BankingBanking BananaBanana SkinsSkins AfterAfter thethe 20102010 ‘quake‘quake
TheThe CSFICSFI surveysurvey ofof bankbank riskrisk InIn associationassociation withwith CSFI Centre for the Study of Financial Innovation
C S F I / New York CSFI
The Centre for the Study of Financial Innovation is a non-profit think-tank, established in 1993 to look at future developments in the international financial field – particularly from the point of view of practitioners. Its goals include identifying new areas of business, flagging areas of danger and provoking a debate about key financial issues. The Centre has no ideological brief, beyond a belief in open and efficient markets. Trustees Governing Council Minos Zombanakis (Chairman) Sir Brian Pearse (Chairman) David Lascelles Sir David Bell Sir David Bell Geoffrey Bell Robin Monro-Davies Robert Bench Sir Brian Pearse Rudi Bogni Peter Cooke Staff Bill Dalton Director – Andrew Hilton Sir David Davies Co-Director – Jane Fuller Prof Charles Goodhart Senior Fellow – David Lascelles John Heimann Programme Coordinator – Lisa Moyle John Hitchins Rene Karsenti Henry Kaufman Angela Knight Sir Andrew Large David Lascelles Philip Martin-Brown Robin Monro-Davies Rick Murray John Plender David Potter Mark Robson David Rule Sir Brian Williamson Peter Wilson-Smith Minos Zombanakis
CSFI publications can be purchased through our website www.bookstore.csfi.org.uk or by calling the Centre on +44 (0) 207 493 0173
Published by Centre for the Study of Financial Innovation (CSFI)
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ISBN: 978-0-9561904-9-9
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CSFI / New York CSFI E-mail: [email protected] Web: www.csfi.org.uk CSFI / New York CSFI E-mail: [email protected] Web: www.csfi.org.uk C S F I / New York CSFI C S F I / New York CSFI NUMBER NINETY TWO FEBRUARY 2010
Preface
Preface The CSFI has been producing its Banking Banana Skins survey almost annually since 1994, latterly with generous support from PricewaterhouseCoopers.
The CSFI has been producing its Banking Banana Skins survey almost annually since 1994, latterlyThe intention with generous has always support been from to PricewaterhouseCoopers. identify those concerns that people in the financial services sector – as well as those who watch, regulate and succour them – believe are the next “banana Theskins” intention on which has the always industry been is likely to identify to slip. thoseNote, concernstherefore, thatthat peopleit is not inpredictive the financial. It is not services what sectorthe CSFI – as– orwell the as author, those Davidwho watch, Lascelles regulate – believes and succour is going them to happen. – believe It is area distillation the next “bananaof what others (most of whom are extremely close to what is going on at the financial coalface) expect to skins” on which the industry is likely to slip. Note, therefore, that it is not predictive. It is not what thehappen, CSFI or – fearor the may author, happen. David Lascelles – believes is going to happen. It is a distillation of what others (most of whom are extremely close to what is going on at the financial coalface) expect to happen,So, don’t or blame fear may us that happen. earlier surveys didn’t always get it right. In particular, don’t blame us that, in 2005 and 2006, pride of place at the top of the Banana Skins list went to “too much regulation”. So,That don’t was blame what theus that industry earlier felt surveys – though didn’t one always can certainlyget it right. make In particular, a case that don’t what blame the industryus that, really needed was either more regulation or, better still, smarter regulation. in 2005 and 2006, pride of place at the top of the Banana Skins list went to “too much regulation”. That was what the industry felt – though one can certainly make a case that what the industry reallyThat said,needed looking was either at the more list regulation of the most or, better important still, Bananasmarter Skinsregulation. since 1996 (page ??), it is significant just how close to the top credit risk, derivatives and risk management have been. It Thatsometimes said, looking seems as at though the list senior of the bankers most important (who are Banana well-represented Skins since in our 1996 survey) (page were 10), it like is significantcompulsive just shoplifters, how close almost to the begging top credit to be risk, caught derivatives and to and be put risk out management of their (peer have pressure- been. It induced) misery. sometimes seems as though senior bankers (who are well-represented in our survey) were like compulsive shoplifters, almost begging to be caught and to be put out of their (peer pressure- induced)But those misery. are conclusions for you, the reader, to make.
ButWhat those we offerare conclusions is an increasingly for you, valuablethe reader, set to of make. multi-year data on what keeps senior City types awake at night – besides the size of their bonuses, of course. Over the next few months, we hope to work the raw data that we have accumulated a bit harder, since the science of statistics has What we offer is an increasingly valuable set of multi-year data on what keeps senior City types awakeadvanced at nightin the – lastbesides decade the –size and of that their may bonuses, well generateof course. some Over even the nextmore few fascinating months, findings.we hope toBut, work in the the meantime, raw data no that surprise we have that accumulated bankers today a bitput harder, “political since interference” the science at ofthe statistics top of their has advancedBanana Skins in the list; last at decadeleast, I –suppose and that that’s may better well generatethan the somethreat evenof ritual more disembowelling fascinating findings. which But,seemed in theon themeantime, cards only no surprisea few months that bankers ago. today put “political interference” at the top of their Banana Skins list; at least, I suppose that’s better than the threat of ritual disembowelling which Andrew Hilton seemed on the cards only a few months ago. Director AndrewCSFI Hilton Director CSFI
This report was written by David Lascelles Cover by Joe Cummings This report was written by David Lascelles Cover by Joe Cummings
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Foreword
PricewaterhouseCoopers is delighted to sponsor another year of Banking Banana Skins.
It has been an extraordinary eighteen months for the banking industry since the last Banana Skins was published in May 2008. Back then, few thought we would see so many banks either collapse or require rescue; events since then make for a fascinating survey. This is the first economic crisis that has drawn out long enough to have two Banana Skins published (let us hope it doesn’t continue for a third!). Once again a brand new banana skin – political interference – heads the list. Respondents are also beginning to focus on what comes after the crisis, although many retain fears that the worst is not yet over, hence credit risk retains its number two spot.
A worrying theme is the question of whether the crisis has taken the industry’s future out of its own hands. With political interference as the top risk and too much regulation at number three there is clear sense that change may be forced onto the industry from outside. Many respondents make the point of how deeply unpopular the banks have become among the populace at large. The need to rebuild trust that the last survey highlighted has become even more acute.
It is always interesting to look back at the previous survey to see which of the top banana skins were slipped on subsequently. Liquidity was the top risk last time and came closer in the autumn of 2008 to bringing the entire system down than any previous banana skin. The survey does get it right sometimes and so this year’s survey could be a well timed warning for politicians not to overreact.
As ever there is a richness of perceptive comment threaded through the survey which repays a careful read.
John Hitchins UK Banking Leader PricewaterhouseCoopers (UK)
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About this survey
This survey describes the risks currently facing the global banking industry, as seen by a wide range of bankers, banking regulators and close observers of the banking scene around the world. The survey was carried out in November and December 2009, and received 443 responses from individuals in 49 countries. The questionnaire (reproduced in the Appendix) was in three parts. In the first, respondents were asked to describe, in their own words, their main concerns about the financial system over the next 2-3 years. In the second, they were asked to rate a list of potential risks, or Banana Skins, selected by a CSFI/PwC panel, both by severity and whether they were rising, steady or falling. In the third, they were asked to rate the preparedness of financial institutions to handle the risks they identified. Replies were confidential, but respondents could choose to be named.
The breakdown of respondent by type was:
Regulators 6%
Observers 32%
Bankers 62%
The responses by country were as follows:
Australia 11 Greece 8 Philippines 2 Austria 5 Guernsey 2 Poland 7 Bahrain 1 Hong Kong 2 Qatar 1 Belgium 3 Hungary 3 Romania 13 Bermuda 2 India 12 Russia 31 Brazil 1 Ireland 4 Serbia 1 Canada 16 Italy 2 Singapore 6 Cayman Is. 1 Japan 4 Slovakia 1 Croatia 1 Jersey 6 South Africa 6 Czech Rep. 9 Kazakhstan 5 Spain 2 Denmark 1 Kenya 1 Sweden 13 Finland 10 Luxembourg 9 Switzerland 17 France 1 Malta 1 Thailand 1 GCC 1 Mauritius 1 UK 156 Germany 17 Multinational 4 Ukraine 1 Gibraltar 1 Netherlands 7 US 29 New Zealand 4
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SummarySummary
ThisThis report report describes describes the therisk risk outlook outlook for forthe thebanking banking industry industry at the at theturn turn of of BankingBanking Banana Banana Skins Skins 2010 2010 the the year year 2010 2010 – – a a time time of of (2008(2008 ranking ranking in brackets) in brackets) unprecedentedunprecedented stress stress in the in the financial financial TheThe biggest biggest markets.markets. The The findings findings are are based based on on 1 Political1 Political interference interference (-) (-) responsesresponses from from more more than than 400 400 2 Credit2 Credit risk risk(2) (2) BananaBanana Skin Skin is is bankers,bankers, regulators regulators and and close close 3 Too3 Toomuch much regulation regulation (8) (8) politicalpolitical observersobservers of the of the banking banking scene scene in 49 in 49 4 Macro-economic4 Macro-economic trends trends (5) (5) countries.countries. 5 Liquidity5 Liquidity (1) (1) interferenceinterference 6 Capital6 Capital availability availability (-) (-) TheThe dash dash by bygovernments governments to rescue to rescue theirtheir banks banks from from the the financial financial crisis crisis 7 Derivatives7 Derivatives (4) (4) maymay have have staved staved off offa collapse a collapse of theof the 8 Risk8 Risk management management quality quality (6) (6) system,system, but but it has it has left left the the banking banking 9 Credit9 Credit spreads spreads (3) (3) industryindustry deeply deeply politicised, politicised, a a 10 10 Equities Equities (7) (7) developmentdevelopment which which respondents respondents to to 11 11 Currencies Currencies (13) (13) this this survey survey find find to be to be the the greatest greatest 12 12 Corporate Corporate governance governance (16) (16) sourcesource of risk of risk now now facing facing the thebanking banking 13 13 Commodities Commodities (12) (12) sector.sector. 14 14 Interest Interest rates rates (9) (9)
15 15 Fraud Fraud (11) (11) As As a risk, a risk, political political interference interference (making(making its its first first appearance appearance as as a a 16 16 Management Management incentives incentives (17) (17) BananaBanana Skin Skin this this year) year) has has many many 17 17 Emerging Emerging markets markets (18) (18) angles:angles: it it distorts distorts commercial commercial 18 18 High High dependence dependence on technologyon technology (15) (15) judgment,judgment, it creates it creates moral moral hazard, hazard, and and 19 19 Hedge Hedge funds funds (10) (10) it raisesit raises uncertainty uncertainty about about how how and and 20 20 Rogue Rogue trader trader (14) (14) whenwhen financial financial support support will will be be 21 21 Business Business continuation continuation (23) (23) removed.removed. Closely Closely linked linked is the is therisk risk of of 22 22 Retail Retail sales sales practices practices (20) (20) too toomuch much regulation regulation (No. (No. 3) from 3) from an an 23 23 Conflicts Conflicts of interest of interest (21) (21) over-reactionover-reaction to the to thecrisis. crisis. 24 24 Back Back office office (19) (19)
25 25 Environmental Environmental risk risk(25) (25) WhatWhat is striking is striking about about these these Banana Banana SkinsSkins is that is that they they are are common common to all to all 26 26 Payment Payment systems systems (27) (27) majormajor banking banking regions, regions, and andare areshared shared 27 27 Money Money laundering laundering (24) (24) by bankersby bankers and andnon-bankers non-bankers alike. alike. 28 28 Merger Merger mania mania (28) (28) PessimismPessimism about about 29 29 Too Toolittle little regulation regulation (29) (29) thethe global global TheThe dominant dominant factor factor shaping shaping risk risk 30 30 Competition Competition from from new new entrants entrants (30) (30) perceptionsperceptions is the is the state state of the of the world world economiceconomic economy.economy. Respondents’ Respondents’ comments comments about about macro-economic macro-economic trends trends (No. (No. 4) were 4) were outlookoutlook broadlybroadly pessimistic, pessimistic, viewing viewing the therecent recent signs signs of recovery of recovery as fragile as fragile and andvulnerable vulnerable to to furtherfurther shocks. shocks. This This accounts accounts for forthe thehigh high position position occupied occupied by creditby credit risk risk (No. (No. 2) 2) wherewhere the the outlook outlook is seen is seen to be to for be for further further losses losses as the as the true true cost cost of the of the crisis crisis is is counted,counted, and andthe thelagging lagging effect effect of the of therecession recession takes takes its toll its tollon borrowers.on borrowers.
AlthoughAlthough liquidity liquidity risk risk (No. (No. 5) has 5) hasslipped slipped from from the thetop topposition position it occupied it occupied in the in the last lastsurvey survey in mid-2008, in mid-2008, it remains it remains a high a high level level concern. concern. Tension Tension in other in other financial financial markets,markets, however, however, is seen is seen to be to easing,be easing, notably notably in derivatives in derivatives (No. (No. 7), 7),credit credit spreadsspreads (No. (No. 9) and 9) andequities equities (No. (No. 10). 10). One One market market where where risk risk is seen is seen to be to risingbe rising is is currencycurrency (up (up from from No. No. 13 to13 No. to No. 11) 11) with with attention attention focusing focusing particularly particularly on theon the prospectsprospects for forthe theUS USdollar. dollar. Concern Concern has hasalso also eased eased about about the theoutlook outlook for forinterest interest ratesrates (down (down from from No. No. 9 to 9 No. to No. 14): 14): although although a sharp a sharp rise risein rates in rates may may be imminentbe imminent in anin environmentan environment of dramatic of dramatic monetary monetary easing, easing, it is it also is also very very predictable. predictable. Another Another notablenotable decline decline is the is therisk risk associated associated with with hedge hedge funds funds (down (down from from No. No. 10 to10 No.to No.
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19) with19) with a falling a falling off inoff their in their aggressive aggressive activity, activity, but alsobut alsoan appreciation an appreciation that thatthey they may maybe less be lessthreatening threatening to financial to financial stability stability than thanthe banks the banks themselves. themselves. TheThe availability availability MakingMaking its first its firstappearance appearance in the in Bananathe Banana Skins Skins series, series, the availabilitythe availability of capital of capital of capitalof capital is is (No.(No. 6) is 6) seen is seen as an as area an areaof high of high risk riskas banks as banks try totry rebuild to rebuild their their balance balance sheets. sheets. a biga big worry worry AlthoughAlthough there there have have been been a number a number of large of large recapitalisations recapitalisations in the in crisis,the crisis, investor investor appetiteappetite could could weaken; weaken; there there will will also also be selling be selling pressure pressure as governments as governments seek seek to to offloadoffload their their stakes stakes in the in medium the medium term. term.
BigB migo mveorvsers RISINGRISING RISKS RISKS PolitiPcoalli tinictaelr finetrernfceere: ndistortsce: distorts commercial commercial judgment, judgment, creates creates moral moral hazard. hazard. Too mTouoc hm ruecghu lraetgiounla: tover-reactionion: over-reaction to the to crisis. the crisis. CapitCaal paivtali lavbaililtayb: hugeility: huge demands, demands, weakening weakening investor investor appetite. appetite. CorpCoroartpeo graotvee grnoavnecrnea: nwillce :banks will banks learn learn lessons lessons from from the crisis? the crisis? CurreCnucrireesn: cworriesies: worries about about US dollar US dollar volatility. volatility.
FALLINGFALLING RISKS RISKS LiquiLdiiqtyu:i dnotity :the not problem the problem it was it awas year a yearago. ago. CredCit rsepdriet asdpsre, addesri,v daetirviveast, ieveqsu,i teieqsu,i tiinetse,r einstte rraetsets r:a marketstes: markets getting getting back back to to normal.normal. HedgHee fdugned sfu: noffds the: off radar the radar screen screen so fa sor as fa riskr as isrisk concerned. is concerned. BackB oafcfikc eo:f fhasice: stoodhas stood up well up inwell the in crisis. the crisis. FraudF ranud raongdu ero tgruaed etr:a fewerder: fewer incidents incidents than thanmight might be expected be expected in a crisisin a crisis period. period.
SomeSome of the of risks the risks facing facing banks banks are seenare seen to be to self-generated. be self-generated. Concern Concern about about the the qualityquality of risk of riskmanagement management (No. (No. 8) remains 8) remains high high following following the disastrousthe disastrous losses losses sufferedsuffered in the in last the lasttwo two years. years. The The risk risk of poor of poor corporate corporate governance governance has risenhas risen sharplysharply (from (from No. No.16 to16 No. to No. 12), 12), and andmanagement management incentives incentives (No. (No. 16) remain16) remain a a preoccupation,preoccupation, though though opinion opinion is divided is divided between between bankers bankers who whoconsider consider the riskthe riskto to be outsidebe outside interference interference and and non-bankers non-bankers who who see see bad bad incentives incentives encouraging encouraging excessiveexcessive risk-taking. risk-taking. Concern Concern about about conflicts conflicts of interest of interest within within financial financial institutionsinstitutions seems seems to be to easing be easing (down (down from from No. No. 21 to 21 No. to No. 23). 23). Many Many of the of the responsesresponses in the in governancethe governance area areawere were tinged tinged with with the worrythe worry that thatbanks banks have have not not learntlearnt lessons lessons from from the crisisthe crisis and areand too are eagertoo eager to get to back get back to business to business as usual. as usual.
