crisis blew up in September
2008 several
national governments
found themselves with
significant stakes in
major banks, with very
little time to pause for
reflection. Their action
was unplanned, generally
unwelcome (to them)
and revealed a terminal
flaw in the Darwinian
economic worldview,
that commercial institutions
should be subject to
the ‘survival of the fittest’.
The banks, we now had
to accept, were too big
to fail, because too many
innocent victims would
fail with them.
A year later, governments,
economists and
bankers have had a
chance to digest the import
of this widespread
bout of nationalisation
and to consider what steps will or should be
taken. Is the state an appropriate long-term
bank owner? Or should states exit their
holdings as soon as possible?
Former International Monetary Fund
economist and CEO of Harvard Management
Company Mohamed El-Erian believes
that government stakes in banks will remain
for years to come, however much they may
wish otherwise. “Governments around the
world had no choice but to intervene and
put the banks’ public balance sheets in play,
in order to offset a very disorderly deleveraging
in the private sector. They didn’t want
to get involved, but exiting will take time.
It is a multi-year process and will take much
longer than the governments themselves
would wish.”
El-Erian argues that governments will
strive for a future where institutions are
no longer ‘too big to fail’, but that this is
achieved through regulation rather than
direct ownership. “Market failure that warrants
government intervention often leads
to government failure. Rather than see a
government as a guiding hand, it ends up as
an undifferentiated fist that causes collateral
damage.”
They offered high risk mortgages to customers
without income, jobs or assets. They
invested in high yield instruments which, like
a pyramid scheme, were bound to collapse
one day.
Today, in the sober light of September 2009,
these same banks, together with governments
and financial experts are busy figuring out
how to avoid such a calamity in future. Key to
their deliberations is how to mitigate the risks
they face.
Some commentators argue that banks need
to return to the plain, low-risk style of business
that pertained up until the 1980s, where
they made solid but unspectacular profits,
leaving the higher risk strategies to specialist
investment firms that do not benefit from
governmental guarantees and so are liable for
their own losses.
In this more cautious climate, banks are
keen to assess their risk profile with more accuracy
and scrutiny than before. Companies
such as Experian specialise in conducting
such assessments, as the company’s European
chief executive Victor Nichols explains.
“In portfolio management, where institutions
have aggregated portfolios of lending
assets that they are servicing, there is a lot of
work going on to better assess the risk, with
broader data and more rigorous analytics
than in the past,” he says.
Where banks have been obliged to merge,
as happened so dramatically in late 2008, Experian
has the tools to help them understand
their risk profile, says Nichols. “We have a
broad view of the data and of the individual
companies, broader than either one of the
companies may be able to bring to bear, so we
can do a more complete portfolio assessment
and the risk they represent.”
Advances in information technology have
meant that financial transactions and portfolios
can be tracked far more accurately and
promptly than in the past, giving banks more
visibility of any potential risks. “They get
more of a dynamic, or ‘real time’ view of their
credit position on a particular loan or portfolio,”
says Nichols. “They are much more in
tune with how it is changing incrementally
over its lifetime and what actions they may
need to take from a capital requirement or
from a servicing viewpoint. Banks can now
do an even better job of assessing information
about a debt position or aggregate liabilities
and the relative risk for any one customer.”
Outside the arena of purely financial risks,
other commentators draw attention to the
risks from political instability, terrorism,
disruptive technologies, hyper competition,
food, energy and environmental crises and
the relentless rise of world poverty. “These
factors will all contribute to a raised level of
turbulence, with unpredictable spikes, and
we have to be prepared for it,” says business
development guru John Caslione, author of
Chaotics. “In the banking sector, that will
mean greater scrutiny and higher reserve
requirements,” he says. “And let’s not forget
that eight of the world’s top ten investment
funds are from autocracies.”
Yet even Caslione is optimistic. “We always
find a solution,” he concludes.
At INSEAD, Ilian Mihov agrees that long term government
ownership of banks is unattractive. “In a market economy,
when banking institutions are taken over by governments they
tend to become less efficient, less productive and eventually
they die out.” Banks should be allowed to fail, but so long as
there is consistent and comprehensive regulation, this does not
need to create systematic risk in global economies.
Mihov believes that the lessons of the Great Depression,
where President Roosevelt acted to introduce the Glass-Steagall
Act separating commercial and investment banks, are now being
remembered. Now that this separation has been removed, he
argues, we need a new set of regulatory tools in order to protect
depositors and to prevent governments having to bail out
banks which have made reckless investments.
Nevertheless, states will already be considering how they
can withdraw from their ownership of banks. “I would guess
99 per cent of economists would say the state doesn’t make
a good long run manager of bank assets,” says Harald Hau,
an economist at INSEAD. “Its current ownership is at best a
transitional role and it has to withdraw.” Until that takes place,
banks will be obliged to increase their capital requirements and to
improve their governance and risk management.
Hau proposes a more ‘market-centred’ financial system, with
more asset securitisation substituting for bank lending. Yet
for some nations such as Germany and Switzerland, adjustment
market centred finance runs counter to political currents,
according to Hau. “I don’t think they have drawn the right
lessons yet from the crisis,” he says.
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