Six Triggers for the Next Financial Crisis

Banks are much safer now than before the financial crisis. Or are they? Certainly, if focusing simply on increased capital and liquidity requirements, and closer regulatory supervision. Yet close questioning of bankers, and regulators past and present, throws up six possible triggers for a crisis.

1. CYBER-SECURITY. Imagine this scenario. A cyber-attack closes down a bank for a week; panicked depositors unable to access their funds form queues on the streets; the regulator is forced to close the bank permanently in a bid to avoid contagion; the strategy fails as queues form at other banks on (fake) news of their vulnerabilities. A former member of the Basel Committee on Banking Supervision believes this could be the most likely spark to trigger the next financial crisis. Another scenario is a cyber-security attack into any part of the wholesale infrastructure, say the estimated $542 trillion derivatives market, which would cause widespread panic as the global system shut down.
   
   In the words of an investment banker with knowledge of the subject: “Of course banks spend lots but as their IT departments are full of contractors and senior management is clueless, the spend is wasted. Their systems are weak, they don’t talk to each other, and are very vulnerable.  It’s impossible to trace where an issue has happened and to fix it.”
   
   Only big banks will be able to afford the enormous amounts needed for proper cyber-security. “Banks need military grade cyber,” asserts the former regulator. New ratings will emerge for a financial institution’s cyber safety. Those with anything less than triple AAA could find themselves frozen out of the wholesale markets. The inevitable consequence is consolidation: small banks will be gobbled up.

1. TOO BIG TO FAIL. An ongoing theme in this column, on which I have been proved wrong. So far. Writing about The Precariousness of JP Morgan Chase in 2014 and suggesting readers should sell, was an abysmal stock recommendation. Yet further consolidation of the financial system in countries from Spain to the US – an outcome of the financial crisis and of the ensuing regulation – has concentrated the risk. The taxpayer will more likely have to bail out the giants, notwithstanding the tough regime for Global Systemically Important Banks (G-SIBs).

1. RISK CONCENTRATION. Risk is also more concentrated now due to “significantly greater harmonisation on, for instance, the risk weighting of assets, the prudential rulebook and accounting standards…it means if something goes wrong, it goes wrong for everybody!” notes the Non-Executive Director of a bank. She points out that in 2008 it was the diversity of standards which helped reduce the problem in some countries. France, for instance, did not apply mark to market accounting, and Canada applied heftier capital standards.
   
   In the 2018 harmonisation recipe, lending to the real economy for investment has generally fallen, while another mortgage bubble in residential property has been created.  There has been a sharp drop in the diversification of business models. Excessive to overvalued property could yet again be the catalyst. Even more so if interest rates increase, unplanned for and unaffordable for many owners. We have raised a generation who think that interest rates of 2% are customary, notes a Dutch former regulator.
   
   Geographic shrinkage is another element in risk concentration and the lack of diversification. Regulatory bias has promoted more domestic exposure: banks like Citigroup of the US, or Unicredito of Italy, sold many of their foreign businesses post-crisis.

1. GEOPOLITICAL JEOPARDY. Italy is a likely suspect. The country could blow up on the back of its bankrupt banks and the unstable government’s argument with Brussels, amid recent evidence that Italian households are no longer willing fools ready to finance government spending by buying its bonds. If Italy goes, so would the euro.
   
   There is also the more obvious imbroglio of Brexit and its unforeseen consequences, however much the Bank of England provides public reassurance on this front. Or China’s debt burden…The list is long.
   
   During the 2008 Beijing Olympics, at the height of the US financial instability, Russian officials made a top-level approach to the Chinese and suggested that together they might sell big chunks of their US Treasury holdings. The Chinese declined. The answer might be more nuanced today, amid heightened political tensions.

1. JUDICIARY RANDOMNESS. A term first heard at a meeting of the G-30, this refers to multimillion fines which fall on banks after scandals such as mortgage abuse in Spain and product mis-selling in the UK. Danske Bank’s recent €200bn money laundering disgrace forced the newly nominated Chairman to speedily reassure the markets that the bank was not facing “an existential crisis” – and that is even before the US Department of Justice’s criminal investigation has reached a conclusion and consequent fine.

1. REGULATORY MICRO-MANAGEMENT. The financial crisis put paid to the idea of principles-based regulation. However, the sharp pendulum swing to prescriptive rules-based regulation isn’t working either. To state the obvious, regulators are not bankers.
   
   “The jerks presume to tell us how to do our business, in extreme detail…you come to Treating Customers Fairly (TCF) – the man from the government has this 100% wrong, “complains an executive board member of a British bank. As he points out, “we are now obliged to treat disparate people the same – [despite the fact that] nature was not fair in how it handed out its gifts.”
   