‘Green‘Green risks’ risks’ On theOn operational the operational risk risk front, front, there there was was a notable a notable decline decline in concern in concern about about fraud fraud (down(down from from No. No.11 to 11 No. to No.15) and15) theand roguethe rogue trader trader (down (down from from No. No.14 to 14 No. to No.20) 20) areare seen seen to beto be despitedespite experience experience which which says says that that both both risks risks rise rise in a in recession. a recession. However However the the smallsmall despite despite rankingranking of these of these risks risks is closely is closely linked linked to the to numberthe number of recent of recent incidents, incidents, of which of which therethere have have been been few few(Madoff (Madoff not beingnot being strictly strictly a bank a bank fraud). fraud). Concerns Concerns about about risks risks climateclimate change change in thein back the back office, office, payment payment systems systems and businessand business continuation continuation – all – of all which of which once once featuredfeatured high high as Banana as Banana Skins Skins – have – have eased eased considerably. considerably. There There has alsohas alsobeen been a fall a fall in thein rankingthe ranking of money of money laundering laundering (down (down from from No. No.24 to 24 No. to No.27) which27) which is now is now viewedviewed as a asreputational a reputational rather rather than thanfinancial financial risk. risk.The Theperception perception of environmental of environmental risk risk(No. (No. 25) was25) wasunchanged unchanged despite despite the heat the heatgenerated generated by the by Copenhagen the Copenhagen Summit. Summit.
AlthoughAlthough competition competition from from new newentrants entrants (No. (No. 30) was30) wasseen seen to be to the be leastthe least of the of the risksrisks facing facing the industry, the industry, it generated it generated much much comment comment from from respondents respondents about about the the dangersdangers of weakened of weakened bank bank competition competition and greaterand greater complacency complacency due todue government to government bail-outsbail-outs and higherand higher regulatory regulatory entry entry barriers. barriers. The Theprospects prospects for structural for structural change, change, as as measuredmeasured by the by risk the riskof merger of merger mania mania (No. (No. 28), 28),were were seen seen to be to small. be small.
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A break-downA break-down of responses of responses shows shows an unusually an unusually high high level level of agreement of agreement among among bankersbankers and non-bankersand non-bankers about about the mainthe main Banana Banana Skins. Skins. Insofar Insofar as there as there are nuances,are nuances, bankersbankers are mainly are mainly concerned concerned with with the political the political and and regulatory regulatory fall-out fall-out from from the the crisis,crisis, and andnon-bankers non-bankers are worriedare worried that thatbanks banks will willfail tofail reform to reform themselves, themselves, and and merelymerely head head straight straight into intoa new a newcrisis. crisis. Regulators Regulators focused focused on the on qualitythe quality of balance of balance sheetssheets and riskand riskmanagement. management. Geographically Geographically, concerns, concerns were were also alsostrikingly strikingly similar similar in thein threethe three regions regions surveyed: surveyed: North North America, America, Europe Europe and and the Asia-Pacific:the Asia-Pacific: all all consideredconsidered political political interference, interference, regulatory regulatory overkill overkill and creditand credit risk riskto be to among be among the the biggestbiggest dangers dangers facing facing the industry. the industry. OnlyOnly 9% 9% of of respondentsrespondents think think Preparedness.Preparedness. We askedWe asked respondents respondents how howwell wellprepared prepared they theythought thought the industrythe industry banksbanks are are well well was wasto handle to handle the risksthe risks they theyhad identified.had identified. Only Only 9 per 9 centper centanswered answered “well” “well” and 11and 11 per centper cent answered answered “poorly”. “poorly”. The Theremainder remainder gave gave a “mixed” a “mixed” reply. reply. This Thisis a is more a more preparedprepared negativenegative result result than thanlast timelast time when when 24 per 24 centper centsaid said“well” “well” and onlyand only 4 per 4 centper centsaid said to handleto handle risk risk “poorly”.“poorly”.
TheT hBea nBaannaa nSak iSnks inInsd Ienxd ex
5 5 EquityEquity 4.5 4.5 mkts mkts CreditCredit LiquidityLiquidity 4 4 risk risk Too muchToo much regulationregulation PoliticalPolitical 3.5 3.5Poor Poor interferenceinterference DerivativesDerivatives Score Score r is k mgtr is k mgt 3 3
2.5 2.5 2 2
9 9 5 5 9 9 04 040 0 9 9 0 0 1998 19981 12000 20002001 20012002 20022003 20032 220 202006 20062007 20072008 20082010 2010
Top riskTop risk Avg. Avg.of all ofrisks all risks The TheBanana Banana Skins Skins Index Index tracks tracks responses responses over over time time and andcan becan read be readas an as indicator an indicator of anxietyof anxiety levels levels on a onscale a scale of 1-5. of 1-5.The Thetop linetop lineshows shows the averagethe average score score given given to the to the top risktop risk over over the last the last 12 years, 12 years, and and the bottom the bottom line line the average the average of all of the all risks. the risks. TheThe Banana Banana Skins Skins AlthoughAlthough the top the risktop risk has hasfallen fallen off, off,the All-risk the All-risk index index is at is an at all-time an all-time high, high, an an IndexIndex is atis anat an indicationindication of the of exceptional the exceptional level level of anxiety of anxiety currently currently gripping gripping the market. the market. all-timeall-time high high The Thecourse course of the of indexthe index over over the lastthe decadelast decade shows shows the financethe finance sector sector emerging emerging in a in a bullishbullish mood mood from from the latethe 1990slate 1990s but runningbut running into intothe frenzythe frenzy of the of dotthe comdot comcrash crash in in the earlythe early 2000s. 2000s. Although Although the top the risktop risk peaked peaked in 2000, in 2000, the overall the overall anxiety anxiety level level continuedcontinued to rise to risefor twofor twoyears years in the in messythe messy aftermath. aftermath. The Therisk risklevel level then thensubsided subsided as stabilityas stability returned returned to the to markets.the markets. However However the firstthe firstindications indications of anxiety of anxiety about about the soundnessthe soundness of the of bullthe bullrun appearedrun appeared in the in 2006the 2006 survey survey with with a sharp a sharp rise risein the in the All-riskAll-risk index, index, which which has continuedhas continued with with the present the present poll. poll.
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WhoWho said said what what
A breakdownA breakdown of the of top the tentop responses ten responses by type by typeshows shows different different levels levels of concern. of concern.
BanBkaenrske–r practitionerss – practitioners of commercial of commercial and and investment investment banking banking 1 Political1 Political interference interference BankersBankers put politicalput political interference interference at the at topthe otopf of 2 Too2 Toomuch much regulation regulation theirtheir risk risklist becauselist because of the of pressurethe pressure it creates it creates 3 Credit3 Credit risk risk to overrideto override commercial commercial judgment, judgment, e.g. e.g. by by 4 Liquidity4 Liquidity forcingforcing them them to lend to lend in a in recession. a recession. Concern Concern aboutabout a regulatory a regulatory over-reaction over-reaction to tothe the 5 Derivatives5 Derivatives financialfinancial crisis crisis is closely is closely linked. linked. Bankers’ Bankers’ 6 Macro-economic6 Macro-economic trends trends worriesworries also alsoinclude include a worsening a worsening credit credit outlook outlook 7 Capital7 Capital availability availability as badas bad debts debts continue continue to pile to pile up, up, and and the the 8 Risk8 Riskmanagement management quality quality availabilityavailability of new of newcapital. capital. Their Their concern concern with with 9 Credit9 Credit spreads spreads liquidityliquidity risk risk and and the the derivatives derivatives market, market, 10 Equities10 Equities particularlyparticularly credit credit default default swaps, swaps, remains remains high. high.
Bankers,Bankers, ObsOebrvseerrsve–rs non-bankers,– non-bankers, analysts, analysts, consultants, consultants, academics academics observersobservers and and 1 Political1 Political interference interference Non-bankerNon-banker respondents respondents share share the thebankers’ bankers’ regulatorsregulators agree agree 2 Macro-economic2 Macro-economic trends trends concernsconcerns about about political political interference, interference, though though on onthe the big big risks, risks, 3 Credit3 Credit risk risk for differentfor different reasons: reasons: they they are worried are worried about about 4 Too4 Toomuch much regulation regulation the moralthe moral hazard hazard created created by bank by bank rescues rescues and and butbut differ differ on onthe the wonderwonder whether whether bankers bankers have have learnt learnt lessons lessons 5 Capital5 Capital availability availability detaildetail fromfrom the crisis. the crisis. They They also also suspect suspect that that banks banks 6 Risk6 Riskmanagement management quality quality havehave not gotnot togot the to bottomthe bottom of their of their bad badloans, loans, 7 Liquidity7 Liquidity and and are skimping are skimping on their on their risk risk management. management. 8 Credit8 Credit spreads spreads Non-bankersNon-bankers are theare mostthe most pessimistic pessimistic of the of the 9 Currencies9 Currencies majormajor respondent respondent groups groups about about the economic the economic 10 Equities10 Equities prospects,prospects, fearing fearing a ‘double a ‘double dip’ dip’recession. recession.
RegRuelagtuolrasto–rs supervisors,– supervisors, gove governmentrnment officials officials 1 Credit1 Credit risk risk The The prospect prospect of another of another wave wave of bad of bad debts debts 2 Political2 Political interference interference headsheads the concernsthe concerns of regulators of regulators as recession as recession 3 Liquidity3 Liquidity takestakes its toll its ontoll borrowers on borrowers – and – anduncertainties uncertainties 4 Currencies4 Currencies still still cloud cloud the thefinancial financial markets. markets. Liquidity, Liquidity, currency,currency, credit credit spreads spreads and and commodity commodity risk risk 5 Macro-economic5 Macro-economic trends trends are allare high all high on their on their list. Regulatorslist. Regulators also alsoworry worry 6 Credit6 Credit spreads spreads aboutabout political political interference, interference, in their in their case case 7 Corporate7 Corporate governance governance becausebecause of the of theuncertainty uncertainty about about how how and and 8 Commodities8 Commodities whenwhen governments governments will will withdraw withdraw their their 9 Risk9 Riskmanagement management quality quality support.support. The Theweaknesses weaknesses in bank in bank governance governance 10 Capital10 Capital availability availability exposedexposed by the by crisis the crisis are another are another concern. concern.
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NorNtho Artmh eArmicearica 1 Political1 Political interference interference GovernmentGovernment intrusion intrusion into intothe bankingthe banking system system 2 Credit2 Credit risk risk throughthrough bail-outs bail-outs and and official official support support heads heads 3 Too3 Toomuch much regulation regulation the listthe oflist risks of risks in North in North America, America, notably notably in in 4 Liquidity4 Liquidity the US.the US. Canadian Canadian banks banks are more are more concerned concerned aboutabout the threatthe threat of regulatory of regulatory over-reaction. over-reaction. 5 Macro-economic5 Macro-economic trends trends The Theimmediate immediate concerns concerns in both in both countries countries are are 6 Risk6 Riskmanagement management quality quality veryvery much much with with crisis crisis fall-out: fall-out: credit credit and and 7 Corporate7 Corporate governance governance liquidityliquidity risk, risk, and and the the shaky shaky prospects prospects for for 8 Derivatives8 Derivatives economiceconomic recovery. recovery. There There was was less less concern concern 9 Credit9 Credit spreads spreads aboutabout the the availability availability of capital of capital than than in in 10 Capital10 Capital availability availability Europe.Europe.
RisksRisks are are EuroEpuerope similarsimilar across across 1 Political1 Political interference interference EuropeEurope is also is also deeply deeply concerned concerned about about the the thethe major major 2 Credit2 Credit risk risk consequencesconsequences of governmentof government involvement involvement 3 Macro-economic3 Macro-economic trends trends withwith banks, banks, notably notably in the in UK the whereUK where there there is a is a regionsregions 4 Too4 Toomuch much regulation regulation lot oflot it, of and it, and where where many many respondents respondents were were located.located. Linked Linked to this to thisis fear is fearof a ofregulatory a regulatory 5 Capital5 Capital availability availability over-reaction,over-reaction, particularly particularly by Brussels. by Brussels. Other Other 6 Liquidity6 Liquidity top top concerns concerns focus focus on crisis-related on crisis-related issues: issues: 7 Risk7 Riskmanagement management quality quality creditcredit risk, risk, capital, capital, liquidity, liquidity, and and the creditthe credit 8 Credit8 Credit spreads spreads derivativederivative markets. markets. The The economic economic mood mood is is 9 Derivatives9 Derivatives pessimistic,pessimistic, with with many many respondents respondents worried worried 10 Equities10 Equities that thethat recovery the recovery will willbe long be long and difficult.and difficult.
AsiaA sPiaac Pifaiccific 1 Too1 Toomuch much regulation regulation RespondentsRespondents from from this thisregion region included included Japan, Japan, 2 Macro-economic2 Macro-economic trends trends Australasia,Australasia, South South East East Asia Asia and and India India – a – a 3 Credit3 Credit risk risk broadbroad group group exposed exposed to a tovariety a variety of risks. of risks. The The 4 Political4 Political interference interference responseresponse is notable is notable for the for strengththe strength of concern of concern aboutabout regulatory regulatory over-reaction over-reaction to the to thecrisis, crisis, 5 Currencies5 Currencies particularlyparticularly in Australia, in Australia, and pessimismand pessimism about about 6 Commodities6 Commodities the economicthe economic outlook, outlook, mainly mainly because because of fears of fears 7 Liquidity7 Liquidity of aof ‘bubble’ a ‘bubble’ in the in tigerthe tiger economies economies and and a a 8 High8 Highdependence dependence on tech. on tech. collapsecollapse of the of creditthe credit markets. markets. The Theregion region also also 9 Derivatives9 Derivatives focusedfocused on the on risksthe risks of fraud of fraud and andthe bankingthe banking 10 Fraud10 Fraud system’ssystem’s high high technological technological dependence. dependence.
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InduInsdtruiaslt rciaolu cnotruienstries 1 Political1 Political interference interference The Theconcerns concerns of industrial of industrial countries countries centre centre on on 2 Too2 Toomuch much regulation regulation the the political political fall-out fall-out from from the the crisis: crisis: the the 3 Liquidity3 Liquidity impactimpact of government of government ownership ownership and support,and support, 4 Credit4 Credit risk risk and andthe ensuingthe ensuing regulatory regulatory crackdown, crackdown, which which is widelyis widely seen seen as potentially as potentially damaging damaging to the to the 5 Macro-economic5 Macro-economic trends trends bankingbanking system. system. The The most most pressing pressing risks risks for for 6 Capital6 Capital availability availability the banksthe banks remain remain on the on creditthe credit front, front, with with the the 7 Risk7 Riskmanagement management quality quality possibilitypossibility of another of another wave wave of bad of baddebts, debts, and and 8 Credit8 Credit spreads spreads continuingcontinuing liquidity liquidity difficulties, difficulties, despite despite recent recent 9 Corporate9 Corporate governance governance improvements.improvements. Recapitalisation Recapitalisation could could be a be a 10 Derivatives10 Derivatives problem.problem. There There is caution is caution about about the economicthe economic IndustrialIndustrial and and outlook.outlook. emergingemerging economieseconomies have have EmeErmgienrgg iencgo encoomnieoms ies differentdifferent concerns concerns 1 Credit1 Credit risk risk The The top concernstop concerns in the in emerging the emerging world world are are 2 Credit2 Credit spreads spreads all linkedall linked to financial to financial pressures pressures arising arising from from 3 Macro-economic3 Macro-economic trends trends the crisis:the crisis: bad loansbad loans and difficultand difficult markets. markets. The The 4 Currencies4 Currencies risksrisks in the in macro-economicthe macro-economic outlook outlook are seenare seen to beto particularly be particularly high, high, for examplefor example in Russia in Russia 5 Risk5 Riskmanagement management quality quality wherewhere the economythe economy is fragile, is fragile, and andin the in Farthe Far 6 Fraud6 Fraud East Eastwhere where ‘bubbles’ ‘bubbles’ are fearedare feared to be to building be building 7 Political7 Political interference interference up. Onup. theOn otherthe other hand, hand, concern concern about about political political 8 Equities8 Equities and and regulatory regulatory pressures pressures is lower is lower than than in in 9 Too9 Toomuch much regulation regulation industrialindustrial countries. countries. The The high high place place taken taken by by 10 Capital10 Capital availability availability fraudfraud is notable, is notable, again again possibly possibly driven driven by the by the economiceconomic downturn. downturn.
