Louis Hernandez, Jr.
Chairman and CEO
Open Solutions Inc.
Glastonbury, Connecticut

The financial meltdown resulting from the subprime mortgage crisis raised the debate about the role of financial institutions and the role of regulators in an increasingly interconnected and rapidly changing world. As a longtime advocate for community-based financial institutions, Open Solutions Inc. Chairman and CEO, Louis Hernandez, Jr., felt compelled to join the debate with his book “Too Small to Fail” to provide a voice for community-based institutions. “Too Small to Fail” presents a path forward and a call to action for the leaders of these community-based institutions. Bob Dye, general manager and COO of Raddon Financial Group, sat down with Louis to discuss his book.

 

 

Bob Dye: Your new book is titled “Too Small to Fail.” Why did you select this title?

Louis Hernandez, Jr.: The first reason is the obvious play on words with the “Too Big to Fail” thesis which is shaping public policy and has become the mantra for systemic risk in our industry.

The second reason was to change the focus from these monolithic organizations at the center of the economic downturn to our country’s community-based institutions that largely avoided the subprime crisis.

Community-based institutions, in my opinion, have unfortunately been lumped in with the regulatory pressures developed to deal with “Too Big to Fail” banks. For the most part, they were doing things the right way. “Too Small to Fail” is how I define the collective strength of the community-based financial institutions that represent a unique pillar of economic stability.

What motivated you to write this book?

For an industry I have been a part of for so many years, one that has served Open Solutions so well, I felt personally compelled to write the book for a couple of reasons.These organizations had entered the crisis stronger than the “Too Big to Fail” banks and exited worse off.

Community-based institutions, in my opinion, have unfortunately been lumped in with the regulatory pressures developed to deal with “Too Big to Fail” banks.

Second, I thought the public wasn’t aware of the strength and stability of our country’s network of community banks and credit unions, nor their steadfast ability to deliver on their mission and their promise to their customers and members.Thirdly, as I travelled around the country and the world, many organizations wanted to talk about what was happening and they wanted a dialogue to develop a path forward.

The book is a call to action for the leaders of these financial institutions. As I wrote in the book, now is the time for these community-based institutions to seize the day and lead the financial services industry back to the center of economic vitality and drive global economic growth, one community at a time.

What type of response have you received to your book?

The response has been overwhelmingly positive. Many state and national associations have purchased bulk quantities as they have asked me to speak on the topic. I don’t think the industry has an advocate outside of the paid trade associations. So, for a relatively independent voice to be dedicating time and energy to highlight their attributes, I think it really touched a nerve and they have embraced it.

What I find inspiring is the number of CEOs who have bought the book for their executive teams and boards. One CEO bought a block of them for her regulators and policy makers.

Why are you such a proponent of community-based financial institutions?

They have stayed true to their principles as trusted financial intermediaries. The original concept of banking, where money exchanges hands among people, is really manifested in community-based financial institutions. A lot has been lost on broader headline-grabbing news, but every day this group is still investing in their communities – helping people achieve goals while closely monitoring risk. They are our best hope for revitalizing the economy, one loan, one person and one community at a time.

In the book, you stated that the financial industry must address its infrastructure issues, deploy technology more aggressively and work collaboratively to lower costs in common processing areas. Tell us more about your thoughts in these areas.

Financial institutions have always talked about collaboration, but as an industry there has not been enough action. Collaborative innovation has to increase dramatically and at a dramatically lower cost. The crisis has created a significant opportunity to accelerate our collaboration as an industry. Margin compression, channel proliferation and regulatory scrutiny have intensified, making it more difficult to run a community-based institution. This moment of clarity should lead us to find areas where we can share information, share processes – where we can lower our costs by working more closely together.

Large institutions have advantages in their obvious ability to access capital, their scale, their breadth, their offerings and their ability to drive down costs. The regulatory and policy decisions have raised the bar on the size an organization needs to be to compete. I think, as an industry, we can shoot for cutting our infrastructure costs in half. The only way that will happen is if we share more ideas; this is an important tenet for community-based institutions to position themselves for greater share growth and long-term viability.

In the book you state, “a great deal of the architecture and platforms that are still in use today were originally developed 30 and even 40 years ago.” Why hasn’t the industry embraced or even demanded newer technology?

It is shocking that an industry with such a history of computational innovation is stuck with some of the oldest enterprise technology of any industry. Now, some of the best new technology is in banking, but it’s all in layered applications.

Having these layered applications masking the weaknesses of older technologies has now turned into a severe competitive disadvantage.

People are realizing it is more risky to stay on these layered applications because they require the financial institution to carry more cost, they limit the institution’s ability to launch new products efficiently and they make it harder to understand the needs of the customer or member.

Well, why hasn’t the industry demanded something different? The first reason is inertia. As an industry, we did an outstanding job of driving down costs by automating lower-level, manual processes. Take check processing, for example. Once the infrastructure is set up, it’s hard to change, so much so that it becomes difficult to even think about doing it differently, so everything gets added to it.