   Form-filling and ever-larger compliance departments are the curse of the post-crisis world. “We have to write a ton of repetitive stuff for the regulator year after year which nobody can read, understand or apply usefully,” notes the banker. The real issue with “this stupid charade” is the resulting risk blindness – either complacency that every risk is covered or an inability to see the forest fire because measuring every inch of the trees is the new normal.

There are other possible catalysts to a financial crisis: from the pile up of debt; to shadow banking; to climate change; to the unimaginable. Two overarching factors could make the next crisis even worse than the last one.  The public’s trust in the financial system, high before the crash, is being continuously eroded from its low base with a repetitive litany of scandals, greed and technical incompetence – examples abound such as Goldman Sachs’s reported Malaysian corruption and TSB’s IT chaos.

Meanwhile, the international cooperation visible in the financial crisis, and ably described in former US Treasury Secretary Hank Paulson’s book On the Brink, is entirely absent. The idea that the Trump government would coordinate action to save the world is risible.

On this cheery note, Robinson Hambro wishes its readers very Happy Holidays

An anti-globalisation duet: Trump & Corbyn

Why domestic bank M&A is set for a boom

As Donald Trump and his toupee continue to ride high in the US presidential opinion polls, I find myself musing on his fellow jockey, UK Labour Party leader Jeremy Corbyn.

Mirror images of each other on the political spectrum, they will never lead their respective countries. Yet the unelectable duo are worth listening to, for they represent large elements of the population that are opposed to the globalised world we live in.

Take their attitude to free trade. Trump calls for a 15% tax for outsourcing jobs and a 20% tax for importing goods, and sees trade deals as “killing American jobs.” He believes trade negotiators are a bunch of “saps” and says he would appoint corporate leaders to do the job properly. Corbyn warns that TTIP, the prospective trade deal between the EU and the US, is nothing but a capitulation to “greedy bankers and multinationals.”

His refusal to campaign for Britain to stay in the EU has, ironically, withdrawn a major weapon from the Conservative government’s armoury for its future referendum. Corbyn and his allies, who embody the discarded remains of the Left’s 1970’s euro scepticism, see the EU as representing the interests of big capital. Rather paradoxical, given that big business sees the EU as excessively defensive of workers’ rights and the progenitor of too many regulatory burdens to protect citizens.

Trump and Corbyn, one 69 years old and the other 66, both fail John Maynard Keynes’s three imperatives for a balanced government. The economist and statesman wrote: ““The political problem of mankind is to combine three things: economic efficiency, social justice and individual liberty….the third needs, tolerance, breadth and appreciation of the excellencies of variety and independence, which prefers, above everything, to give unhindered opportunity to the exceptional and aspiring.”*

For Corbyn, social justice can be achieved without economic efficiency and individual excellence. This would result in a country with not enough profits to pay for a safety net for the disadvantaged. The reality for Trump, who would lay claim to both economic efficiency and individual liberty, is a country where protectionism kills efficiency and individual liberty applies to some, but not all. And certainly not to the roughly 11 million illegal immigrants who water his many lawns and serve in his many restaurants.

Just as surprising as their similarities, are their allies in the anti-globalisation movement. Joining them in the stop-the-world-I-want-to-get-off gang, are financial regulators on both sides of the Atlantic.

The European Central Bank’s post-crisis conventional wisdom is that geographical diversification of multinational banks does not protect against risk and adds a layer of complication. Long gone are the days when banks followed their corporate clients abroad and then proceeded to buy local entities and grow. The European Central Bank “comes out in a rash” when a Spanish bank mentions buying bank assets in emerging economies, affirms a bank CEO. The Federal Reserve in the US takes the same position, according to most accounts.

Regulators learned a lesson from the last financial crisis. It may, of course, not be the right lesson, for every crisis is different – the drying up of wholesale bank funding markets in 2007/2008 was very different from the run on the deposits of 37 banks in the Japanese Empire in 1927.

With foreign expansion off the cards, cost cutting reaching its finale, new digital entrants threatening the traditional business and financial supervisors breathing down their necks, banks will focus on local acquisitions to grow their profits. A domestic M&A boom is forecast for 2016.

Regional movements like those in Cataluña and Scotland are part of the anti-globalisation trend. Allied to the sense of alienation from their existing rulers is an almost blind belief that raising the barriers will lead to paradisiacal economies with full employment.

To these misguided idealists I would add proponents of Brexit, the exit of the UK from the European Union. The world is moving into ever larger trade groupings. Being outside is not a reasonable option for a major country – unless there is an appeal to being emailed instructions from Brussels without having a seat at the table. Norway pays a heavy price for its nominally freestanding position since it is forced to incorporate EU legislation into its own.