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Banana Skins: The Top Ten 1996-2010
1996 1998 2000 1 Poor management 1 Poor risk management 1 Equity market crash 2 EMU turbulence 2 Y2K 2 E-commerce 3 Rogue trader 3 Poor strategy 3 Asset quality 4 Excessive competition 4 EMU turbulence 4 Grasp of new technology 5 Bad lending 5 Regulation 5 High dependence on tech. 6 Emerging markets 6 Emerging markets 6 Banking market o’-capacity 7 Fraud 7 New entrants 7 Merger mania 8 Derivatives 8 Cross-border competition 8 Economy overheating 9 New products 9 Product mis-pricing 9 Comp from new entrants 10 Technology foul-up 10 Grasp of technology 10 Complex fin. instruments
2002 2003 2005 1 Credit risk 1 Complex financial instruments 1 Too much regulation 2 Macro-economy 2 Credit risk 2 Credit risk 3 Equity markets 3 Macro economy 3 Corporate governance 4 Complex financial instruments 4 Insurance 4 Derivatives 5 Business continuation 5 Business continuation 5 Hedge funds 6 Domestic regulation 6 International regulation 6 Fraud 7 Insurance 7 Equity markets 7 Currencies 8 Emerging markets 8 Corporate governance 8 High dependence on tech. 9 Banking market over-capacity 9 Interest rates 9 Risk management 10 International regulation 10 Political shocks 10 Macro-economic trends
2006 2008 2010 1 Too much regulation 1 Liquidity 1 Political interference 2 Credit risk 2 Credit risk 2 Credit risk 3 Derivatives 3 Credit spreads 3 Too much regulation 4 Commodities 4 Derivatives 4 Macro-economic trends 5 Interest rates 5 Macro-economic trends 5 Liquidity 6 High dependence on tech. 6 Risk management 6 Capital availability 7 Hedge funds 7 Equities 7 Derivatives 8 Corporate governance 8 Too much regulation 8 Risk management quality 9 Emerging markets 9 Interest rates 9 Credit spreads 10 Risk management 10 Hedge funds 10 Equities
Some Banana Skins come and go, some are hardy perennials. The Top Ten since 1996 show how concerns have changed over more than a decade. The 1990s were dominated by strategic issues: new types of competition and technologies, dramatic developments such as EMU, the Internet and Y2K. Many of these faded, to be replaced by economic and political risks and particularly by concern over the growth of regulation. The period after 2000 also saw the rise of newfangled risks such as derivatives and hedge funds, the latter making their first appearance in 2005. The 2008 survey, conducted at the height of the crisis, brought the focus sharply onto credit and market risks, and propelled two new entrants to the top of the charts: liquidity and credit spreads. This year’s survey shows a preoccupation with the crash aftermath: lingering debt and funding problems, but also looming questions about the state of the world economy and the intrusion of government into the banking sector.
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1. 1.Political Political interference interference (-) (-)
The Thedash dash by governments by governments to rescue to rescue their their banks banks from from disaster disaster may mayhave have staved staved off aoff a collapsecollapse of the of system,the system, but itbut has it hasleft leftthe bankingthe banking industry industry deeply deeply politicised, politicised, a a developmentdevelopment which which is seen is seen by our by respondentsour respondents to be to the be greatestthe greatest risk risknow nowfacing facing the the financefinance sector. sector.
PoliticalPolitical interference interference on this on this scale scale being being rare, rare, it has it neverhas never before before appeared appeared in 15 in 15 yearsyears of Banana of Banana Skins Skins surveys surveys (though (though “political “political shocks” shocks” such suchas revolutions as revolutions and and warswars have). have). But concernBut concern about about it is strongit is strong and widespread,and widespread, and itand includes it includes bankers bankers as as well well as non-bankers, as non-bankers, even even regulators. regulators. Geographically, Geographically, it came it came top topof the of listthe inlist in EuropeEurope and Northand North America, America, and No.and 4No. in 4the in Asia the Asia Pacific Pacific region. region.
ConcernConcern falls fallsinto intothree three areas. areas. PoliticalPolitical meddling meddling in bankingin banking is is One Oneis the is moral the moral hazard hazard created created by bank by bank rescues. rescues. The Themanaging managing director director of risk of riskat a at a invariablyinvariably largelarge US bankUS bank said saidthat thatit had it hadalready already begun begun to breed to breed complacent complacent attitudes: attitudes: “We'll “We'll alwaysalways be bailed be bailed out”. out”. Ros Ros Altmann, Altmann, a policy a policy adviser adviser at the at Londonthe London School School of of ‘negative’‘negative’ Economics,Economics, said saidthat thatbanks banks now nowassumed assumed that thatthey theycannot cannot fail “whichfail “which distorts distorts their their operationaloperational decisions decisions and andpermits permits different different behaviour behaviour than thanwould would otherwise otherwise be the be the case.case. They They also also know know that that governments governments need need bank bank share share prices prices to stay to stay strong strong in in orderorder to offload to offload taxpayer taxpayer stakes stakes in future in future which, which, again, again, gives gives them them the one-waythe one-way optionoption of reaping of reaping the rewardsthe rewards of risk-taking, of risk-taking, but butnot notsuffering suffering the penaltiesthe penalties of of failure”.failure”.
The The second second is the is thepoliticisation politicisation of lending of lending. Having. Having bailed bailed the the banks banks out, out, governmentsgovernments are pushingare pushing them them to keep to keep lending lending through through the recession,the recession, against against their their betterbetter judgment. judgment. A director A director at a atlarge a large UK UKbank bank said saidthat that“political “political meddling meddling in the in the financialfinancial sector sector is almost is almost universally universally contradictory contradictory and and negative. negative. One One can't can't lend lend moremore to support to support the economythe economy and buildand build up capital up capital bases bases at the at samethe same time”. time”. A credit A credit analystanalyst at a largeat a large Japanese Japanese bank bank said saidthat that“political “political interference interference in both in both banking banking and and regulationregulation is likely is likely to lead to lead to a to mis-allocation a mis-allocation of resources, of resources, which which will will probably probably increase,increase, not decrease,not decrease, the risk the profilerisk profile of the of system”. the system”.
The The third third concern concern is how is how governments governments will will withdraw withdraw their their support support without without upsettingupsetting the bankingthe banking system system and and jeopardising jeopardising the recoverythe recovery. A .respondent A respondent from from Ireland,Ireland, where where the government the government is deeply is deeply involved, involved, said: said: “Currently “Currently the system the system is is extensivelyextensively supported supported by individual by individual states. states. The Theability ability of individual of individual banks, banks, and andthe the systemsystem in general, in general, to extricate to extricate itself itself from from such such support support and andraise raise capital capital on a onstand- a stand- alonealone basis basis is an is issue”. an issue”. The Thechief chief risk riskofficer officer of a oflarge a large South South African African bank bank said: said: “The“The main main immediate immediate concerns concerns have have been been alleviated alleviated through through government government intervention.intervention. The Theremaining remaining concern concern is mostly is mostly around around the disengagementthe disengagement process process of of governmentsgovernments from from their their intervention, intervention, and and whether whether this this would would occur occur in an in orderly an orderly way”.way”.
The Thefuture future of government of government intervention intervention is also is alsoa crucial a crucial question question for regulators,for regulators, one one of whomof whom said said that that “premature “premature withdrawal withdrawal of government of government support support could could leave leave weakerweaker banks banks unable unable to finance to finance their their assets assets on a on sustainable a sustainable basis basis given given their their high high leverage”.leverage”. Several Several respondents respondents raised raised the additionalthe additional worry worry that thatthere there was wasno money no money left toleft bail to bailbanks banks out ofout a ofnew a newround round of failures. of failures. A senior A senior risk riskofficer officer at a atlarge a large US US bankbank said said that that “should “should the ‘greenthe ‘green shoots’ shoots’ prove prove false, false, and and these these countries countries have have exhaustedexhausted their their resources, resources, no company no company will willbe ‘too be ‘toobig tobig fail’ to fail’- which - which could could create create a a crisiscrisis deeper deeper than thanany ofany us of have us have seen”. seen”.
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ThereThere is a is reason, a reason, of course, of course, for for the the politicisation politicisation of banking: of banking: the the need need to rescue to rescue banksbanks in thein thefirst first place. place. This This will will leave leave a political a political legacy legacy no matterno matter how how the thecrisis crisis runsruns its itscourse. course. Many Many respondents respondents said said that that banks banks would would have have to repair to repair their their relationsrelations with with governments governments and andthe thepublic public if they if they wanted wanted to expunge to expunge political political risk. risk.
HereHere is a isselection a selection of comments of comments on thison thistheme. theme.
“Banks“Banks just just don’t don’t get get how how unpopular unpopular they they are are and and how how much much has has to to change.”change.” – Former – Former regulator. regulator. A legacyA legacy of of “The“The banks banks still still fail failto realise to realise the thedepth depth of public of public anger anger against against them. them. As aAs a mistrustmistrust result,result, their their behaviour behaviour seems seems to have to have changed changed not notat all. at all.The The result result is likely is likely to beto abe period a period of tensionof tension between between banks banks and andregulators, regulators, which which means means that that banksbanks concentrate concentrate on politicson politics to the to the detriment detriment of their of their ordinary ordinary banking banking business.”business.” – City – City lawyer. lawyer.
“The“The financial financial sector sector as aas lobby a lobby group group is not is notaligned aligned with with the theinterests interests of of the thereal real economy economy or the or thetaxpayer.” taxpayer.” – City – City trader. trader.
“We“We need need to get to getback back to business to business without without government government support.” support.” – UK – UKbank bank chairman.chairman.
2.2. Credit Credit risk risk (2) (2)
TheThe risk risk of large of large credit credit losses losses remains remains a top-level a top-level Banana Banana Skin Skin because because of fears of fears that that thatthat banks banks have have not notgot gotto the to thebottom bottom of theirof their existing existing their their bad baddebts, debts, and andbecause because loanloan problems problems always always lag lagthe therecovery recovery and andcould could still still increase. increase. This This was was the theNo. No. 1 1 riskrisk for forregulators. regulators. Bankers Bankers and andobservers observers put putit at it No. at No. 3. Geographically,3. Geographically, the therisk risk waswas seen seen to be to most be most severe severe in the in theAsia Asia Pacific Pacific region region because because of asset of asset bubbles. bubbles.
ManyMany respondents respondents felt feltthat that the theworst worst was was yet yetto come. to come. US USbank bank analyst analyst Ray Ray Soifer Soifer said:said: “The “The economy economy is not is not yet yet out out of the of the woods, woods, and and credit credit losses losses are are a lagging a lagging TheThe worst worst yet yet indicator.indicator. I do I notdo notbelieve believe that that they they have have peaked.” peaked.” Chris Chris Pettit, Pettit, head head of strategyof strategy at at to tocome come the theRoyal Royal Bank Bank of Scotland,of Scotland, said said that that “the “the economic economic outlook outlook still still looks looks miserable; miserable; onon credit? credit? creditcredit risk risk remains remains high,” high,” while while from from Ireland, Ireland, a respondent a respondent wrote: wrote: “A “Areal real concern concern wouldwould be thebe theimpact impact on bankon bank balance balance sheets sheets of a of ‘double a ‘double dip’ dip’ in the in theeuro/worldwide euro/worldwide economies.”economies.”
ConcernsConcerns focused focused particularly particularly on real on real estate estate, commercial, commercial as well as well as domestic. as domestic. A A respondentrespondent from from the the US US said said that that rising rising unemployment unemployment was was a harbinger a harbinger of of potentiallypotentially huge huge losses losses on propertyon property lending. lending. A Nordic A Nordic regulator regulator said said that that “companies “companies are are only only surviving surviving due due to low to low interest interest rates”. rates”. On On the the home home loan loan front, front, several several respondentsrespondents could could see see banks banks facing facing a dilemma a dilemma as borrowers as borrowers defaulted defaulted on ontheir their mortgages,mortgages, but but the the political political climate climate made made it hard it hard for for them them to foreclose. to foreclose. Adrian Adrian Coles,Coles, director-general director-general of theof theUK’s UK’s Building Building Societies Societies Association, Association, saw saw a squeeze a squeeze betweenbetween “rising “rising unemployment unemployment in 2010, in 2010, and and a diminishing a diminishing ability ability on theon the part part of of mortgagemortgage lenders lenders to exercise to exercise significant significant forbearance forbearance policies”. policies”.
AnotherAnother area area of concernof concern is consumer is consumer credit credit – credit – credit cards cards and andcar carloans loans – where – where bankersbankers said said that that bad baddebts debts “had “had not notbottomed bottomed out outyet”. yet”. There There is also is also the thequestion question of of leverageleverage: past: past deals deals built built on largeon large amounts amounts of debt of debt which which investors investors cannot cannot now now service.service. A UK A UK regulator regulator saw saw “continuing “continuing economic economic weakness weakness affecting affecting highly highly leveragedleveraged borrowers, borrowers, particularly particularly commercial commercial property property lending lending and andleveraged leveraged buy- buy- outs”.outs”.
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TheThe other other major major area area of concernof concern is is assetasset valuation valuation: are: are banks banks on ontop top of of A sAu bsutlbet blee baesta st theirtheir exposures, exposures, and and have have they they valued valued themthem realistically? realistically? Many Many respondents respondents CreditCredit risk riskis a iscomplex a complex and andsubtle subtle felt felt the the answer answer to both to both questions questions was was beast.beast. Even Even if the if upturnthe upturn continues continues no. no. Richard Richard Farrant, Farrant, chairman chairman of theof the it willit manifestwill manifest itself itself in a innumber a number of of auditaudit committee committee of Daiwa of Daiwa Securities, Securities, differentdifferent ways. ways. Europe,Europe, said said that that “while “while mark-to- mark-to- marketmarket means means that that banks' banks' trading trading UK bUaKn kbianngk cinogn scuolntasnutlt ant portfoliosportfolios are are probably probably reasonably reasonably realisticallyrealistically valued, valued, I am I am much much more more sceptical sceptical that that their their loan loan books books are, are, and and that that couldcould well well become become a source a source of pressure of pressure if the if therate rate of economic of economic recovery recovery diminishes diminishes or stalls”.or stalls”. Peter Peter Moffatt Moffatt of theof the Guernsey Guernsey Financial Financial Services Services Commission Commission was was concernedconcerned about about “unexpected “unexpected loss loss due dueto mispricing/misunderstandingto mispricing/misunderstanding of assetsof assets on on banks’banks’ balance balance sheets sheets (or clients’(or clients’ balance balance sheets)”. sheets)”.
Geographically,Geographically, a respondent a respondent from from a major a major banking banking trade trade association association said said this thiswas was a a particularparticular issue issue in the in theeurozone eurozone where, where, unlike unlike the theUS USand andthe theUK, UK, banks banks tend tend to use to use lessless mark mark to market to market accounting. accounting. “Failure “Failure to admit to admit the theextent extent of the of thewrite-downs write-downs that that are arenecessary necessary will will prolong prolong the theperiod period of instability of instability in both in both the thesystem system and andfor forsome some individualindividual eurozone eurozone banks”. banks”. A respondent A respondent from from a Middle a Middle East East bank bank said said that that “European“European banks, banks, Middle Middle Eastern Eastern banks banks and andin particular in particular Dubai Dubai banks banks are arein denial in denial aboutabout their their exposures, exposures, which which could could very very well well set backset back Europe Europe and andthe theMiddle Middle East East for aboutfor about five five years”. years”.
3.3. Too Too much much regulation regulation (8) (8)
TheThe torrent torrent of new of new regulation regulation being being proposed proposed in the in thewake wake of the of thecrisis, crisis, however however well well intentioned,intentioned, is seen is seen as potentially as potentially weakening weakening the the banking banking industry industry rather rather than than strengtheningstrengthening it. Many it. Many respondents respondents described described it as it a as dangerous a dangerous over-reaction over-reaction which which couldcould end endup damagingup damaging not notjust justthe thebanks banks but butthe thewider wider economy. economy.
ExcessiveExcessive ThisThis concern concern was was particularly particularly strong strong among among bankers, bankers, who who ranked ranked it No. it No. 2, but 2, butalso also amongamong observers observers of the of the banking banking industry industry who who put put it at it No. at No. 4. Regulators 4. Regulators took took a a regulationregulation may may differentdifferent view: view: they they thought thought the the problem problem was was too too little little rather rather than than too too much much weakenweaken rather rather regulation.regulation. All Allgeographical geographical regions regions gave gave this thisBanana Banana Skin Skin a high a high score: score: it came it came top top in Asiain Asia Pacific. Pacific. thanthan strengthen strengthen thethe banks banks RespondentsRespondents gave gave many many reasons reasons for fortheir their concerns concerns about about regulation. regulation. Chief Chief among among themthem was was that that the theregulatory regulatory crackdown crackdown was was politically politically driven driven and andtherefore therefore likely likely to beto be overdone. overdone. The The chairman chairman of aof large a large UK UK bank bank was was said said his his worry worry was was “overbearing“overbearing regulation regulation which which is not is not proportionate proportionate or ofor aof level a level playing playing field field character”.character”. Many Many respondents respondents made made the the point point that that the the risk risk lay lay in politicians in politicians and and regulatorsregulators going going for forquantity quantity rather rather than than quality quality. The. The chief chief auditor auditor of a of large a large CanadianCanadian bank bank said said regulators regulators took took the theview view that that “more “more work work equals equals more more control, control, whenwhen they they need need intelligent intelligent risk-based risk-based regulation”. regulation”. A particular A particular concern concern for Europeanfor European respondentsrespondents was was the the EU’s EU’s response response, which, which was was likely likely to be to particularly be particularly heavy- heavy- handedhanded and andpolitically politically driven. driven. Sonja Sonja Lohse, Lohse, head head of group of group compliance compliance at Nordea at Nordea in in Sweden,Sweden, said said that that the the EU’s EU’s new new regulatory regulatory proposals proposals had had not not been been properly properly evaluated,evaluated, and andcould could “squeeze “squeeze out outflexibility flexibility from from the themarkets” markets” and anddamage damage the thefew few banksbanks which which had hadmanaged managed to make to make it through it through the thecrisis crisis unscathed. unscathed.
