Why is banking in such a mess, not only in the UK but right around the world? There is no simple answer but here are a number of key factors which can be recognised with the benefit of hindsight. Some folk did foresee things coming to a head but no one in a position of authority wanted to call a halt to the party that has been lining a lot of pockets for many years. After all when you are enjoying yourself at the party of a life time, who wants to be the party pooper.
Banks Too Big For Their Own Good.
For a good many years, governments and their regulatory authorities had been concerned about the growth of major players in the financial services sector. Their concern was that the major players had become so big and powerful that they might be too big to rescue should they fail, and were to big to be allowed to fail as failure on such a scale would likely represent systemic risk. This is a dilemma that has been known about and talked about for a good many years. Failure to address this dilemma in any meaningful way is a major part of the problem.
Banks Allowed To Grow Too Quickly.
In the absence of any constraint, bankers saw an advantage in getting bigger and raising their profile from largely domestic institutions to the point where all but specialist niche players harboured aspirations to become international or even global players. It is a reasonable response in the sense that if your clients are international or global institutions there is a desire meet those clients' needs wherever they arise. This has led to greater competition among the banks and while they were all making money, no objections were raised. However two things changed dramatically over the last 10 years. Firstly assets grew at an unprecedented rate and secondly banks became increasingly dependent on external funding as their client deposit bases declined. This in itself created a significant increase in risk as the banks became dependent on very sophisticated valuation models to address the new types of financial instruments and derivatives that comprised a large proportion of their newly acquired asset growth; and secondly, new sources of funds were required over which the banks had no control other than paying premium prices.
Valuation Models and Risk Management.
The age of computers has allowed us to look at value and analyse risk in ways that were not possible in the past. In itself that is a very positive development but that does not mean that risk is avoidable just because we have devised sophisticated models to deal with it. I believe that too much reliance was placed on such analysis. I recall in my early career, a former banking CEO who would lecture me that value was what a willing buyer was prepared to pay and whenever I brought in a new deal, the first question he would ask was "If it goes wrong, would it bring the roof in?." We have moved on from there but in doing so we have become too dependent on risk and valuation models that very few people understand. Artificial intelligence models that can find correlations in price movements that would not be visible to mere mortals became a reality and were to some extent a distraction from those more fundamental issues mentioned above. Financial markets are predictable, but only when they perform within certain parameters. During periods of serious price dislocation, fear and greed take over and historical data on which most of these models are based make them unreliable. We were kidding ourselves that we new the value of our assets and the extent of our risk exposure.
Senior Management Out Of Touch
As new products and more sophisticated means of measurement have been introduced, board level executives have given too much licence to "specialists" who have built up a track record driving revenues in a positive direction. Consequently they have been allowed to get on with their activities without any real oversight or deep understanding at board level.
The Role Of The Rating Agencies
There has been much criticism of the role of the rating agencies particularly with regard to collateralised debt obligations and the like. With asset backed securities it has been my experience that the rating agencies adopted a formulaic approach to rating such instruments. and did all that they reasonably could to make the market aware that this was the case and also published the basis on which their rating was given. Quite often this involved some form of credit enhancement and again the way that this was handled was made public. It could be argued that retail investors were entitled to put some reliance on ratings but surely this could not apply to banks or other sophisticated financial institutions. If they were relying on the rating agencies as a means of managing their risk, it was a serious abbrogation of their own responsibilities.
The Role Of Governments, Central Banks And Regulators
As far as I am aware no government or government agency in the world took or indeed saw the need to take pre-emptive action to avert the current fiasco. In London particularly, anyone who tried to slow the party down or was seen as acting in a way that might have prejudiced London's competitive position in financial markets was discouraged. No one saw the scale of the problem or its implications for the world economy. Since 1997 The Bank Of England has been publishing a half yearly stability report which drew attention to data that should have been taken more seriously but they were no longer responsible for the supervision of banks and it has been suggested in the press on a number of occasions that the FSA had given warnings of increased risk but were told not to make a fuss. The extraordinary three way split of financial responsibilities in the UK between the Treasury, The Bank of England and the FSA did not help.
It will take a long time to undo the damage that has been done to the Financial Services Industry worldwide and there will likely be more casualties before the crisis is over. For some folk, banking and bankers have been seen as unproductive parasites living on the back of the commercial world, while others take a more positive view of the sevices provided by their banks. Either way the perception of banks has taken a very big knock. They are no longer seen as responsible institutions that can be trusted to look after our money without a government guarantee. They have behaved in a reckless manner and may indeed have assumed that they could afford to accept disproportianate levels of risk for greater personal reward because the government would have to bale them out if anything went wrong. The outsiders view of the integrity of our banks has been shot to pieces and most of us now tend to regard banks as a necessary evil at best. Particularly when some of the most senior people involved in the carnage have shamlessly walked of with massive payouts and pension deals that they would have foregone if they had any sense of responsibility for what has happened.
As someone who has spent more than40 years working in banks I now feel embarrassed to be linked by my past to this shoddy mess. But I retired 8 years ago and I cannot believe what a mess they have made without my contribution!!