In 1944, Keynes warned in the House of Lords against “little Englandism” which pretended that “this small country” could survive by a system of bilateral and barter agreements or by keeping to itself in a harsh and unfriendly world. His words continue to ring true.*

Both Trump and Corbyn remind me of the rutting impalas I saw in Zambia this summer. A fresh male impala, the handsomest and most macho, fights off the others to breed with the herd of females. After around three weeks of non-stop sex, with no time to feed or groom himself, he is weak and easily taken out by a challenger, a young buck from the group of male impalas. If he’s lucky, the exhausted male impala might then re-join the all-male herd or, just as likely, be eaten by a herd of lions.

The only question about the future disappearance of fraternal twins Corbyn and Trump is whether they slip back into their old lives or are gobbled up by the forces of globalisation.

*Universal Man: The Seven Lives of John Maynard Keynes by Richard Davenport-Hines

Why the UK’s output lags behind

August 18, 2015

School holidays and their effect on the Establishment

In a lighthearted post in the Financial Times, To boost Britain’s productivity, cancel August, Karina’s Column addressed the UK’s efficiency conundrum via the City’s holiday habits.

Six Steps to Retaining Your Promising Female Executives

Six Steps to Retaining Your Promising Female Executives

686 Lord Mayor Fiona Woolf advises

The City of London retains its ranking among the top two global world centres, but Asian centres are snapping at its heels. The City is only as good as the talented workforce that joins, grows and leads it. The fact that too many promising female executives drop out is a problem that must be addressed as part of the ongoing work to boost its international appeal.

Dame Fiona Woolf, 686th Lord Mayor, instituted the Power of Diversity programme in her 2013/14 term, a strategy followed by subsequent Lord Mayors. Here are her six practical steps to retaining women and supporting their rise.

1. Think of it as Talent Development

I ran a survey a while ago that delivered the unsurprising answer that the quality of supervision and personal development were the top factors that would keep people in a job. Next came the quality of work – everyone wants access to the top jobs. In people businesses (and most businesses claim that they are), success depends on recruiting, training and deploying the best talent so that it gets better all the time. When I ask how many of us have been trained in on-the-job talent development, very few hands go up. We should teach managers how to develop skills and create an environment where everyone learns from on-the-job experience. Regular “what went well, what went less well” conversations would be good. I am a fan of sharing individual development plans. Transparency about the way work is allocated will help to deal with unconscious bias, such as the assumption that a woman with a family will not want to get involved in a big deal, without asking her.

1. Identify and Motivate the Keepers of the Talent Pipeline

Many of the keepers of the executive talent pipeline are managers at mid-level who are busy doing the work, generating the income, looking for new business and trying to go home at night. They may not realise that they are responsible for talent development and that they will really benefit from it. There is a saying that you are only as strong as your weakest link. So it follows that these keepers of the talent pipeline need to be motivated to value and invest time in talent development. They need to be a part of a workplace culture that regards it as mainstream in the day job and do a little of it every day. The senior leadership can do a lot of messaging but also lead by example and be seen to monitor and celebrate promotions and vibrant teams. Understanding the costs to the business of losing and replacing someone is key. More positively, remember that the attractiveness of someone who is developing well to a client is a terrific marketing tool (and if they go and work for the client they will return as a client)!

1. What Gets Measured Gets Done

I have not come across many organisations that actually measure individual performance in talent development and reward it, but there are some. Diversity and inclusion is often a soft, but important value rather than a performance indicator. Income generation and new business acquisition as performance indicators are easier to measure and reward. We are now working with Business Schools and firms to find ways to monitor and reward talent management and development looking at the outcomes. An obvious example is to measure the number of people who leave a manager each year and to understand the reason through exit interviews. Another is the number of promotions and lateral transfers.

1. Senior Leadership Commitment to a Concerted Culture Change

In a survey that was part of what is now the continuing Power of Diversity programme, we discovered that 84% felt that their senior leadership were doing the right thing to create diversity and inclusion but only 27% felt under any pressure to do anything about it at their level. There are clearly many good initiatives like affinity networks, unconscious bias training, mentoring and sponsorship schemes but none of them will work unless they are embedded in a big change programme involving everyone. Think of it more like a campaign, led from the top but full of excitement in the big middle that then becomes the new normal!

1. Develop Support for all Rising Talent

My motto is “Get lucky and say “yes”!” because everyone these days wants women to succeed and we will be supported. We all need support when we take on something new (however senior we are) and we can be smarter at asking for it and giving it. It is not a sign of weakness. So often, we adopt the “sink or swim” approach, “dumping“ rather than helping, in the hope that people will figure it out for themselves. The same applies to returners after a career break. We should be seeing a growing market in “returner courses”. Mentoring meetings on a regular basis are good, but what about asking for someone to go to who can give you the background or a quick second opinion on what to do next?