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ThereThere was was also also the the fear fear that that regulation regulation would would stifle stifle the the recovery recovery by loadingby loading the the banksbanks with with expensive expensive capital capital and andliquidity liquidity rules. rules. John John Hitchins, Hitchins, UK UKbanking banking leader leader at PricewaterhouseCoopers,at PricewaterhouseCoopers, said said that that “the “the cumulative cumulative effect effect of all of theall the regulatory regulatory initiativesinitiatives could could have have an inadvertentan inadvertent permanently permanently damaging damaging effect effect on theon theindustry’s industry’s profitability”.profitability”. The The chief chief risk risk officer officer of aof large a large German German bank bank warned warned that that pressure pressure fromfrom politicians politicians and and regulators regulators “could “could lead lead to overregulation to overregulation of banks. of banks. This This may may TooToo much much reducereduce banks’ banks’ willingness willingness to taketo take further further risks, risks, and andcould could lead lead in turnin turn to ato further a further contractioncontraction of the of theeconomy”. economy”. regulationregulation couldcould stifle stifle the the TheThe sheer sheer volume volume of new of new regulation regulation was was also also a concern, a concern, from from the thepoint point of view of view of of costcost and andmanagement management distraction. distraction. Michael Michael McKee, McKee, a partner a partner at law at lawfirm firm DLA DLA Piper Piper recoveryrecovery saidsaid that that “there “there has has to be to a be limit a limit to how to how much much change change a financial a financial institution institution can can safelysafely take take on board on board at oneat one time”. time”. Tougher Tougher regulation regulation may may also also have have unintended unintended consequencesconsequences. The. The higher higher costs costs will will have have to be to passedbe passed on toon consumers, to consumers, which which will will be unpopular.be unpopular. The The impact impact on profitabilityon profitability could could also also spur spur banks banks to take to take more more risk risk or or abscondabscond to more to more lightly lightly regulated regulated centres. centres.
TheThe risk risk of excessive of excessive regulation regulation was was No. No. 1 in 1 the in theAsia Asia Pacific Pacific region region. In .Australia, In Australia, GaryGary Dingley, Dingley, chief chief operational operational risk risk officer officer of the of the Commonwealth Commonwealth Bank, Bank, saw saw the the riskrisk of a of regulatory a regulatory overreaction overreaction “without “without the the necessary necessary review, review, consultation consultation and and analysisanalysis of overall of overall impact impact on theon theindividual individual banks banks or the or thefinancial financial sectors”. sectors”. A banker A banker fromfrom India India commented: commented: “The “The current current crisis crisis has hasled ledto all to typesall types of banks of banks failing, failing, large large small,small, investment, investment, retail, retail, the the works. works. Largely Largely the the common common denominator denominator is poor is poor liquidityliquidity management. management. As weAs comewe come out outof this of thiscrisis crisis the themain main threat threat to safety to safety will will be be over-reactionover-reaction from from regulators regulators which which leads leads to a to too a toocostly costly system system and andunsustainable unsustainable businessbusiness models.” models.”
RegulatorsRegulators were were not, not, however, however, blind blind to these to these dangers. dangers. Michael Michael Lesser, Lesser, managing managing directordirector of supervision of supervision and andauthorisation authorisation in Qatar, in Qatar, wrote: wrote: “Regulators “Regulators (and (and I am I amone) one) needneed to be to carefulbe careful about about how how new new rules rules are arewritten, written, to avoid to avoid either either overly overly restricting restricting the the ability ability of of banks banks to todo do business business or or by by restricting restricting some some business business lines, lines, inadvertentlyinadvertently encouraging encouraging firms firms to getto getinvolved involved in other,in other, less less restricted, restricted, but butriskier riskier business.”business.”
4.4. Macro-economic Macro-economic trends trends (5) (5)
TheThe economic economic outlook outlook remains remains extremely extremely uncertain, uncertain, pushing pushing this thisBanana Banana Skin Skin up aup a notch.notch. Most Most of ourof ourrespondents respondents sounded sounded very very pessimistic. pessimistic. For Formany, many, the thedanger danger is is not not simply simply that that there there will will be abe “double a “double dip” dip” recession, recession, but but that that bankers bankers will will be be FearsFears of ofa a unpreparedunprepared for it.for it. ‘double‘double dip’ dip’ recessionrecession Broadly,Broadly, non-bankers non-bankers seem seem to beto morebe more pessimistic pessimistic than than bankers bankers (No. (No. 2 versus 2 versus No. No. 6), and6), andAsia Asia Pacific Pacific (No. (No. 2) more2) more pessimistic pessimistic than than either either Europe Europe (No. (No. 3) or3) Northor North AmericaAmerica (No. (No. 5). If5). there If there is a isconsensus, a consensus, it is it that is that the thecurrent current recovery recovery is very is very weak, weak, sustainedsustained only only by lowby low interest interest rates rates and andmassive massive fiscal fiscal and andmonetary monetary support. support. It is It is alsoalso vulnerable vulnerable to a to reversal a reversal caused caused by freshby fresh problems problems on theon thebanking banking front: front: a surge a surge in badin bad debts, debts, a continuing a continuing shortage shortage of credit, of credit, mounting mounting pressures pressures on governmenton government resources,resources, and and wavering wavering investor investor confidence. confidence. The The question question is whether is whether the the global global economyeconomy will will somehow somehow struggle struggle on, on,suffer suffer a setback, a setback, or even or even collapse collapse into into deflation. deflation.
TheThe chief chief investment investment officer officer at a at large a large UK UK investment investment group group said: said: “I believe “I believe the the actionsactions of the of the authorities authorities to guarantee to guarantee depositors depositors have have significantly significantly reduced reduced the the likelihoodlikelihood of aof systemic a systemic wide wide collapse. collapse. However, However, the thepossibility possibility of aof ‘W’ a ‘W’ path path for for the the economy economy with with a further a further leg leg down down in 2010 in 2010 remains remains significant. significant. While While not not our our
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centralcentral scenario, scenario, such such an outcome an outcome could could put severeput severe further further pressure pressure on asset on asset prices prices and wouldand would clearly clearly lead leadto a tohigher a higher level level of defaults”. of defaults”. Elbert Elbert Pattijn, Pattijn, chief chief risk riskofficer officer at DBSat DBS Bank Bank in Singapore, in Singapore, saw saw the main the main risks risks as “double as “double dip indip terms in terms of global of global GDP,GDP, leading leading to high to high inflation inflation and andinterest interest rates rates that thatwould would impact impact property property values values and and the ability the ability of property of property owners owners to service to service their their floating floating rate rate loans”. loans”. A London A London economisteconomist wondered wondered whether whether governments governments would would be able be able to fine to fine tune tune policy policy sufficientlysufficiently to navigate to navigate between between “the “the Scylla Scylla of inflation of inflation and and the Charybdisthe Charybdis of a of a doubledouble dip recession”.dip recession”. Russian Russian respondents respondents were were specially specially gloomy. gloomy. A senior A senior bank bank economisteconomist said saidthat that“significant “significant credit credit risks risks are generated are generated by the by overall the overall instability instability in in the economy,the economy, and aand worsening a worsening of the of business the business climate”. climate”.
A newA new ‘asset ‘asset ManyMany respondents respondents felt thatfelt thatgovernment government actions actions to pump to pump liquidity liquidity into intothe marketsthe markets had merelyhad merely inflated inflated an “asset an “asset bubble” bubble” which which would would eventually eventually burst burst with with damaging damaging bubble’bubble’ on onthe the consequences,consequences, as it as did it indid 2007. in 2007. This This concern concern underlay underlay the highthe high risk risk that that Asian Asian way?way? respondentsrespondents placed placed on the on economicthe economic outlook. outlook. The Thechief chief executive executive of a ofFar a EasternFar Eastern bankbank said said that that liquidity liquidity “is being “is being poured poured mostly mostly into into 'financial 'financial assets' assets' such such as as equitiesequities and andreal realestate, estate, thus thuscreating creating a bubble a bubble economy. economy. More More needs needs to be to done be done to to createcreate jobs jobsand andboost boost credits credits and andinvestment investment flows flows into intoproductive productive industries”. industries”. The The chiefchief economist economist at a atlarge a large hedge hedge fund fund said saidthat thathis mainhis main concern concern “is that “is thatwe getwe yetget yet anotheranother asset asset bubble bubble developing developing and and bursting…The bursting…The excess excess liquidity liquidity in markets in markets meansmeans that thatmany many asset asset prices prices are already are already starting starting to look to look frothy”. frothy”.
ThereThere was was also also a concern a concern that that the rally the rally had hadcreated created a false a false sense sense of security, of security, and and broughtbrought a return a return of complacency, of complacency, even even recklessness recklessness to the to financial the financial markets markets (see (seebox box below).below). A respondent A respondent from from a large a large US bankUS bank said saidthat that“risk “risk is inadequately is inadequately calibrated calibrated againstagainst an uncertain an uncertain economic economic recovery”. recovery”.
TheT hCe w Co rwdord
ComplacencyComplacency may maybe the be biggest the biggest Banana Banana Skin Skinof all. of Many all. Many of our of respondents our respondents were were alarmedalarmed by the by “business the “business as usual” as usual” attitude attitude of banks of banks despite despite the huge the huge amount amount of of workwork that wasthat stillwas neededstill needed to clear to clear up the up mess the mess and stabiliseand stabilise economies. economies. A UK A UK investmentinvestment manager manager saw “thesaw “thereturn return of hubris/over-confidence of hubris/over-confidence and theand old the short old short termterm habits habits among among investment investment banks, banks, notably notably Wall WallStreet Street ones.” ones.”
ApartApart from from exposing exposing banks banks to the to risk the ofrisk a doubleof a double dip recession, dip recession, these these attitudes attitudes also alsobode bode ill for ill the for future. the future. They They imply imply that thethat lessons the lessons of the of crisis the crisis may maynot be not be learnt.learnt. A regulator A regulator wondered wondered whether whether “changes “changes in behaviour in behaviour will result, will result, or whether or whether therethere will be will a bereturn a return to the to practices the practices that ledthat to led the to problems, the problems, or to ornew, to new, but just but just as risky,as risky, behaviour.” behaviour.” UK consultant UK consultant economist economist David David Kern Kern saw “inadequatesaw “inadequate changeschanges in culture in culture and mentalityand mentality within within the financial the financial system; system; an inability an inability or or unwillingnessunwillingness to learn to learn from from the crisis,” the crisis,” and aand Swiss a Swiss banker banker observed observed that “productthat “product developmentdevelopment goes goes ahead ahead almost almost like before”.like before”.
A respondentA respondent from from an Australian an Australian bank bank said saidthat “partsthat “parts of Asia of Asiaare improving are improving rapidly rapidly and someand some of the of issues the issues are again are again emerging. emerging. Pricing Pricing for risk for isrisk being is being eroded, eroded, the the cost costof human of human resources resources is moving is moving up. The up. governanceThe governance framework framework is more is more bureaucraticbureaucratic than thanaddressing addressing risk”. risk”.
A beliefA belief that thethat crisis the crisis is over is overmay mayalso alsosap thesap political the political will to will reform to reform the financial the financial system.system. The directorThe director of a USof a project US project on financial on financial reform reform said: said: “My main“My main worry worry is that is that a gooda good crisis crisis will have will have been been wasted. wasted. On Wall On WallStreet, Street, folk arefolk back are back doing doing business business as as normal.normal. On Main On Main Street, Street, loans loans aren't aren't getting getting made made and aand bunch a bunch more more smaller smaller banksbanks have have yet to yet go to belly go bellyup - whichup - which they theywill. Andwill. onAnd Capitol on Capitol Hill, thereHill, there is a realis a real dangerdanger we will we get will some get some symbolic symbolic moving moving of deck of deck chairs chairs and nothing,and nothing, nada nada, in the, in the way ofway steps of steps to reduce to reduce the chances the chances of another of another $15tr $15tr dip in dip economic in economic activity.” activity.”
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5. 5.Liquidity Liquidity (1) (1)
A criticalA critical shortage shortage of liquidity of liquidity triggered triggered the creditthe credit crunch crunch two twoyears years ago, ago,which which is is why whythis thisBanana Banana Skin Skin shot shotto the to topthe oftop our of surveyour survey last time.last time. It remains It remains high, high, not not becausebecause liquidity liquidity is still is stillsuch such an urgent an urgent problem, problem, but becausebut because new newliquidity liquidity has beenhas been artificiallyartificially created created by central by central bank bank actions actions such such as Quantitative as Quantitative Easing Easing (QE) (QE) which which mustmust come come to an to end an atend some at some point. point. Then Then what? what?
LiquidityLiquidity was was a high a high level level concern concern for allfor respondent all respondent categories. categories. A Eurozone A Eurozone regulatorregulator said: said: “The “The current current optimism optimism on financial on financial markets markets is probably is probably overstated. overstated. Banks'Banks' liquidity liquidity and andsolvency solvency position position appears appears to be to less be less critical critical for the for moment, the moment, but…liquiditybut…liquidity risk riskis still is stillvery very much much an issue. an issue. The Thereopening reopening of short of short and longand long term term fundingfunding markets markets is fragile is fragile and andsome some firms firms are stillare stilloverly overly wholesale wholesale and andshort short term term funded.”funded.” Another Another respondent respondent said saidthat “QEthat “QE creates creates an illusion an illusion which which will willburst”. burst”.
WhatWhat happens happens The Thequestion question of when of when and andhow howcentral central banks banks wind wind down down their their QE programmesQE programmes is is crucial.crucial. The The finance finance director director of a of major a major international international banking banking group group saw saw banks banks afterafter sufferingsuffering from from “an excessive“an excessive reliance reliance on the on hugethe huge liquidity liquidity boost boost that thatcentral central banks banks QuantitativeQuantitative havehave injected”. injected”. A City A Cityof London of London economist economist said saidhe feared he feared that that“QE “QE will willend beforeend before banksbanks have have been been forced forced to refinance”. to refinance”. Easing?Easing? NewNew regulations regulations will willrequire require banks banks to keep to keep higher higher levels levels of liquidity of liquidity which which would would reducereduce the scale the scale of this of this risk, risk, though though some some respondents respondents feared feared this this would would add add to to banks’banks’ funding funding costs, costs, and thereforeand therefore the cost the costof credit. of credit.
ManyMany respondents respondents also alsomade made the pointthe point that, that, until until the creditthe credit crunch crunch at least, at least, liquidity liquidity was wasnot viewednot viewed as a ashigh a high risk riskarea. area. Now, Now, things things are different,are different, and oneand oneof the of issuesthe issues is whetheris whether lessons lessons have have been been learnt. learnt. A German A German bank bank adviser adviser said saidthat that“if we “if havewe have learntlearnt something something from from the crisis,the crisis, it is itthat is thatliquidity liquidity risk riskneeds needs to be to in be the in mindsthe minds of of authorities,authorities, boards boards and and senior senior management”. management”. A UK A UK bank bank chairman chairman described described liquidityliquidity as “the as “thenext nextproblem problem to solve, to solve, post-central post-central bank bank withdrawal”. withdrawal”.
6. 6.Capital Capital availability availability (-) (-)
BanksBanks have have been been able ableto raise to raise impressive impressive amounts amounts of new of newcapital capital in the in wakethe wake of the of the crisis.crisis. But But can can this this continue? continue? Will Will banks banks be able be able to meet to meet the thetougher tougher capital capital requirementsrequirements that thatare on are the on way, the way, and willand willthey theybe able be ableto service to service them? them?
ThisThis is a newis a newBanana Banana Skin: Skin: shortages shortages of capital of capital for the for bankingthe banking industry industry were were never never a problema problem in the in boomthe boom times. times. But Butthey theycould could be now, be now, particularly particularly if hard if hard economic economic conditionsconditions persist, persist, and theand ability/willingness the ability/willingness of governments of governments to support to support them them begins begins to fade.to fade. This This concern concern was wasstrongest strongest in Europe. in Europe.
ManyMany respondents respondents were were sceptical sceptical about about the adequacythe adequacy of bank of bank capital, capital, even even after after the the recentrecent round round of capital-raising. of capital-raising. A City A Cityof London of London economist economist said: said: “Banks “Banks have have too too littlelittle equity equity and and bankers bankers (even (even bankers!) bankers!) know know this. this. Until Until they they are forced are forced to raise to raise largelarge amounts, amounts, they theywill willnot lend.”not lend.”
And Andcompulsion compulsion is on is the on way. the way. New New rules rules will willoblige oblige banks banks to hold to hold more more capital capital and and contingencycontingency funding, funding, and forceand force them them to salt to earningssalt earnings away away in the in goodthe good times times to help to help pay forpay the for bad.the bad.The Thehead head of a ofEuropean a European banking banking association association said: said: “The “The demands demands of of the newthe new Basel/EU Basel/EU requirements requirements are in are excess in excess of some of some banks’ banks’ ability ability to raise to raise the the necessarynecessary capital. capital. This This will willmean mean more more of them of them having having to seek to seek government government support, support,
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eg eg some some Japanese Japanese banks, banks, some some eurozone eurozone banks, banks, the the mutual mutual sector sector in the in the UK, UK, LandesbanksLandesbanks in Germany, in Germany, the themutuals mutuals in France in France and andSpain.” Spain.”
HigherHigher capital capital requirements requirements will will also also mean mean higher higher costs costs for forbanks, banks, which which will will put puta a strainstrain on onprofitability, profitability, and and possibly possibly create create incentives incentives to take to take on onnew new risks. risks. The The directordirector of group of group risk risk at a at UK a UKmerchant merchant bank bank said said that that “higher “higher capital capital requirements requirements and and lower lower returns returns increase increase the the relative relative attractions attractions of trading of trading activities…” activities…” while while a a respondentrespondent from from a Japanese a Japanese bank bank said said that that “as “as memories memories fade, fade, there there will will be be HigherHigher capital capital significantsignificant pressure pressure from from shareholders shareholders to boost to boost returns, returns, which which will will lead lead to banks to banks takingtaking unacceptable unacceptable risks risks again”. again”. One One banker banker summed summed up theup theparadox: paradox: “Regulation “Regulation requirementsrequirements willwill increase increase demand demand for forcapital, capital, whereas whereas decreased decreased bank bank profitability profitability will will reduce reduce maymay push push banks banks the thesupply supply of capital.” of capital.”
to totake take SomeSome banking banking respondents respondents felt feltthat that higher higher capital capital requirements requirements were were unwarranted, unwarranted, greatergreater risks risks givengiven the the work work that that banks banks were were doing doing to clean to clean up uptheir their balance balance sheets sheets and and de- de- leverage.leverage. The The head head of governmentof government relations relations at aat large a large international international banking banking group group saidsaid this thiswas was “a key “a keyissue, issue, but butdriven driven by politicalby political and andmisinformed misinformed agendas”. agendas”.
