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An old Japanese proverb says: "After you have won a victory, fasten the strap on your helmet even tighter."
A victorious mood pervades the financial markets at the moment. Everywhere stockmarkets are up, interest rates stable, and banks are making record profits. Goldman Sachs, for example, reported profits of $1.9 billion for the nine months to the end of August double the figure in the same period last year. HSBC is on course to make $6 billion during 1996 more than twice as much as any bank before.
Moreover, there appears no obvious threat that the good times will end soon. There is no sign of inflation re-emerging; most developing countries continue to implement reforms; bank managements seem to be more thoughtful and cautious than in the past.
Such a period of euphoria is exactly the right time to stand back and prepare for the next downturn. We do not expect an imminent recession in the western economies or an immediate bear market. But economies and markets are cyclical a downturn will inevitably come sooner or later.
That is why a major part of this issue (see page 54 on) is devoted to risk: to identifying the major risks that threaten the stability of the financial system; and to generating new techniques for quantifying those risks.
The latter is a particularly significant development for banking. "Operational risk" has become a buzzword among senior bank management. Like many buzzwords, the concept is important but over-hyped.
In the past decade, banks have developed useful tools to measure and therefore cope better with credit and market risk. But they have been forced to leave out of their measurements operational risk in other words all other risks banks face, from fraud to systems failure. Forward-thinking banks, such as Bankers Trust and Barclays are now tentatively trying to put numbers to those risks.
We find those efforts worthwhile. Quantifying operational risk could give banks useful pointers to dangers that are bigger or different in nature than they seem.
Some banks such as Citibank with its quarterly "windows on risk" committee have regular brainstorming sessions with senior managers to identify and pre-empt potential disasters. Danger areas can be the bank's own back office, excessive competition in a financial product, a political upheaval in a country where the bank has exposure, or a shock to the world economy.
Nailing down and quantifying risk, and avoiding its worst shocks, is an increasingly important aspect of finance. Now, while the battlefield seems relatively calm, is the time to tighten those helmets.
The Wolfensohn effect
Gary Perlin, the World Bank's new treasurer, calls it the "Jim Wolfensohn effect".
The Bank has been talking for years about giving its borrowers a choice of which currency to borrow in. After Wolfensohn took over as president of the Bank last year, he cut short the discussions. The single-currency programme which gives borrowers greater flexibility in liability management went into effect in July.
At the time of his first full interview with the media, in last year's Euromoney IMF/World Bank issue, Wolfensohn frankly admitted that he was worried whether he could turn round the super-tanker that was the World Bank.
As recently as March this year, in a meeting with the Bank's senior managers Wolfensohn expressed his dismay that many inside the institution seemed not to share his vision and enthusiasm. The minutes of the meeting, leaked to the press, record him saying: "There is a lack of trust and there is cynicism and there is a lack of commitment and there is a sense, 'Will you [Wolfensohn] make it?'."
But, after 16 months in the job, Wolfensohn does at last seem to be shifting the tanker's course. Some of his initiatives besides the single-currency loans are beginning to have an effect. He has begun to clamp down on corruption (and used the word "corruption" for the first time instead of World Bank-speak "misgovernance"). His plan, with the IMF, to forgive the poorest countries part of their debt, looks likely to be approved during the Washington meetings. Some organizational reforms he has implemented relocating the Mexico office to Mexico and the shake-out of the Africa department are moves in the right direction.
From conversations with former and current World Bank employees, we suspect he hasn't yet won the confidence of everyone in the organization. The Bank's default mode still tends to favour bureaucracy and stifling paperwork.
But it is a start. And if the Wolfensohn effect can keep working if his recent illness does not hinder him, for example further progress should ensue.
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