1. Recruit and Promote on the Basis of Intellectual Capacity and Transferable Skills, not just Experience

Is it a stereotype that, unlike men, women are reluctant to apply for jobs and promotion unless they tick all the boxes? Some people do recruit and promote square pegs to square holes based on all the “previous experience” boxes. I have always hired on the basis of intellectual capacity, motivation and transferable skills. I was seldom able to find people with directly relevant experience and turn them into international electricity lawyers, so an excited engineer working in South Africa who spoke Russian was a good answer! I was not taking much risk in hiring or promoting bright people with transferable skills, nor did I have to invest excessive time in supporting them. They learned very quickly, brought new ideas and make a great contribution. Women can do this too and we should not worry about moving from a square hole to a round one!

Time to call a halt to regulatory overkill

…and why even Archbishop Welby agrees

None can disagree with the need for a regulatory transformation of the banking sector following the 2008 financial crisis. Yet after seven years the blitzkrieg of rules continues amidst a confusion of overlapping and contradictory requirements. It beggars belief that the rules on too big to fail were only agreed in principle in November last year by the G20, while the details have yet to be made final.

Speaking to bank CEOs and Chairs in the UK and Europe, who dare not complain publicly, the regulatory fatigue that Bank of England Governor Mark Carney spoke of is apparent, as are a number of the unintended, negative consequences.

Capital has become local as global banks withdraw to their home markets. Surpluses of capital are not being used, while demand lies unfilled. When you add in Anti Money Laundering and Counter Terrorism requirements, even long-standing, legitimate businesses in Africa are having their bank accounts closed down. Let alone HSBC’s strategically absurd decision to exit Brazil, still responsible for approximately 60% of South America’s GDP, and to do so at the worst time possible time, when the country is in the doldrums.

Secondly, loan capital has diminished substantially. The creation of credit is a problem. And which sector or instrument that credit goes to is determined by regulatory requirements rather than business sense. This can itself lead to a new crisis.

Competition has contracted, with banks either going bust or being absorbed by others, while regulatory requirements have increased the barriers to entry. As the latest results from the big US banks testify, only the large can absorb regulatory burdens and fines. JP Morgan has moved from being a big financial institution pre-2008 to bestriding the world like a colossus. There are some so-called challenger banks – new entrants unencumbered with the legacy of old systems and debts – while internet-only loan providers are growing at a dizzying pace, but it will take a very long time for them to fill the gap, if they manage to do so.

Fourthly, the myth that Brussels is responsible for myriad new rules is helping push the UK out of the EU. In fact, with regulatory equivalence, the UK would not escape more regulation even if it did leave the EU.

Lastly, even as banks cut down on front line staff, there is a vast increase in their recruitment of compliance specialists, as well as the information technology personnel needed to change systems to comply with new rules. Regulators are asking for the traceability of all credit decisions, even the smallest, all of which consumes management time. Top bank executives complain that they spend hours in meetings with junior, inexperienced supervisors who have never worked in banks and are more intent on protecting themselves from criticism by painfully ticking every box.

Complexity is not progress.

At board level the situation is no better. Bank board meetings are about the modelling of risk, rarely about strategy or how to grow the business, according to board members. One FTSE-100 financial services institution conducted 29,000 different simulations. The Non-Executive Director in charge of the Risk Committee was dismissive of the exercise. Meanwhile, potential NEDs with insight and experience say that you would have to be “reckless” to jeopardise a 30-year career by taking up an appointment on a bank board – even more so if criminal liability is extended to independent directors, as has been proposed in the UK.

The Bank for International Settlements, the so-called central banks’ bank, recently said the wave of regulation is coming to an end. Bankers disagree.

Seven years after the financial crisis, regulation needs to focus on being an enabler of financial services rather than an obstructer. To change the mind-set of the regulators – and the bankers – a system of secondment needs to be set up. Modelled on the very successful Takeover Panel, which has been ruling on mergers and acquisitions in the UK since 1968, bankers would be seconded to regulators for a pre-agreed period, with their salaries paid for by the banks. This is idea has been mooted before in the Salz Review of what went wrong at Barclays Bank, but sunk without trace.

On the macro front, the focus should shift to stimulating the capital markets so that the provision of credit does not lie mainly on bank balance sheets, as it does in Europe, while capital requirements should be lowered and the focus should shift to the leverage ratio.

Speaking to the Worshipful Company of International Bankers a couple of months ago, the Archbishop of Canterbury, Justin Welby said: “2008 continues to lurk around as an impediment, which undermines confidence. Creativity and confidence go hand in hand…Creative leadership that does more than manage is essential.”

It is time to move on.

This column is based on private conversations with bank CEOS, Chairs and board members in Europe, as well as knowledge gained in my prior career as Senior Editor of The Banker and a former banking columnist for the International Herald Tribune.

It will be published in the next issue of Dialogue Review.