It’sI tn’so nt oatll ablal bdad
A numberA number of respondents of respondents said said there there was was too muchtoo much pessimism pessimism around, around, and andthat that we we werewere in danger in danger of talking of talking ourselves ourselves into intoanother another crisis. crisis. The Thechief chief executive executive of a of a London-basedLondon-based bank bank said said emphatically: emphatically: “I think “I think the globalthe global banking banking system system and andall all majormajor national national banking banking markets markets are aresound. sound. Therefore Therefore I have I have no concerns no concerns about about ongoingongoing systemic systemic risk.” risk.”
AnotherAnother respondent respondent said said that that an overly an overly pessimistic pessimistic outlook outlook would would result result in in “regulators“regulators setting setting too muchtoo much store store by stress by stress tests tests which which turn turn out toout be to too be severe.too severe. ThisThis constrains constrains growth, growth, and andforces forces failures failures or consolidation or consolidation which which need need not havenot have happened…happened… It also It also leads leads to pessimism to pessimism amon amongst ratinggst rating agencies agencies who who adopt adopt an ultra an ultra cautiouscautious approach approach which which restricts restricts access access to wholesale to wholesale funding.” funding.”
SusanSusan Rice, Rice, managing managing director director of Lloyds of Lloyds Banking Banking Group Group Scotland, Scotland, said said that that while while therethere were were still stillrisks, risks, “financial “financial institutio institutions andns andthe thefinancial financial system system as a as whole a whole are are far saferfar safer than than a year a year ago. ago. This This is due is dueto lessons to lessons learned, learned, public public and andregulatory regulatory scrutiny,scrutiny, regulatory regulatory reformation, reformation, economic economic factors, factors, the newthe new Banking Banking Act andAct andother other factors.”factors.”
7.7. Derivatives Derivatives (4) (4)
ThisThis is the is thelowest lowest position position that that derivatives derivatives have have occupied occupied in the in theBanana Banana Skins Skins table table sincesince 2000 2000 when when they they were were viewed viewed as an as up-and-comingan up-and-coming risk. risk. Is this Is thisa sign a sign that that they they havehave lost lost their their sting, sting, or that or that people people have have got got used used to them? to them? Interestingly, Interestingly, bankers bankers rankedranked this thisrisk risk much much higher higher (No. (No. 5) than 5) than non-bankers non-bankers (No. (No. 11) 11)and andeven even regulators regulators (No.(No. 13). 13). This This reverses reverses the theusual usual position, position, and andmay may be connectedbe connected with with bankers’ bankers’ pre- pre- occupationsoccupations with with credit credit derivatives. derivatives.
TheThe risks risks in derivatives in derivatives are are still still seen seen to lie to lie in their in their complexity, complexity, and and a poor a poor understandingunderstanding of the of the exposures exposures they they create. create. One One respondent respondent said said they they remained remained “weapons“weapons of mass of mass destruction”. destruction”. Consultant Consultant Andrew Andrew Leung Leung said said that, that, in the in the near near future,future, “the “the risk risk is that is that the the depth depth of toxic of toxic debt debt remains remains largely largely hidden hidden under under the the carpet,carpet, especially especially with with commodities commodities and and foreign foreign exchange exchange derivatives derivatives and and credit credit defaultdefault swaps”. swaps”. Some Some respondents respondents thought thought that that this this risk risk would would grow grow as banksas banks
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developeddeveloped ever ever more more innovative innovative instruments instruments to deal to deal with with tougher tougher regulation regulation and and squeezesqueeze higher higher margins margins out outof a of low a low yield yield environment. environment. Giles Giles Vardey, Vardey, consultant consultant to to institutionalinstitutional fund fund managers managers Babson Babson Capital Capital Europe, Europe, said said that that “any “any significant significant 'tightening''tightening' of banking of banking regulations regulations will will only only serve serve to create to create new new ways ways to circumvent to circumvent thesethese rules rules and andthus thus create create even even more more exotic exotic products”. products”.
But But others others felt felt there there were were reasons reasons to feel to feel more more relaxed relaxed about about the the dangers dangers of of derivatives.derivatives. One One said said that that “simplification, “simplification, reduced reduced volumes volumes and andbetter better transparency transparency havehave made made this thismarket market safer”. safer”. WorriesWorries about about derivativesderivatives are are OthersOthers pointed pointed out out that that new new regulations regulations will will force force Over-the-Counter Over-the-Counter derivative derivative tradingtrading on toon the to theopen open exchanges exchanges where where it can it canbe betterbe better monitored monitored and andcontrolled. controlled. A A easingeasing UK UK investment investment manager manager said said that that “the “the move move to an to anexchange-traded exchange-traded basis basis will will probablyprobably take take at least at least three three years. years. Whilst Whilst some some of theof thework work being being done done will will reduce reduce risksrisks through through standardisation, standardisation, the theresulting resulting fragmentation fragmentation between between asset asset classes classes and and regulatoryregulatory environments environments may may adversely adversely impact impact the thebanks’ banks’ client client base”. base”.
8.8. Risk Risk management management quality quality (6) (6)
ThatThat risk risk management management in banks in banks leaves leaves much much to be to desiredbe desired is obvious, is obvious, and and the the bankersbankers among among our ourrespondents respondents ranked ranked this thisBanana Banana Skin Skin almost almost as highlyas highly as non-as non- bankers.bankers. “This “This is the is thekey,” key,” said said one onebanker. banker. “I don't “I don't think think anyone anyone can cansay saythat that it does it does not notneed need improvement improvement and andattention.” attention.”
But Butwhat what are arethe theissues? issues?
RespondentsRespondents identified identified a string a string of failings, of failings, including including an excessivean excessive focus focus on short-on short- termterm results, results, inadequate inadequate skills, skills, a lack a lack of rigour,of rigour, poor poor understanding understanding of newfangledof newfangled instruments,instruments, overdependence overdependence on on box- box- tickingticking and and models, models, a afailure failure to to appreciateappreciate that that risk risk management management is not is nota a Is bIsa bnakninkgi negv enve an a costcost but but a source a source of ofvalue value etc.. etc.. “A “A propfreosfseiossnio?n ? properlyproperly managed managed business business should should be onbe on top top of of risks,” risks,” said said Henry Henry Angest, Angest, The Theconcept concept of banking of banking as 'a as 'a Chairman/CEOChairman/CEO of Arbuthnotof Arbuthnot Banking Banking profession'profession' has hastaken taken a hammering a hammering in thein pastthe past 10 years10 years with with apologists apologists Group.Group. arguingarguing that that there there is no is need no need for for specificspecific banking banking qualifications qualifications or or TheThe question question is whether is whether banks banks have have learning.learning. It is Itenough, is enough, they they say, say, to to learntlearnt lessons lessons from from the the crisis crisis and and taken taken havehave an 'appropriate' an 'appropriate' qualification qualification stepssteps to correct to correct these these failings. failings. withoutwithout making making clear clear what what that that means.means. No otherNo other 'profession' 'profession' is so is so A A tone tone of of scepticism scepticism pervaded pervaded the the cavaliercavalier in its in requirement its requirement for for responsesresponses here. here. One One respondent respondent feared feared practitionerspractitioners to have to have proper proper and and relevantrelevant skills skills and andknowledge. knowledge. thatthat “board “board members members and and senior senior managersmanagers may may not not have have learnt learnt the the PrinPcirpinacl,i pparol, fpersosfieosnsailo innaslt iitnustteitute lessonslessons of the of therecent recent crisis crisis and andthat that their their banksbanks continue continue to take to take risks risks on on their their books books that that they they don't don't understand”. understand”. The The managingmanaging director director of product of product control control at a atSwiss a Swiss bank bank worried worried that that banks banks would would “fail “fail to properlyto properly and andrigorously rigorously embed embed new new control control processes processes and andcultures cultures arising arising from from the the lessons lessons learned learned during during the the crisis, crisis, and and return return to the to the complacency complacency that that existed existed beforebefore the the crisis”. crisis”. Some Some respondents respondents even even felt felt the the risks risks would would get get worse worse in the in the difficultdifficult period period ahead ahead as banksas banks struggled struggled to maketo make profits profits and andwere were tempted tempted to cutto cut cornerscorners on riskon risk management. management. Stewart Stewart Fleming, Fleming, research research visitor visitor London London School School of of Economics,Economics, was was concerned concerned about about “the “the threat threat of excessive of excessive speculation speculation by financialby financial
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institutions,institutions, driven driven not notonly only by extremelyby extremely low low (too (too low) low) interest interest rates rates and andmonetary monetary easing,easing, but but also also by bypressures pressures to build to build up upprofitability profitability as quickly as quickly as possible as possible to to strengthenstrengthen capital, capital, cope cope with with cyclical cyclical losses losses and andraise raise new new equity”. equity”.
ManyMany respondents respondents commented commented on theon theneed need not notjust just for forstronger stronger controls controls but butfor fora a changechange in culturein culture to includeto include a more a more positive positive attitude attitude towards towards risk risk management. management. A A CanadianCanadian consultant consultant said said that that “there “there are arefew few really really good good risk risk managers. managers. Many Many suffer suffer fromfrom too too little little independence independence or authority, or authority, and and executive executive management management must must be be attunedattuned to theirto their issues”. issues”. A managing A managing director director in onein oneof theof theleading leading US USinvestment investment banksbanks said said he was he was concerned concerned about about “the “the loss loss of good of good people”. people”.
But Butnot noteveryone everyone saw saw risk risk management management as aas black a black spot. spot. A managingA managing director director at a at a largelarge Swiss Swiss bank bank said said there there had hadbeen been “clear “clear enhancements enhancements following following the thecrisis” crisis” and and the therisk risk manager manager of aof large a large Greek Greek bank bank said said that that the thework work banks banks had haddone done on riskon risk managementmanagement will will “improve “improve the the efficiency efficiency of financialof financial institutions institutions and and reduce reduce systemicsystemic risks risks the thecoming coming years”. years”.
9.9. Credit Credit spreads spreads (3) (3)
SpreadsSpreads may may be be TheThe sudden sudden widening widening of creditof credit spreads spreads in mid-2007in mid-2007 was was one oneof theof thetriggers triggers of theof the crisis,crisis, propelling propelling this thisrisk risk high high up theup thelist. list. Concerns Concerns on thison thisfront front are arenow now easing easing as as tighteningtightening marketsmarkets re-price re-price credit credit risk risk to more to more relaxed relaxed levels, levels, and andspreads spreads begin begin to narrow. to narrow. The The ‘too‘too fast’ fast’ focusfocus of concern of concern has hasshifted shifted to whether to whether the thenew new spreads spreads accurately accurately reflect reflect the thelevel level of riskof risk in the in the system, system, or whether or whether their their seeming seeming return return to normality to normality is but is but another another symptomsymptom of unfounded of unfounded optimism optimism in the in thefinancial financial sector. sector.
ManyMany respondents respondents noted noted an improvementan improvement in the in thecredit credit default default swaps swaps market market where where differentdifferent types types of credit of credit risk risk are arepriced. priced. One One of them of them said said that that “a major “a major re-evaluation re-evaluation of creditof credit risks risks has hasnow now been been factored factored in”. in”. But Butgenerally generally the theresponses responses contained contained a a notenote of caution. of caution. A European A European regulator regulator said said that that “a reversal “a reversal of the of the credit credit spreads spreads decreasedecrease we weare arecurrently currently witnessing” witnessing” was was a “likely a “likely market market risk”. risk”. A German A German bank bank adviseradviser thought thought that that “spreads “spreads are aretightening tightening very very fast, fast, and andmay may start, start, once once again, again, not not to reflectto reflect the thecorrect correct balance balance between between risk risk and andreward”. reward”.
10.10. Equities Equities (7) (7)
EquitiesEquities have have slipped slipped down down the therisk risk scale, scale, possibly possibly because because they they have have come come back back so so stronglystrongly since since the thelast lastBanana Banana Skins Skins survey survey when when they they had hadcrashed. crashed. But Butthe therecovery recovery is fuellingis fuelling a fresh a fresh set setof concerns of concerns around around the the sustainability sustainability of the of the rally, rally, and and what what wouldwould happen happen if there if there was was another another crash. crash.
ManyMany respondents respondents commented commented on onthe the irrationality irrationality of markets. of markets. “If “If only only someone someone couldcould explain explain why why equities equities are arebehaving behaving as they as they are” are” moaned moaned a UK a UKconsultant. consultant. The The headhead of group of group risk risk at a atUK a UKfinancial financial group group said said that that “equity “equity markets markets could could have have run run too toofar aheadfar ahead if there if there are arenegative negative earnings earnings surprises”. surprises”.
TheThe consequences consequences of anotherof another crash crash would would be besevere severe for for the the “real “real economy”, economy”, probablyprobably plunging plunging it back it back into into recession recession and andlanding landing the thebanks banks with with further further heavy heavy losses,losses, and and dashing dashing their their recapitalisation recapitalisation plans. plans. One One respondent respondent pointed pointed out out that that equitiesequities were were important important not not just just as a as source a source of earnings of earnings and and capital capital “but “but as a as a bellwetherbellwether of confidence” of confidence” in a in crisis a crisis that that was was essentially essentially about about confidence. confidence.
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11.11. Currencies Currencies (13) (13)
TheThe currency currency markets markets are are expected expected to remain to remain volatile volatile over over the the recovery recovery period period becausebecause of the of thesharp sharp rise risein government in government borrowing borrowing and andthe thepossibility possibility of big of biginterest interest raterate movements movements in the in thenext next year year or two.or two. One One respondent respondent said: said: “The “The market market is very is very FocusFocus on on the the volatilevolatile and andsubject subject to shifts to shifts in reaction in reaction to statements to statements by seniorby senior financial financial officials”. officials”. volatilevolatile TheThe focus focus is particularly is particularly on theon theUS USwith with its trillionits trillion dollar dollar debts, debts, but butalso also on otheron other USUS dollar dollar vulnerablevulnerable countries countries such such the theUK UKas wellas well as theas theBaltic Baltic states states whose whose currencies currencies are are peggedpegged to the to theeuro, euro, but butcould could snap, snap, plunging plunging the theregion region into into economic economic chaos. chaos.
QuestionQuestion marks marks also also hang hang over over the the US US dollar dollar in the in the longer longer term term with with mounting mounting speculationspeculation that that it could it could be be toppled toppled from from its its reserve reserve currency currency throne. throne. Many Many respondentsrespondents focused focused on theon thepossibility possibility that that sentiment sentiment might might finally finally crack, crack, leading leading to to the the dollar’s dollar’s collapse collapse and and a major a major shift shift in the in the world’s world’s reserves. reserves. A bank A bank supervisor supervisor sawsaw “possible “possible market market upheaval upheaval as the as the dollar dollar becomes becomes less less important important as a as reserve a reserve currency”.currency”. China, China, with with its massiveits massive holdings holdings of dollars,of dollars, is seen is seen as playingas playing a central a central rolerole in any in anyscenario scenario that that develops. develops.
But Buta number a number of respondentsof respondents were were more more sanguine sanguine about about currency currency risk. risk. “I think “I think we we havehave learned learned to live to live with with currency currency movements” movements” said said one onebanker. banker. Another Another described described the the collapse collapse of the of the dollar dollar as “a as low “a low probability probability high high impact impact event”. event”. A third A third said said “sensible“sensible hedging hedging helps”. helps”.
12.12. Corporate Corporate governance governance (16) (16)
ThisThis Banana Banana Skin Skin shows shows a strong a strong rise rise since since the the last last survey, survey, reflecting reflecting mounting mounting concernconcern about about the the quality quality of governance of governance within within banks. banks. No No surprise, surprise, perhaps, perhaps, that that non-bankersnon-bankers and andregulators regulators saw saw it as it a as greater a greater risk risk than than bankers. bankers. It was It was also also seen seen to to be morebe more of an of issue an issue in America in America than than in Europe in Europe or the or theAsia Asia Pacific Pacific region. region.
TheThe perceived perceived failings failings of corporate of corporate governance governance are are many. many. Here Here is a is selection a selection of of quotes:quotes:
ThereThere is “a is lack“a lack of realismof realism in recognising in recognising that that the thecauses causes of problemsof problems lie withinlie within organisations organisations (as (asopposed opposed to pointing to pointing at external at external factors)”. factors)”. – – ScepticismScepticism about about ManagingManaging director, director, US USbank. bank.
thethe prospects prospects TheThe risk risk lies liesin “the in “the failure failure of chief of chief executives executives to serve to serve the theinterests interests of of forfor better better theirtheir depositors depositors and andcustomers customers rather rather than than their their own own (in particular)(in particular) and and governancegovernance theirtheir shareholders' shareholders' short short term term interests”. interests”. – London – London trust trust company. company.
ThereThere is concernis concern about about “the “the static static and and self-preserving self-preserving ‘buddy ‘buddy networks’networks’ in high in high management management that that will will perpetuate perpetuate incompetence, incompetence, hide hide deficiencies,deficiencies, and andleave leave urgent urgent issue”. issue”. – Bank – Bank director, director, Luxembourg. Luxembourg.
