compliance and business growth areas enabled by artificial intelligence and big data capabilities.

Small banks & credit unions could not engage in multi billion programmes like the larger banks, small banks are trying to catch up with limited funds and resources. Lack of data, technology, and analytical capabilities to predict creditworthiness of borrowers puts them at a higher risk for loss. The current industry trends show a large portion of SMB and credit unions have been eaten away by larger banks and fin-techs, they need to act quickly to survive.

Considering the troubled times ahead with another recession looming on the horizon, small banks need to gear up with the current times to avoid a crisis. They need to invest in data, technology, and analytics capabilities to arm themselves with predictive tools to mitigate loss while seezing potential areas for growth.With the experts stating that recession has already begun, currently, in the growth recession phase, the survival of small banks and credit unions comes with their ability to compete with the larger banks and Fin-Techs.

BANK+1’s team has considered this information while partnering with esteemed professors from top universities as well as industry thought leaders to create their concept of a Digital Banking Platform. Founded in 2017 by Harvard Business School and Carnegie Mellon University Alumni, we are a a research and solution development company focused on delivering innovative and value-driven business analytical solutions using Data Science, Robotics, Artificial Intelligence & Cognitive Technology. Our ultimate goal is to combine Artificial Intelligence with Human Intelligence to explore infinite possibilities.

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