Another reason is the regulatory framework creates a disincentive for financial institutions in taking any risk at the core level of the enterprise. Because of the financial crisis, boards and executives are more open to change because they are beginning to realize that the disjointed way information was flowing was causing their book of business to erode in ways they couldn’t see.

The combination of inertia, a conservative industry, the large tech spend and disruption, and the regulatory disincentive has allowed these older technologies to live well beyond their useful life and well beyond what they have lived in other industries.

But, we have already begun to see a change happening with more enterprise switches, and I think that will accelerate over the next few years. Just like other countries have bypassed telephone lines and gone straight to wireless, there are financial institutions around the world that are leap-frogging entire generations of layered U.S. banking technology by going straight to newer architectures. At the same time, many forward thinking U.S. institutions are adopting more innovative platforms.

Are financial institutions that have not embraced newer technology taking on added risk?

They are. They are increasingly disjointed in their decision-making and increasingly unable to meet their strategic goals in a very dynamic environment.

People are realizing it is more risky to stay on these layered applications because they require the financial institution to carry more cost, they limit the institution’s ability to launch new products efficiently and they make it harder to understand the needs of the customer or member. Each layer requires a separate interface, connection points, redundant databases and limitations on product and service types. So, the cost to maintain the old infrastructure is leading financial institutions to change.

I think that is why the better-capitalized, high-performing institutions are making the changes first. Perhaps it’s because they have the financial wherewithal to do it, but I also think it is because they are more forward-thinking. They think about thriving not just surviving. The others could be in a category of those that want to sell or maybe just not interested in taking advantage of what should be a great time for a community-based institution. Those are probably the institutions that will get consolidated and won’t have much of a future.

How do you believe the financial institution’s business model to be changing?

I think this is probably the most significant thing that is happening. The financial crisis highlighted that our industry was going through a fundamental shift. And this is the biggest realization I hope institutions will have. Even before the crisis, our industry has been in this slow steady drumbeat of intensifying competition. Some of the biggest and best components of our value chain have eroded, leaving us with much of the lowest-margin, transaction-based components when we really should be at the forefront of everything that is happening within our communities.

You mention “reputational damage” recently experienced by many of the biggest banks in the U.S. How do you believe this creates potential opportunities for well-managed community-based financial institutions?

So, we have an oligopoly of large banks and the public preferring to do business with a local institution, leaving a perfect opportunity for community-based institutions to capture share more rapidly by delivering on their unique attributes.

When you look at the market share, deposits and offices of the big banks, you’ll see an oligopoly has been created. At the same time, the bailout has damaged the reputations of the large banks. Raddon has studied consumer perceptions of community-based institutions compared to large institutions. The conclusions show that both banks and credit unions have a unique opportunity to capture share from the largest institutions. So, we have an oligopoly of large banks and the public preferring to do business with a local institution, leaving a perfect opportunity for community-based institutions to capture share more rapidly by delivering on their unique attributes.

This is somewhat a basis of my frustration. At a time when community-based organizations should be enjoying a lot of success, they are being slowed down by regulatory and policy decisions. With some dedicated leadership and a few institutions committing to show the way, community-based institutions could be enjoying an extended period of share gain reshaping our industry over the longer term.

What actions do you believe the well-managed community-based financial institutions will need to take to seize these current and future opportunities?

Chapter four and five of the book lay out a plan to win. Chapter five, particularly, is a call to action for executives and board members to personally commit to making the most out of the time ahead of them.

First is to recognize this significant moment of clarity. The industry has changed; consumerization has set in, the basic business model is under severe pressure, the threat of disintermediation continues by a series of groups trying to take their most valuable components. Regulatory changes are making it harder to make money and have pressured capital levels. It all seems very daunting. But this moment of clarity should lead them to examine why they are here, what makes them different, build an infrastructure to make those differences more obvious, and create a culture and a team that allows them to execute.

These are some of the steps I mentioned in the book that will allow institutions to navigate through what has become an unnecessarily difficult time in the face of what can be a huge opportunity to win more business from larger institutions and deliver on the promise of what community–based institutions are all about. It is incumbent on individuals to show the way for the rest of the industry. They have a chance to make a real difference.

I think we have the greatest opportunity for community-based institutions in decades.

 

At RFG’s 2010 CEO Forum, Louis Hernandez, Jr. will present strategies from his book, “Too Small to Fail,” in which he urges community-based financial institutions to lead the financial services industry back to the center of economic vitality.

The CEO Forum is being held August 11-13th at the Broadmoor in Colorado Springs, Col.  For more details, visit www.raddon.com/forum.

 

 

To order a copy of “Too Small to Fail,” visit http://www.opensolutions.com/2small2fail.htm

Net proceeds from the book are going to a charity which supports advances in healthcare and education and provides opportunities for children.

 

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