Editor's letter: Life in the fast lane

When we launched this magazine 25 years ago, some high street banks didn’t even have a finance director and yet they had all managed to survive for a century or more.

Now they all have a full complement of financial management skills, risk management processes, internal controls, boards of directors that are fully compliant with everything from the Combined Code to the Sarbanes-Oxley Act, they are overseen by regulators from the Bank of England, the Treasury and the Financial Services Authority, and that’s just the ones in Britain. Their annual reports contain hundreds of pages thanks to international financial reporting standards and a Companies Act or two.

And yet we’re starting to lose count of how many of them have either been forced into shotgun marriages with other banks or thrust into the protective arms of the taxpayer. Are banks simply ungovernable? If so, don’t tell Standard Chartered, or even HSBC. Or the Canadian banks.

Sometimes, though, these things are clearer than the wealth of available detail might lead you to believe. For example, there were only two things you really needed to know about Northern Rock: as I recall it was something like the 50th-largest bank in the world. And it was the seventh-most active issuer in the securitisation markets. This alone ought to tell you that this was a business doing 85 miles an hour ­ in second gear. Obvious, really.

The Hall of Fame of Financial Markets Risk was already pretty full. There was Long-Term Capital Management (LTCM), a vehicle devised by jolly clever people including a Nobel prize-winning economist. It went bang as the model imploded. There was Barings, which went up in smoke thanks, one might say, to a single rogue trader ­ but a rogue trader who managed to convince an nth-generation Baring that a business could make vast numbers of millions in profit while consuming vast numbers of millions in cash.

In my career, Latin America was my first banking crisis, back in the early 1 980s. Nobody expected entire countries to default on their debts. Barring the legal niceties, that’s exactly what happened. When investment bankers made and lost squillions chasing dotcom stocks up and down the Nasdaq market, they learned to their cost ­ and everyone else’s ­ that the internet changed many things, but not the laws of financial physics. The UK recession of 1990-92 proved the vulnerability of house prices ­ and mortgage lenders ­ to an artificial macroeconomic boom.

There are other great disasters. BCCI, which proved that an entire bank can be built on fraud. The London Borough of Hammersmith & Fulham escaped huge losses in swaps deals in the 1980s by the skin of its teeth, damaging London’s reputation in the process. And Procter & Gamble’s foray into derivatives took it into transactions that a sophisticated multinational found too complicated to understand.

The point is, no bank board director should ever have been under any illusion that it’s all ‘steady as she goes’. No one should ever have thought impossible things can’t happen.

There are two problems: one, judging from the parade of bankers in front of the Treasury Select Committee, seems to be that the messages that get to the board are sanitised and aggregate to the point of meaninglessness. They don’t know what’s going on. The people below them possibly do but ­ and here’s the second problem ­ the culture of the organisation (and the bonus structure) dissuades them from worrying about it all very much.

A new approach has to start not with the probability but with the downside ­ what would cause this strategy to be worthless? Unfortunately, there is also a tougher, bigger role for the regulators. That role must be to see and understand the interconnectedness of the banks, to understand how if everyone is driving at top speed in the fast lane then there is a great dependency on absolutely nothing upsetting that delicately balanced state of affairs. The regulator is going to get tough and, we hope, the regulator is going to start banging its fist on the table. All the rulebooks and risk strategies in the world can’t match that. Sadly, neither could many of the boards.