“Boards“Boards are are still still underpopulated underpopulated with with serious serious experts, experts, and and thus thus too too subservientsubservient to management.” to management.” – Economist, – Economist, New New York. York.
WillWill things things get getbetter? better? The The responses responses here here were were notable notable for fortheir their scepticism, scepticism, even even theirtheir cynicism cynicism about about the the corporate corporate governance governance debate. debate. Doubts Doubts that that much much would would changechange centred centred on banks’on banks’ seeming seeming reluctance reluctance or inability or inability to pick to pick up theup thelessons lessons from from the thecrisis. crisis. A senior A senior Swiss Swiss banker banker said: said: “Firms’ “Firms’ governance governance mechanisms mechanisms and andcultures cultures
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need to fully embed the lessons from the past 18 months. Many will struggle to do this”.
Another concern was the lack of high calibre non-executive directors. Dennis Cox of bank consultancy and training firm Risk Reward, said that “the expectations of management and especially non-executive management is a major concern, and we doubt whether there is the talent required to meet these revised obligations”. Another respondent put it more bluntly: “Reforms will happen – but who in their right mind would want to be a bank NED?”
But many respondents also felt that the corporate governance debate was on the wrong track. The risk was that more regulation would weaken the sense of responsibility of bank managements and directors, and that the answer lay in “removing the interference of governments and politics in management”.
Trust
The damage done by the crisis to confidence in banks could be a major source of risk, and banks will have to work hard to repair it. This was a recurring theme in the responses to this survey.
A fund manager said that “the fall in confidence by the public, investors and governments has damaged credibility in the sustainability of the system. Redressing this will take years, limiting the ability of a number of banks to regain capital strength and develop.”
Adrian Lloyd, enforcement and regulatory affairs director at the UK’s Banking Code Standards Board, said that “confidence in banks in Europe and the USA remains fragile at best. Informed depositors are willing to leave savings in banks and mutuals only where they are secured by government-backed deposit protection schemes or by government guarantees, whether explicit or implicit ('too big to fail').”
Several respondents raised the possibility of more bank failures, particularly where governments can no longer afford to bail them out. A UK respondent asked: “If there is another significant bank that fails during this recovery process, what would the public and government reaction be? Has all the stress testing dealt with this issue?”
Mistrust is not just about the soundness of banks but about the quality of their accounts. Many respondents felt that “accounting fudges” were being used to conceal the worst of bank exposures, and that sophisticated trading techniques were being deployed to move risk out of sight. A US banker feared that “financial- economic pressures may lead to 'creative' accounting practices becoming more widespread”.
13. Commodities (12)
Concern about the risks in commodity markets has changed little during the course of the crisis. They are still seen as volatile and unpredictable, with oil and gold heading the list, and China’s voracious appetite and US energy profligacy the causes. Concern about this risk was strongest in the Asia Pacific region (No. 6).
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RespondentsRespondents made made the thepoint point that that commodity commodity volatility volatility should should not notpose pose a major a major risk risk to banksto banks because because these these markets markets are arewell well understood, understood, and andthere there are areplenty plenty of waysof ways banksbanks can canprotect protect themselves themselves against against them. them.
In someIn some ways ways the thegreater greater risks risks lie inlie the in thepolitical political consequences: consequences: what what will will unstable unstable oil dooil todo the to theMiddle Middle East East and andRussia, Russia, how how will will China China react react if it ifcannot it cannot gain gain access access to to the theresources resources it needs? it needs?
“Still“Still volatile volatile – and – andstill still prone prone to over-reaction”, to over-reaction”, said said one onerespondent. respondent.
14.14. Interest Interest rates rates (9) (9)
ConcernConcern about about interest interest rates rates has has eased eased – at – least at least for forthe the time time being. being. The The medium medium termterm outlook outlook (up (upto ato year?) a year?) is for is forlow low and andrelatively relatively stable stable interest interest rates. rates. The The fun fun comescomes later, later, when when central central banks banks have have to extricate to extricate themselves themselves from from the themarkets markets and and governmentsgovernments begin begin to address to address their their mounting mounting debts. debts. At thatAt that point, point, inflation inflation may may also also beginbegin to rear to rear its ugly its ugly head, head, and anda rise a risein rates in rates looks looks inevitable. inevitable. A surgeA surge in ininterest interest ratesrates is isinevitable, inevitable, But But while while the the rate rate outlook outlook is alarming, is alarming, it is it also is also to some to some extent extent predictable. predictable. One One butbut also also respondentrespondent asked: asked: “What “What happens happens when when the the'punch 'punch bowl' bowl' is removed. is removed. Will Will we havewe have a a seriesseries of rate of rate rises rises similar similar to 1994?” to 1994?” predictablepredictable TheThe impact impact could could be severe. be severe. Michael Michael Taylor, Taylor, adviser adviser to the to theCentral Central Bank Bank of Bahrain, of Bahrain, warnedwarned that that changes changes in interest in interest rates rates would would hit assethit asset values values and andbond bond prices. prices. “So “So far far the the extraordinary extraordinary measures measures have have worked worked in the in the sense sense that that they they have have averted averted somethingsomething far far worse, worse, but but have have we we therebythereby already already laid laid the thefoundations foundations for for TheTh cea ucatiuotnio fna cftaocrt or the thenext next crisis?” crisis?” The Thebiggest biggest problem problem now now is the is the RisingRising rates rates would would put put a strain a strain on on combinationcombination of the of followingthe following factors factors borrowersborrowers and and produce produce a surge a surge in bad in bad distractingdistracting management management from from doing doing their their debts.debts. A shiftA shift in the in the yield yield curve curve could could job: job:government government regulation regulation in the in widestthe widest alsoalso cause cause problems. problems. John John Grout, Grout, sense;sense; fear fear of repeating of repeating the themistakes mistakes of of the past;the past; uncertainty uncertainty about about the abilitythe ability of of policypolicy and and technical technical director director at theat the counterpartiescounterparties to stay to stay solvent; solvent; AssociationAssociation of ofCorporate Corporate Treasurers, Treasurers, uncertaintyuncertainty about about central central bank bank policy; policy; saidsaid that that “big “big movements movements up mustup must be be impactimpact of central of central bank bank policies policies on the on the expectedexpected at some at some point. point. The The biggest biggest futurefuture value value of currencies, of currencies, and andon the on re-the re- riskrisk for for banks banks is a is flattening a flattening of theof the emergenceemergence of inflation; of inflation; uncertainty uncertainty yieldyield curve”. curve”. aboutabout the theinevitability inevitability of the of latterthe latter and and the timingthe timing thereof. thereof. Meanwhile,Meanwhile, low low interest interest rates rates can canbring bring All theseAll these lead lead to excessive to excessive caution, caution, problemsproblems of of their their own. own. Some Some inhibitinginhibiting the extendingthe extending of credit of credit to the to the respondentsrespondents saw saw them them providing providing a spur a spur productiveproductive sector, sector, and andcorrespondingly correspondingly to greaterto greater risk-taking risk-taking to earn to earn profits. profits. the theincreasing increasing risk riskof mispricing of mispricing of asset of asset ConsultantConsultant Paul Paul Hattori Hattori said said that that “long “long values.values. termterm interest interest rates rates at low at low levels levels will will onlyonly encourage encourage investors investors to do to domore more City Ccihtya irchmaairnm an stupidstupid things things in search in search of yieldof yield as theyas they comecome to believe to believe the theworst worst is over”. is over”. They They also also squeeze squeeze profitability. profitability. A Luxembourg A Luxembourg bankerbanker feared feared that that “the “the negative negative impact impact to the to theP&L P&L of theof thebanks banks may may occur occur before before balancebalance sheets sheets are are restored restored from from the the impact impact of the of the current current crisis”. crisis”. A divisional A divisional directordirector of one of one of the of the large large UK UK building building societies societies was was concerned concerned about about “ongoing “ongoing supersuper low low interest interest rates rates which which suppress suppress margins”. margins”.
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15.15. Fraud Fraud (11) (11)
OneOne reason reason why why fraud fraud has has slipped slipped down down the the ranking ranking is that is that there there have have been been few few recentrecent headline-grabbing headline-grabbing cases. cases. In fact,In fact, many many respondents respondents commented commented on on the the surprisingsurprising scarcity scarcity of frauds of frauds during during a time a time of recession, of recession, which which is usually is usually when when they they comecome to light, to light, Madoff Madoff being being a case a case in point, in point, though though that that was was not notexactly exactly bank bank fraud. fraud. TheThe incidence incidence of fraud of fraud “has “has not notyet yetrisen risen by asby much as much as one as onewould would expect expect given given the the statestate of the of thetide,” tide,” said said one onerespondent. respondent. “I am “I amconvinced convinced more more serious serious frauds frauds will will be be exposedexposed before before economic economic recovery recovery arrives,” arrives,” said said another. another.
TheThe main main variation variation in this in thisrisk risk was was geographical: geographical: it scored it scored higher higher in the in theAsia Asia Pacific Pacific regionregion (No. (No. 10) 10)and andamong among emerging emerging economies economies (No. (No. 6). 6).
TheThe concern concern is both is both about about internal internal and and external external fraud fraud as systems as systems become become more more complexcomplex and andvulnerable. vulnerable. Advances Advances in electronic in electronic technology technology are arealways always widening widening the the scopescope for for intrusion intrusion and and data data manipulation, manipulation, according according to Topi to Topi Manner, Manner, executive executive vice-presidentvice-president at Nordeaat Nordea Bank Bank in inFinland. Finland. A RussianA Russian respondent respondent said said that that informationinformation security security was was probably probably the the greatest greatest risk risk that that Russian Russian banks banks faced faced over over the thenext next 2-3 2-3years. years.
A concernA concern among among banking banking respondents respondents was was the theeffect effect that that a big a bigbank bank fraud fraud might might havehave on bankingon banking confidence confidence at a attime a time when when the thesystem system is so is fragile. so fragile. The The head head of of regulatoryregulatory strategy strategy at a at large a large US US bank bank said said that that “fraud “fraud may may undermine undermine investor investor confidenceconfidence resulting resulting in excessive in excessive caution”. caution”.
16.16. Management Management incentives incentives (17) (17)
TheThe row row over over bonuses bonuses and andincentives incentives has haspushed pushed this thisBanana Banana Skin Skin up aup place. a place. But But whatwhat is theis the risk: risk: that that perverse perverse incentives incentives will will destroy destroy banks, banks, or orthat that new new regulation/taxregulation/tax will will kill killthe thegolden golden goose? goose? Respondents Respondents were were sharply sharply divided divided on thison this WhatWhat is isworse: worse: question.question. payingpaying bonuses bonuses or or Non-bankersNon-bankers tended tended towards towards the thefirst first of these of these views. views. The The bonus bonus culture culture was was not notonly only banningbanning them? them? out out of control of control but but dangerous: dangerous: it was it was creating creating the the wrong wrong incentives, incentives, and and dulling dulling bankers’bankers’ sense sense of risk. of risk. Moreover, Moreover, banks banks were were failing failing to take to take on boardon board that that something something neededneeded to be to donebe done about about it. Martin it. Martin Hall, Hall, a non-executive a non-executive director director of Broadcastle of Broadcastle Bank,Bank, said said that that “banks “banks do notdo not appear appear to have to have got got the the message message and and are are likely likely to to remainremain in thein thepolitical political doghouse”. doghouse”. A London A London consultant consultant said said that that the thesituation situation was was “gradually“gradually improving improving – but – but the the need need for for reform reform is not is not yet yet fully fully ‘owned’ ‘owned’ by theby the firms”.firms”. A banker A banker added added that that “perverse “perverse incentives incentives (not (not necessarily necessarily the the level level of of incentives)incentives) are are the the core core of our of our industry's industry's problems, problems, at all at all levels levels of significant of significant managementmanagement and andrisk risk taking. taking. These These have have not notbeen been solved”. solved”.
TheThe opposing opposing view view holds holds that that remuneration remuneration should should not notbe abe political a political issue, issue, and andthat that attemptsattempts to regulate to regulate it could it could end endup damagingup damaging the thebusiness, business, specially specially if it ifis it done is done on on a country-by-countrya country-by-country basis basis rather rather than than through through international international agreement. agreement. A London A London investmentinvestment banker banker asked: asked: “Will “Will remuneration remuneration be sortedbe sorted out outon aon level a level playing playing field field basisbasis so that so that there there is not is not a run a run on talenton talent to other to other markets, markets, leaving leaving some some markets markets vulnerablevulnerable to a to shortage a shortage of talent,of talent, leading leading to decline to decline in market in market position?” position?” This This was was not notmerely merely an Anglo-Saxonan Anglo-Saxon preoccupation. preoccupation. A German A German bank bank respondent respondent warned warned that that tax taxand andregulatory regulatory interference interference in bonuses in bonuses “could “could lead lead to a to deterioration a deterioration in morale”. in morale”.
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A USA US bank bank risk risk manager manager even even argued argued that, that, with with banks banks now now holding holding billions billions of of dollarsdollars of taxpayers’ of taxpayers’ money, money, it was it was in the in the public public interest interest to have to have compensation compensation schemesschemes that that attracted attracted the thebest best talent talent to manage to manage it. “If it. these“If these firms firms are arenot notpermitted permitted to payto paycompetitively, competitively, we wewill will find find that that those those who who remain remain in employment in employment there there will will not not be the be the brightest brightest and and best, best, and and hence hence not not the the best best stewards stewards to turn to turn these these firms firms aroundaround and andreturn return the thegovernment/taxpayers government/taxpayers funds.” funds.”
But Butothers others felt feltthe thesteam steam was was going going out outof the of theissue. issue. A regulator A regulator said said that that there there was was “more“more awareness awareness and and concern concern about about perverse perverse incentives, incentives, hence hence a lowering a lowering of the of the riskrisk level”. level”. A Swiss A Swiss banker banker saw saw this thisrisk risk “falling “falling due dueto compensation to compensation rules”. rules”.
17.17. Emerging Emerging markets markets (18) (18)
AreAre emerging emerging markets markets a risky a risky bet betor, inor, today’s in today’s environment, environment, a better a better prospect prospect than than the thedeveloped developed world? world?
Clearly,Clearly, it is it hard is hard to generalise, to generalise, but but the the tone tone of many of many responses responses was was cautious. cautious. ConcernConcern about about the themacro-economic macro-economic outlook outlook was was stronger stronger among among respondents respondents from from emergingemerging countries countries (No. (No. 3) than3) than industrial industrial countries countries (No. (No. 5), mainly5), mainly because because of theof the dangersdangers over-hasty over-hasty recovery recovery producing producing asset asset bubbles.. bubbles.. There There was was “overconfidence “overconfidence in in the thesafety safety of emerging of emerging markets”, markets”, according according to Sheila to Sheila Page, Page, senior senior research research associate associate at theat theUK’s UK’s Overseas Overseas Development Development Institute. Institute. “Vulnerabilities “Vulnerabilities remain”, remain”, according according to to the thedirector director of risk of risk management management at one at oneof the of thelarge large regional regional development development banks. banks.
SomeSome of theof thecaution caution has hasto do to withdo with uncertainty uncertainty over over China’s China’s prospects, prospects, the theopaque opaque A betterA better prospect, prospect, politicalpolitical situation situation in Russia, in Russia, and and the the growing growing assertiveness assertiveness of leaders of leaders in Latin in Latin or ora riskya risky bet? bet? America.America. Ioannis Ioannis Gousios, Gousios, director director of bankingof banking supervision supervision at theat theBank Bank of Greece,of Greece, waswas particularly particularly concerned concerned about about emerging emerging European European economies economies where, where, he said,he said, therethere was was a risk a risk that that “loans “loans that that were were restructured restructured to avoid to avoid default default become become non- non- performingperforming anyway, anyway, that that collateral collateral pledged pledged proves proves to be to worthbe worth less less than than initially initially thoughtthought and and that that rising rising unemployment unemployment and and corporate corporate insolvencies insolvencies in the in the region region createcreate more more bad baddebts”. debts”. The The chief chief risk risk officer officer at a at bank a bank in Indiain India said said there there was was “a “a generalgeneral perception perception that that the the country country is either is either fairly fairly immune immune to economic to economic activity activity elsewhere,elsewhere, or is or already is already benefiting benefiting from from an economican economic recovery, recovery, both both of which of which points points of viewof view might might be over-optimistic”. be over-optimistic”.
But But other other respondents respondents were were more more upbeat. upbeat. James James Prichard, Prichard, an emergingan emerging markets markets tradertrader at WestLB at WestLB in London, in London, said said that that worries worries about about emerging emerging market market exposure exposure meantmeant that that “many “many banks banks are arepulling pulling back, back, leaving leaving just justa few a few players players to benefit”. to benefit”.
18.18. High High dependence dependence on on technology technology (15) (15)
TheThe high high dependence dependence on technologyon technology that that banks banks have have built built up overup over the theyears years is no is no longerlonger the thecritical critical issue issue that that it once it once was was (this (this Banana Banana Skin Skin was was consistently consistently in thein the TopTop Ten Ten in earlier in earlier times times – see – psee ??). page The 10). problems The problems are better are understood, better understood, the pace the of changepace of has change slowed, has andslowed, in some and areasin some such areas as the such customer as the customer interface interfaceit has even it has beeneven pushed been back pushed a bit back with a the bit drivewith theto deliver drive to a delivermore personalised a more personalised service. service.
But But issues issues remain. remain. This This was was ranked ranked a Top a Top Ten Ten risk risk in the in the Asia Asia Pacific Pacific region, region, particularlyparticularly among among emerging emerging economies. economies. The The chief chief executive executive of an of Indianan Indian bank bank said said thatthat “operational “operational and andreputational reputational risks risks from from increasing increasing dependence dependence on technologyon technology and andpayment payment systems systems are areamong among the therisks risks that that banks banks face face currently.” currently.”
