Finally, banks need to develop risk-exposure frameworks that span the enterprise and aggregate exposures in a timely manner, say consultants. "Risk concentrations are not attributable to any particular category of risk," comment Allan D. Grody and Peter J. Hughes of ARC Best Practices Ltd. in a recent paper. "Indeed, the unmeasured and unreported risk exposures that contributed to the current financial crisis were a cocktail of all the principal categories of risk."

Decent Exposure
Even if banks do manage to bolster capital and buttress risk management, they will have to shed more light on their balance sheets if they want to regain the confidence of borrowers, investors, and other banks. Openness is not something banks are very good at. As evidenced in the CFO banking survey (see "Waiting to Exhale"), finance chiefs are still looking for assurances from their banks about financial strength and stability. Yet they often have to pay third-party firms for assessments of the safety and soundness of an individual lender.

In general, banks' financial reports are just too complex, says Sterling National's Millman. "When you talk about money-center banks with multiple lines of businesses and all kinds of hedging and swap products, I can't pick up the financial statement and understand what's going on," Millman says. "I hope the regulators can."

According to Richard J. Herring, a finance professor at the University of Pennsylvania's Wharton School, regulators have been part of the problem, permitting banking complexity to run amok. The top 16 financial institutions have 2.5 times as many majority-owned subsidiaries as the top 16 nonfinancial corporations have, he notes. Such complexity can have serious systemic ramifications if a financial firm goes under, as demonstrated by Lehman Brothers's 2008 bankruptcy. One solution Herring recommends: require every bank to have a live bankruptcy plan that gets updated quarterly, to ensure an orderly unwinding if a bank fails.

The Return of Banking
What, ultimately, is going to revive financial institutions, assuming they survive the economic meltdown? New regulations can reduce risk by stemming excesses. Previous programs that purported to manage systemic risk simply didn't work, says Roel Campos, a partner at Cooley Godward Kronish LLP and former commissioner at the Securities and Exchange Commission. "The markets didn't handle this very well by themselves — you need a diligent referee to enforce legitimate, smart rules," he says. "And you need new software, new models, and people who understand them."

But perhaps it would be best if the federal government didn't burrow too deeply into the fabric of banking, suggest some observers who fret over possible governmental control of capital allocation. After all, it took the federal government seven years to extricate itself from an 80 percent takeover of just one bank — Continental Illinois, in 1984.

Consultant Speer says bank CFOs can't rely on the emergence of a silver-bullet product to reignite profits. Instead, smaller improvements in the economic outlook and the mathematics of banking will have to do for now, at least for "spread lending" institutions that don't dabble in exotic financial instruments.

Kelly King, CEO of BB&T Corp., said in a recent earnings call that the bank is encouraged by the restoration of some pricing discipline in business loans. The bank saw a 100-plus basis-point improvement in loan rates in the fourth quarter. In the last three months of 2008, most banks increased the spread between their cost of funds and the rate they charge commercial and industrial borrowers, according to the Fed. They also charged higher premiums for riskier loans and raised the cost of credit lines, while lowering both the maximum maturity and size of loans and credit lines.

Banks are probably hoping that the combination of a low federal funds rate and the power to increase pricing continues. For that to happen over a long period, credit would have to remain scarce. But lower benchmark interest rates also spur refinancing by other kinds of borrowers, says Dime's Caplanson. "We're going to see accelerated prepayments on loans; that will flood us with cash that we're going to have to put to work," he says.

That raises the problem at the heart of commercial banking: how to keep credit quality high while generating greater loan volume. "Are there going to be enough good credits out there?" Caplanson asks. If not, banks will be happy to stay in a semifrozen state, and the winter of customers' discontent may drag on for many months.

Vincent Ryan is a senior editor at CFO.

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