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.