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BoBttootmto mlin elin weo wrroierrsies
Ultimately,Ultimately, all Banana all Banana Skins Skins are arerisks risks to the to thebottom bottom line. line. Here Here is a isselection a selection commentscomments on that on that theme. theme.
The Theprospects prospects for bankingfor banking profitability profitability are arenot notgreat, great, thanks thanks to a toraft a raftof factors of factors includingincluding general general economic economic weakness, weakness, low lowinterest interest rates, rates, political political pressure pressure on on banksbanks to engage to engage in low-profit in low-profit activities activities for thefor goodthe good of the of theeconomy, economy, and andtighter tighter regulatoryregulatory constraints. constraints. ExecEuxteivceu tdiviree dctiroerc, tboarn, kbianngk tirnagd ter agdroeu gpr oup
ThereThere must must be concern be concern about about whether whether financial financial services services firms firms will bewill able be able to to generategenerate sufficient sufficient profit profit to remain to remain viable. viable. ChieCf heixeef ceuxteivceu,t iUvKe, bUuKil dbiunigld sinogc iseotyc iety
LackLack of profitability of profitability is going is going to be to a be drain a drain on the on thevitality vitality of the of systemthe system going going forward, forward, all theall themore more so in so Europe in Europe if leverage if leverage is capped is capped with with relatively relatively little little regard regard for thefor the qualityquality of what of what is being is being leveraged. leveraged. CredCirt esdtrita stetrgaistet,g misut,l tminualtionnaatilo dneavl edleovpemloepnmt ebnatn kb ank
HighHigh capital capital requirements requirements will reducewill reduce retu return onrn equity, on equity, which which will leadwill lead to lower to lower equityequity prices prices and andmore more problems problems raising raising new new capital. capital. BoaBrdo amredm mbeemr,b Geer,r mGearnm baann kbank
TheThe management management of online of online systems systems is a isbig a bigproblem, problem, as isas data is data security. security. A Russian A Russian respondentrespondent said said that that “as “asinternet internet banking banking develops, develops, attacks attacks on clienton client bank bank accounts accounts willwill increase”. increase”. The The upcoming upcoming migration migration of Over-the-Counterof Over-the-Counter derivatives derivatives to public to public exchangesexchanges will will increase increase technology technology risk, risk, according according to one to one respondent. respondent. New New York York economisteconomist Roger Roger Kubarych Kubarych said said that that firms firms and and regulators regulators take take for for granted granted that that informationinformation technology technology is well is well run. run. “What “What if it ifisn't? it isn't? It has It hasbeen been starved starved of resources of resources in manyin many financial financial institutions institutions for short-sighted,for short-sighted, near-term near-term budgetary budgetary concerns.” concerns.”
ConsultantConsultant Steve Steve Dyson Dyson said said that that “the “the sector sector needs needs to invest to invest a huge a huge amount amount in new in new technologytechnology to keepto keep pace pace with with the themonitoring monitoring and andmanagement management of risk.of risk. This, This, allied allied withwith the the need need to invest to invest in upgrading/replacing in upgrading/replacing legacy legacy systems, systems, will will place place a huge a huge burdenburden on budgetson budgets over over the thenext next 2-3 2-3years”. years”.
SomeSome respondents respondents made made the the point point that that risk risk not not only only lies lies with with the the systems systems but but in in managingmanaging – and – andretaining retaining – the – thepeople people who who run runthem them and andunderstand understand them. them. A banker A banker in Luxembourgin Luxembourg said said banks banks depended depended “on “onparticular particular individuals individuals with with a monopoly”. a monopoly”.
19.19. Hedge Hedge funds funds (10) (10)
A dramaticA dramatic drop drop in concernin concern here, here, in linein line with with the thegenerally generally lower lower profile profile taken taken by by hedgehedge funds funds during during the thecrisis. crisis.
A sharpA sharp drop drop in in TheThe funds funds are are not not attracting attracting the the level level of attention of attention they they did did earlier earlier through through their their aggressiveaggressive position position taking, taking, short short selling selling and andshareholder shareholder activism. activism. Some Some respondents respondents concernconcern about about pointedpointed out out that thatthey they were were actually actually better better managed managed than than banks. banks. Regulatory Regulatory moves moves hedgehedge funds funds are arealso also afoot afoot to put to putthem them on aon shorter a shorter leash. leash. “The “The once once dominant dominant sector sector is no is longerno longer in charge.in charge. Real Real money money investors investors make make longer longer term term decisions decisions with with their their own own money”, money”, saidsaid one onerespondent. respondent.
But But the the funds funds are are still still making making their their presence presence felt. felt. An An investment investment banker banker said said that that whilewhile hedge hedge funds funds “are “are not not now now a concern a concern with with respect respect to driving to driving up leverageup leverage in in
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buy-outs etc., they are making work-outs more volatile/uncertain as they are purchasing distressed debt at significant discounts and acting with a very different agenda to banks within work-outs”. Many respondents said that banks’ exposure to hedge funds needed to be “well-managed”.
Referring to regulatory initiatives in this area, one respondent said that “at present there is more risk to the funds than from them”. However some respondents feared that tougher controls would merely drive the sector to less well regulated centres. “Many hedge funds will relocate outside the EU”, said one. In Hong Kong, Paul Lejot of the Asian Institute of International Financial Law said that “a loss of business is likely from the regulated sector”.
20. Rogue trader (14)
This Banana Skin goes up and down in line with recent history. The last survey (in 2008) followed the discovery of Jérôme Kerviel’s massive fraud at Société Générale. Since then, there have been no major incidents, and so the risk of rogue trading is seen to have eased.
The question is whether the pressures of recession make a rogue trader more likely. The answer seems to be yes. A regulator said: “The risk is always there. They tend to be discovered in falling markets.”
A consultant observed that there are “fewer traders. But those that are left may be under more pressure to save their jobs (which is a more powerful encouragement to fraud than getting a bonus)”. Since major incidents tend to occur every 3-4 years, the time for another one must be approaching.
21. Business continuation (23)
Little change in the perceived risk here: the Banana Skin that shot high up the list in the wake of 9/11 has eased off sharply.
Although terrorist attacks continue to earn mentions as potential sources of risk, pandemics such as swine ‘flu are there too, as are crashes in the system.
However, the broader feeling is that banks have put a lot of work into this area, and are less vulnerable, though this could also lead to complacency. “Some danger of this falling off the radar”, said one consultant.
22. Retail sales practices (20)
The mistreatment of retail clients continues to be a source of risk to banks, even though the worst of the mis-selling abuses may now be behind us. Some of the risk is of a reputational kind, some financial. In the words of a Canadian banker, the risk is “over-promising in a competitive market fuelled by bonus objectives”. New regulation proposed through initiatives like the FSA’s Retail Distribution Review to separate the sales and advice functions in financial products should help contain some of this risk, though some respondents felt that mis-selling is now so deeply ingrained in banks that they will have trouble adjusting. Regulation will be “a huge shock” said one UK respondent.
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ThereThere is also is also the thewider wider question question of how of how the thecrisis crisis will will affect affect banking banking relationships relationships at at the theretail retail end. end. Some Some respondents respondents feared feared that that it may it may aggravate aggravate them them by forcingby forcing banks banks to passto pass on on the the costs costs of additional of additional regulation, regulation, and and to take to take a tougher a tougher line line with with delinquentdelinquent customers. customers. There There is also is also the theopposite opposite risk: risk: that that bank bank customers, customers, having having beenbeen rescued rescued from from the thebanks’ banks’ mistakes, mistakes, will will start start “mistreating” “mistreating” the thebanks. banks. A group A group strategiststrategist at one at oneof theof thelarge large UK UKbanks banks foresaw foresaw “a further“a further erosion erosion of anyof anysense sense of of personalpersonal responsibility responsibility by consumers”.by consumers”.
RichardRichard Higham Higham of ofsales sales training training consultancy consultancy Mercuri Mercuri International International said said the the objectiveobjective for forbanks banks should should be tobe make to make their their sales sales and andrisk risk cultures cultures more more consistent. consistent. ThisThis would would help help them them “retain “retain good good customers customers who who feel feel abused abused by theirby their treatment treatment overover the thepast past year”. year”.
23.23. Conflicts Conflicts of of interest interest (21) (21)
ThisThis is one is one of those of those Banana Banana Skins Skins (like (like corporate corporate governance governance and and management management incentives)incentives) on onwhich which bankers bankers and and non-bankers non-bankers take take sharply sharply different different views, views, for for fairlyfairly obvious obvious reasons. reasons. The The bankers bankers think think they they understand understand the therisk risk and andplay play it down, it down, the thenon-bankers non-bankers think think the thebankers bankers are areignoring ignoring it, wilfully it, wilfully or otherwise. or otherwise. ConflictsConflicts are are becomingbecoming more more TheThe risk risk is that is that banks banks will will damage damage confidence confidence by placingby placing their their own own interests interests above above thosethose of their of their clients, clients, a risk a risk that that has hasgrown grown with with the theemergence emergence of “universal of “universal banks” banks” complicatedcomplicated combiningcombining many many different different functions. functions. The The bankers’ bankers’ viewpoint viewpoint was was summed summed up byup aby a respondentrespondent from from a Channel a Channel Islands Islands bank: bank: “This “This is always is always an issue,an issue, but butwell well managed managed in ourin our business”. business”. Others Others said said that that the the perception perception of conflicts, of conflicts, if not if not the the conflicts conflicts themselves,themselves, was was rising. rising.
But Butwith with the theintrusion intrusion of state of state ownership ownership during during the thecrisis, crisis, these these conflicts conflicts have have also also becomebecome more more complex. complex. Who Who are are bankers bankers now now supposed supposed to beto beserving: serving: their their customers,customers, their their shareholders shareholders or theor the taxpayers? taxpayers? One One respondent respondent saw saw the the risk risk increasingincreasing “as “as the theoligopoly oligopoly shrinks shrinks and andgovernments governments get getmore more entwined entwined with with the the financialfinancial services services industry”. industry”.
HoweverHowever a number a number of respondents of respondents felt felt that that banks banks and and regulators regulators were were addressing addressing thesethese conflicts conflicts and andreducing reducing the thescale scale of the of therisk. risk.
24.24. Back Back office office (19) (19)
TheThe risks risks in the in the back back office office usually usually arise arise because because of cost of cost cutting. cutting. Many Many of our of our respondentsrespondents said said that that back back office office budgets budgets had had been been trimmed trimmed as part as part of recession- of recession- drivendriven cutbacks, cutbacks, and andthat that these these were were false false savings. savings. Even Even though though business business volumes volumes are are down, down, the the complexity complexity of the of the current current environment environment – plus – plus panics panics and and failures failures – – meansmeans that that banks banks need need to haveto have very very robust robust back back offices. offices. It is It not is notonly only a matter a matter of of processingprocessing business, business, but but documenting documenting collateral collateral and and guarantees, guarantees, tracking tracking defaults defaults and andensuring ensuring contract contract enforceability. enforceability.
“Cost“Cost cutting cutting and and consolidation consolidation strains strains are are impacting impacting the the ability ability [of [of banks] banks] to to strengthenstrengthen processes processes and andcontrols controls around around new new product product offerings offerings at a attime a time when when they they are are already already struggling struggling to provideto provide an anadequate adequate service service for for existing existing clients clients for for products”,products”, said said a London a London investment investment manager. manager.
CSFI / New York CSFI E-mail: [email protected] Web: www.csfi.org.uk 27 C S F I / New York CSFI
On Onthe theother other hand, hand, much much work work has hasalso also been been done done to improveto improve this thisside side of banks’of banks’ operationsoperations through through greater greater automation automation and andthe theresolution resolution of specificof specific problems problems like like derivativesderivatives settlement. settlement. And And they they have have held held up wellup well in the in thecrisis. crisis. One One banker banker said said that that this this was was “always “always a risk a risk area, area, but but becoming becoming less less so with so with established established systems systems and and processes”.processes”.
A loomingA looming issue issue is how is how back back offices offices will will cope cope with with a growing a growing regulatory regulatory and and compliancecompliance workload. workload. A respondent A respondent from from a large a large Swiss Swiss bank bank said said that that “pressures “pressures on on backback offices offices seem seem to beto beeasing, easing, however however the the spectre spectre of newof new regulations regulations and and accountingaccounting standards standards will will add addnew new demands”. demands”. Looking Looking at the at thebudgetary budgetary implications implications of of this this workload, workload, another another Swiss Swiss banker banker admitted admitted to toa dilemma a dilemma over over “the “the implementationimplementation of regulations of regulations versus versus cost cost control control pressure”. pressure”.
25.25. Environmental Environmental risk risk (25) (25)
No No change change here here despite despite the the growing growing pressures pressures of climate of climate change change and and the the recent recent prominenceprominence of the of theCopenhagen Copenhagen Summit. Summit.
BankersBankers are arenot notknown known for givingfor giving a high a high ranking ranking to environmental to environmental risk. risk. The The highest highest positionposition this thisBanana Banana Skin Skin has hasreached reached in morein more than than 15 years15 years of surveysof surveys is No. is No. 25, 25, reflectingreflecting a belief a belief that that the therisk risk to profits to profits is political is political rather rather than than financial, financial, and andeven even wherewhere it is it financial, is financial, the theexposures exposures are arenot notcritical critical or near or near term. term.
At theAt the same same time, time, though, though, the the environment environment has has always always earned earned a high a high place place as a as a risingrising risk: risk: No. No. 10 this10 thisyear, year, on aon par a parwith with concern concern about about the theglobal global economy, economy, so it so is it is obviouslyobviously on theon theradar radar screen. screen.
ThisThis is a is risk a risk with with many many angles: angles: reputation, reputation, litigation litigation (banks (banks are are“deep “deep pockets”), pockets”), pollutionpollution liability, liability, cost cost and anddirect direct financial financial exposure. exposure. One One respondent respondent listed listed climate climate changechange as an as issuean issue that that could could complicate complicate the the economic economic recovery recovery and and make make life life difficultdifficult for banksfor banks as well. as well.
But But it was it was hard hard to ignoreto ignore a tone a tone of dismissiveness,of dismissiveness, even even impatience, impatience, in thein the responses.responses. “Overstated” “Overstated” was was one one comment. comment. “At “At the the moment, moment, who who cares?” cares?” was was another.another.
26.26. Payment Payment systems systems (27) (27)
LikeLike the the back back office, office, this this is an is area an area where where much much work work has has been been done done to improve to improve speedspeed and andreliability, reliability, notably notably the themove move to real-time to real-time payment payment and andsettlement settlement at both at both the thewholesale wholesale and andretail retail levels. levels. And And these these have have stood stood up wellup well during during the thecrisis. crisis. But But AnAn area area facing facing moremore could could always always be donebe done in what in what is, afteris, after all, all,“the “the key keyto financial to financial stability” stability” in the in the wordswords of one of onerespondent. respondent. competitioncompetition from from non-banksnon-banks OneOne risk risk that that was was mentioned mentioned was was that that banks banks may may not not make make the the most most of theof the investmentinvestment they they have have put put into into this this area. area. Payment Payment systems systems consultant consultant Nick Nick Collin Collin saidsaid that that “the “the piecemeal piecemeal deployment deployment of ofFaster Faster Payments Payments [the [the UK UK electronic electronic paymentspayments system] system] has hasmeant meant that that the thebanking banking industry industry has hasnot notmade made as much as much out outof of this this huge huge leap leap forward forward in near-real-time in near-real-time payments payments as they as they might might have have done, done, and and havehave so farso notfar notbeen been in a in position a position to build to build on theon therelatively relatively rich rich FPS FPS infrastructure infrastructure withwith added added value value applications". applications".
28 CSFI / New York CSFI E-mail: [email protected] Web: www.csfi.org.uk C S F I / New York CSFI
27.27. Money Money laundering laundering (24) (24)
OnceOnce high high on theon therisk risk agenda agenda (it was(it was No. No. 11 in11 2002), in 2002), this thisBanana Banana Skin Skin is slipping is slipping fast fastwith with the theeasing easing of concern.of concern. It has It hasto be to saidbe said that that bankers bankers have have never never taken taken this this riskrisk as seriously as seriously as non-bankers, as non-bankers, believing believing it to it be to “got be “got up” up” politically. politically. But But now, now, non-bankersnon-bankers too tooare areless less worried, worried, and andthis thisyear year they they put putit almost it almost at the at thevery very bottom bottom of theirof their list. list.
ManyMany of theof therespondents’ respondents’ comments comments focused focused on theon therisk risk of regulatoryof regulatory overkill, overkill, and and the thefact fact that that banks banks are aremore more vulnerable vulnerable to this to thisBanana Banana Skin Skin from from a reputational a reputational than than a financiala financial standpoint. standpoint. “There “There is plenty is plenty of regulation of regulation in place” in place” said said the thechairman chairman of a of a LondonLondon banking banking group. group.
But Butregulators regulators are arestill still focusing focusing on it.on One it. One said: said: “During “During a prudential a prudential crisis, crisis, this thisarea area getsgets less less attention, attention, hence hence it is it a is high a high risk.” risk.” A Russian A Russian banker banker said said there there was was a a temptationtemptation for for banks banks to turn to turn a blind a blind eye eye to money to money flows flows during during recession recession when when depositsdeposits and andprofits profits were were under under pressure. pressure.
28.28. Merger Merger mania mania (28) (28)
ThisThis may may not notbe thebe thetime time to embark to embark on aon major a major acquisition acquisition spree, spree, and andsome some of ourof our respondentsrespondents even even scoffed scoffed at the at theidea. idea. Many Many even even pointed pointed out outthat that the thetrend trend was was now now towardstowards demerger demerger as combinations as combinations forged forged in the in the heat heat of the of the crisis crisis had had to be to be unwoundunwound for competitionfor competition or other or other reasons. reasons.
But Butthere there is more is more to itto than it than that. that. The The banking banking system system will will clearly clearly have have to undergoto undergo somesome restructuring restructuring as theas thedust dust settles: settles: rationalisation, rationalisation, consolidation, consolidation, a shrinkage a shrinkage of of capacity,capacity, and andthis thisis bound is bound to requireto require deals deals to be to struck,be struck, with with the therisk risk that that some some of of themthem will will not notwork. work.
MergerMerger mania mania “could “could be inducedbe induced by theby thecrisis”, crisis”, said said a Swiss a Swiss banker. banker. It might It might even even be healthy.be healthy. A Luxembourg A Luxembourg banker banker said said that that “as “aslong long as theas theexcess excess capacity capacity in ourin our industryindustry is not is notreduced reduced and andmore more closely closely adapted adapted to client-driven to client-driven earnings earnings potential, potential, we willwe will see seecontinued continued risk-taking risk-taking drawing drawing upon upon market market volatile volatile earnings earnings sources”. sources”.
29.29. Too Too little little regulation regulation (29) (29)
TheThe persistently persistently low low position position of thisof thisBanana Banana Skin Skin over over the theyears years suggests suggests that that the the riskrisk in regulation in regulation is seen is seen to be to toobe toomuch much of it of rather it rather than than too toolittle. little. That That remains remains the the case,case, despite despite the theobvious obvious regulatory regulatory failures failures that that led ledto the to thecrisis. crisis. While While bankers bankers and and PlentyPlenty of of non-bankersnon-bankers put putthis thislow low on theiron their list, list, regulators regulators placed placed it higher, it higher, at No. at No. 21. 21. ‘blind‘blind spots’ spots’ Yet Yetthere there is a isvocal a vocal minority minority which which asserts asserts – with – with understandable understandable reasons reasons – that – that we we onon the the needneed more more regulation, regulation, or at or least at least better better regulation regulation which which often often amounts amounts to the to thesame same regulatoryregulatory map map thing.thing. A UK A UK banking banking consultant consultant who who has has responded responded to the to the CSFI’s CSFI’s Banana Banana Skins Skins surveysurvey for for many many years, years, had had the the following following to say: to say: “Yes, “Yes, there there will will be anbe over-an over- reaction,reaction, but butfrom from a starting a starting point point that that was was manifestly manifestly too toolow. low. Those Those who who listed listed [too [too muchmuch regulation] regulation] as the as thetop topBanana Banana Skin Skin in 2004-6, in 2004-6, just justas the as thebanking banking system system piled piled intointo toxic toxic assets assets funded funded by cheapby cheap wholesale wholesale money money and andwith with pressure pressure to show to show that that capitalcapital was was being being used used ‘economically’, ‘economically’, now now look look absurd. absurd. The The problem problem was was that that there there waswas too toomuch much regulation regulation in places, in places, but buttoo toolittle little of it of centred it centred on prudentialon prudential issues.” issues.”
CSFI / New York CSFI E-mail: [email protected] Web: www.csfi.org.uk 29 C S F I / New York CSFI
Other comments included: “More regulation will come and rightly so”, and “Only a banker would argue there's too much”. Many emphasised the need for better regulation (more professional, better informed), and for gaps to be plugged in a string of areas: disclosure, risk management, governance, international coordination, and specific functions such as derivatives, hedge funds and credit rating agencies.
A strong concern was that the regulatory reform effort would flag, leaving necessary work undone. One respondent feared that risky deal-making would get going again “before new regulations and controls can be introduced, together with a failure of regulators to agree on how to reduce moral hazard across the industry. This means that a second melt-down cannot yet be ruled out”. Canadian banking consultant John Pattison feared that governments “will not act to put in place appropriately tighter regulation in a number of areas. Financial institutions do not like some of these proposals but for the sector as a whole and institutions of all sizes they are desirable”.
A number of respondents wanted to see a split created between safe “utility banks” serving the high street, and “casino banks” dealing in markets. But they feared that this wouldn’t happen. Andrew Cornford, senior adviser to the Observatoire de la Finance, a Swiss think tank, said that “regulatory reform will concentrate on prudential and transactional problems revealed by the crisis, rather than on structural reforms, in particular the separation of traditional commercial and investment banking and insurance”.
London’s position at risk
A regulatory over-reaction could damage financial centres, particularly London.
The group corporate strategist of a large City-based institution said his concern was that “[FSA chairman Lord] Turner's thrashing of the banking sector will reduce London's position on the global stage to the detriment of the entire UK economy.”
Some also saw the City vulnerable to a crackdown from Brussels. A respondent from one of the large UK banks said that EU regulations would “force financial institutions outside the UK, either to become concentrated in the US and Caribbean, or increasing activity on continental Europe.” A specific concern is the EU’s proposal to regulate hedge funds and bonuses. A respondent said that “volume and expertise may be lost from London markets as hedge funds relocate to Zug thanks to EU rules, and traders move to avoid UK bonus rules.”
Antony Elliott, director of FairBanking in the UK, said that “clear thinking will be needed to separate the issue of safety for UK banks from that of allowing the City to flourish.”
30. Competition from new entrants (30)
Although this Banana Skin is at the bottom of the pile, it contains the important issue of how you stop banks becoming “too big to fail” and make markets more competitive.
Yes, there are new entrants: supermarket giant Tesco announced plans to step up its banking presence in the UK as this survey got under way, and at a different level, Chinese banks are emerging as a force on the world stage.
30 CSFI / New York CSFI E-mail: [email protected] Web: www.csfi.org.uk C S F I / New York CSFI
‘To‘oT osom samll atoll tsou rsviveurvi’ve’
The Thecrisis crisis has hasshown shown that that many many banks banks are aretoo bigtoo tobig fail. to fail.But Butthe theopposite opposite is also is also true. true. ManyMany respondents respondents felt thatfelt that one oneoutcome outcome will bewill a be loss a loss of banking of banking capacity, capacity, particularly particularly at theat thesmall small end endwhere where banks banks have have been been left toleft sink to sink or swim, or swim, and andwhere where survivors survivors now now faceface competition competition from from state-supported state-supported behemoths. behemoths. This This concern concern showed showed up in up many in many markets,markets, including including specialised specialised ones ones like likeLuxembourg Luxembourg where where small small banks banks feel feel particularlyparticularly threatened. threatened.
The Thechief chief executive executive of a ofLuxembourg a Luxembourg bank bank feared feared that that “many “many small small banks banks in the in the privateprivate banking banking business business will disappear…becawill disappear…because useclients clients will havewill have to go to to go safer to safer banks.banks. Small Small credit credit providers providers will alsowill also suffer suffer due dueto liquidity to liquidity issues. issues. These These trends trends will will encourageencourage consolidation consolidation from from which which big institutionsbig institutions will benefit”.will benefit”. In Australia, In Australia, a a respondentrespondent saw saw heavier heavier regulation regulation “causi “causing theng demisethe demise of marginal of marginal players”. players”.
NewNew regulatory regulatory costs costs will alsowill also fall heavilyfall heavily on small on small banks. banks. Antony Antony Thomlinson Thomlinson of City of City lawyerslawyers Eversheds Eversheds said said that that new new funding funding requirements requirements penalised penalised small small banks banks “to the“to the detrimentdetriment of competition of competition in the in thebanking banking sector”. sector”. David David Colvin, Colvin, executive executive director director of of JordanJordan International International Bank, Bank, said said there there was was a risk a riskthat that remedial remedial measures measures “will “will place place a a disproportionatedisproportionate burden burden on smaller on smaller banks banks and andfinancial financial institutions. institutions. The Thecounterpart counterpart to 'tooto 'toobig tobig fail' to fail'is 'too is 'toosmall small to survive' to survive' which which will bewill the be theresult result if the if thesins sins of the of themega- mega- banksbanks are arevisited visited on the on small”.the small”.
But But while while this this might might be abe good a good moment moment for for new new competitors competitors to launch to launch business business modelsmodels untainted untainted by bythe the crisis, crisis, respondents respondents doubted doubted that that they they would would have have the the stomachstomach for for it. “My it. “My concern concern is there is there will will not not be realbe real new new entrants,” entrants,” said said one. one. AnotherAnother said said bitterly: bitterly: “The “The real real issue issue is unfair is unfair competition competition from from state-owned state-owned businesses”.businesses”.
As As regulation regulation gets gets tighter, tighter, the the barriers barriers to entry to entry will will get get higher. higher. There There were were “few “few candidatescandidates for forentry entry – and – andthose those there there are arewill will find find it difficult it difficult to getto getestablished established in in the theface face of marketof market and andregulatory regulatory scepticism”, scepticism”, said said a respondent. a respondent. Another Another observed observed thatthat it was it was large, large, failed failed banks banks that that attracted attracted capital, capital, not notexciting exciting new new ones. ones.
Prof.Prof. Michael Michael Mainelli Mainelli of Z/Yenof Z/Yen Group Group said said the thekey keywas was not notto reformto reform regulation regulation but butto toughen to toughen up monopolyup monopoly rules rules to encourage to encourage more more small small banks banks that that were were not not“too “too big big to fail”. to fail”. He He said: said: “The “The debate debate should should be aboutbe about ‘open’ ‘open’ markets markets rather rather than than dogmasdogmas of ‘free’of ‘free’ or ‘regulated’or ‘regulated’ markets markets – breaking – breaking up upoligopolies, oligopolies, not not saving saving institutions.”institutions.” A US A US respondent respondent agreed, agreed, but but was was not not hopeful. hopeful. “It “Itwould would be a be very a very goodgood thing thing to make to make financial financial activity activity more more contestable. contestable. Smaller Smaller institutions, institutions, more more entryentry and andexit exit ... ahh ... ahhthat that would would be wonderful!” be wonderful!”
JonathanJonathan Howitt, Howitt, head head of group of group risk risk at Man at Man Group, Group, said said that that increased increased protectionism protectionism TheThe seeds seeds of ofthe the and andregulation regulation would would “stifle “stifle the themarket market and andproduct product innovation innovation that that we weneed need to pull to pull nextnext crisis crisis out out of the of the crisis. crisis. Worse Worse still, still, with with fewer fewer banks banks and and higher higher barriers barriers to entry, to entry, the the ‘may‘may already already have have financialfinancial system system is far is farmore more concentrated concentrated than than it was it was before before the the crisis. crisis. Hence Hence the the seedsseeds of theof thenext next crisis, crisis, even even if it if is it a is few a few decades decades away, away, may may already already have have been been beenbeen sown’ sown’ sown”.sown”.
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PreparednessPreparedness
We Weasked asked respondents: respondents: How How well well prepared prepared do youdo you think think the thesector sector is to is handleto handle the therisks risks you you have have identified? identified?
20082008 200920102009
PoorlyPoorly WellWell PoorlyPoorly WellWell 4% 4% 9% 9% 11%11% 24%24%
MixedMixed MixedMixed 72%72% 80%80%
OnlyOnly 9 per 9 percent cent of respondentsof respondents thought thought banks banks were were well well prepared, prepared, and and11 per11 percent cent thoughtthought them them poorly poorly prepared. prepared. The The remainder remainder gave gave a mixed a mixed response. response. This This was was a a considerablyconsiderably more more negative negative result result than than last lasttime time when when 24 per24 percent cent said said “Well” “Well” and and4 4 per percent cent said said “Poorly”. “Poorly”. In our In our2006 2006 survey, survey, 64 per64 percent cent answered answered “Well”. “Well”.
% % Well Well Mixed Mixed Poorly Poorly BankersBankers 12 12 81 81 7 7 BankersBankers are are the the ObserversObservers 4 4 79 79 17 17 mostmost positive positive RegulatorsRegulators 0 0 90 90 10 10 aboutabout their their ability ability to tohandle handle risk risk A breakdownA breakdown of the of the responses responses shows shows bankers bankers to be to the be the most most positive positive about about their their abilityability to handle to handle risk, risk, and and non-bankers non-bankers the the most most negative. negative. Although Although no regulatorsno regulators thoughtthought banks banks were were well well prepared prepared to handle to handle risk, risk, most most of them of them gave gave a mixed a mixed response.response.
ThoseThose who who answered answered “Well” “Well” emphasised emphasised the theamount amount of work of work that that had hadbeen been done done to to strengthenstrengthen banks banks and and develop develop better better risk risk controls. controls. A typical A typical comment comment was: was: “The “The recentrecent crisis crisis has hasheightened heightened the thesense sense of awareness of awareness of, andof, andappreciation appreciation for, for,various various risks.risks. This, This, coupled coupled with with active active regulatory regulatory oversight, oversight, ought ought to enable to enable the thesector sector with with the thenecessary necessary mindset mindset to manageto manage the thekey keyrisks risks faced faced by theby theindustry.” industry.” Those Those who who answeredanswered “Poorly” “Poorly” said said that that banks banks had hadnot notlearned learned the thelessons lessons from from the thecrisis crisis and, and, if if anything,anything, had had become become complacent. complacent. A UK A UK respondent respondent said: said: “The “The fundamental fundamental disciplinediscipline of fearing of fearing bankruptcy bankruptcy is now is now severely severely diminished diminished for forlarge large institutions, institutions, leavingleaving regulation regulation and and political political pressure pressure to fill to fill the the gap. gap. This This is not is not a viable a viable way way forward.”forward.”
TheThe “Mixed” “Mixed” responses responses stressed stressed the thedifficulty difficulty of generalisingof generalising about about a sector a sector which which had had been been so sharply so sharply split split into into winners winners and and losers, losers, to the to the point point where where it was it was now now possiblepossible to differentiate to differentiate very very clearly clearly between between well well and andbadly badly run runbanks. banks. One One senior senior bankerbanker said: said: “My “My impression impression is that is that many many banks banks have have learned learned the the lesson lesson and and are are focusingfocusing and andimproving improving risk risk management, management, and andare areready ready to accept to accept lower lower profitability profitability and andRoE. RoE. Unfortunately Unfortunately there there are arestill still many many banks, banks, probably probably one onethird third of the of theones ones I I havehave talked talked to, thatto, that believe believe that that they they did did nothing nothing wrong wrong and and that that it is it business is business as as usual.”usual.”
32 CSFI / New York CSFI E-mail: [email protected] Web: www.csfi.org.uk C S F I / New York CSFI CSFI CENTRE FOR THE STUDY OF FINANCIAL INNOVATION 5, Derby Street, London W1J 7AB, UK Tel: +44 (0)20 7493 0173 Fax: +44 (0)20 7493 0190
Banking Banana Skins 2010
Each year we ask senior bankers and close observers of the financial scene to describe their main worries about the banking industry as they look ahead. We’d be very grateful if you would take a few minutes to fill out this form, and return it to us by December 19th CSFI, 5 Derby Street, London W1J 7AB, UK Fax: +44 (0) 20 7493 0190 Email: [email protected]
Name Position
Institution Country
Replies are in confidence, but if you are willing to be quoted in our report, please tick
Question 1. Please describe your main concerns about the safety of financial institutions (both individual institutions and the system as a whole) as you look ahead over the next two to three years.
Please turn over
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Question 2. Here are some areas of risk which have been attracting attention. How do you rate their severity, and what is their trend: rising, steady or falling? Use the right hand column to add comments. Insert more risks at the bottom if you wish. Severity Trend 1=low Rising 5=high Steady Comment Falling
1 Back office Big market movements: 2 - commodities 3 - credit spreads 4 - currencies 5 - equities 6 - interest rates 7 Business continuation 8 Capital availability 9 Competition from new entrants 10 Conflicts of interest 11 Corporate governance 12 Credit risk 13 Derivatives 14 Emerging markets 15 Environmental risk 16 Fraud 17 Hedge funds 18 High dependence on technology 19 Liquidity 20 Macro-economic trends 21 Management incentives 22 Merger mania 23 Money laundering 24 Payment systems 25 Political interference Regulation: 26 - too much 27 - too little 28 Retail sales practices 29 Risk management quality 30 Rogue trader 31
Question 3. How well prepared do you think the sector is to handle the risks you have identified?
Poorly Mixed Well
Comment:
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1776 Consulting LCH Clearnet ACT LIBA ACCA Lombard Street Research Alpheus Solutions London Metropolitan University Bank of Italy Mobile Financial Service Banking Code Standards Board NM Rothschild Brigade Electronics Quest4 Consulting Centre for Cities Record Currency Management Chown Dewhurst Semiocraft CII Serious Fraud Office Credit Suisse Taiwan FSC IFSL The Share Centre Jersey Finance THFC LandesBank Berlin
We also received special purpose funding from: - CGAP and Citi (for Microfinance Banana Skins) and; - PwC (for Banking Banana Skins and Insurance Banana Skins).
In addition, we set up the following fellowship programmes: - the Generali/CSFI fellowship in Insurance; - the Visa/CSFI fellowship in European Payments and; - the DfID/Citi/CSFI fellowship in Development.
The CSFI also received support in kind from, inter alia: - Financial Times - RUSI - ifs School of Finance - Linklaters - NERC - Standard Chartered - Lovells - Taylor Wessing - Ruffer - NESTA
UK £25 Registered Charity Number 1017353 US $45 Registered Office: North House, 198 High Street, Tonbridge, Kent TN9 1BE €35 CSFI Registered in England and Wales limited by guarantee. Number 2788116