CEO Roundtable - After the meltdown: Top bank CEOs explain their hopes and fears

Special focus: Banking 2008 and beyond

Bank management: CEOs learn the lessons and right the wrongs

How are bank chief executives changing their risk management and compensation policies? What do they fear from the regulatory backlash? What collective endeavours are they undertaking to improve systemic resilience? Peter Lee finds that the CEOs of 11 of the world's leading financial institutions are full of insights into what went wrong and how to put it right.

What are the key lessons your bank has learnt from the present financial market turbulence?

VP, Citi There are many lessons we and many others have learnt. Some of these are that an organization must stay focused on basic risk principles such as managing concentrations, thoughtful stress testing, a high-quality and empowered risk organization, and senior management involvement. Other lessons that many relearnt in this cycle are that it’s not enough to focus on only your positions – you must have an understanding of the market’s positions and the implications of that under stress scenarios, and that liquidity is also a crucial part of risk analysis, especially in a mark-to-market framework, where there could be very real implications to capital.

AS, Santander For Santander, it hasn’t been so much a case of lessons learnt but a reminder and reaffirmation of some of the basic principles of risk and balance-sheet management followed by the group.

We have always avoided this dynamic and have made it very clear that creation of value for our shareholders is based on our relationships with clients and not in taking on major financial risks.

Therefore, we haven’t changed the way in which we manage the bank. Some of our competitors that did so have had to return to traditional banking business. We have an advantage today because we are not part of this.

"It is hardly the time to sound too triumphant because we see the unprecedented market volatility, limited liquidity and intensified competition for deposits continuing well into 2009" Michel Tilmant, ING

MT, ING

At the same time, financial institutions were able to access cheap funding and leverage themselves. They created complex products such as CDOs and CLOs. These are relatively new and immature asset classes of which many investors, including financial institutions, had limited understanding and over-relied on rating agencies and their complex valuation models.

I am an old-fashioned banker. In the old days, the first thing that bank executives would go to was a credit course, where they learned how to assess the quality of loans, borrowers and collateral and therefore the ability of the loan to be repaid. Somehow it seems that those lessons are now sometimes forgotten. You should always do your own credit analysis. Credit risk is one of the fundamentals of banking.

Secondly, you should not buy or sell things you don’t fully understand. If you repackage complex products and associate them with complex constructions and then on-sell them to third parties who don’t understand what they are doing, you are organizing a bit of trouble.

It is essential that financial institutions weed out the excesses of the last period to come back to the fundamentals. At ING we concentrate on these fundamentals. We basically collect savings and invest them for clients to make a good return, while at the same time generating long-term profit for our shareholders.

NK, MUFG The problems underlying the present financial market turbulence are deep-rooted and involve a complex sequence of developments that includes the following: (i) the correction of excessive expansion (leveraging) of banks’ balance sheets; (ii) concerns about the worsening performance of some US and European banks in light of the enormous losses they have recorded; (iii) increasing risk aversion among investors in anticipation of accounting system changes and tighter regulations; and (iv) the collapse of property bubbles in the US and Europe and a global economic slowdown.

In general, Japanese banks had learnt an important lesson with the non-performing loan disposal that followed the collapse of the bubble [in Japan], and were therefore more rigorous in their evaluation and assessment of credit risk. In particular, they viewed the sudden rise in property prices in the US and some other countries with considerable caution, and were conservative in their approach to securitized business, since it involves CDOs and other secondary or tertiary securitized products that are at a remove from actual conditions.

The stability in long-term interest rates and credit risk premium contraction that continued globally from 2004 to the start of 2007 was anomalous. These exceptional financial circumstances gave rise to the spread of the originate-to-distribute (OTD) model of securitization, in which banks’ balance sheets became more liquid and leverage increased. Sub-prime mortgages and leveraged loans were securitized on the assumption that the subordinated tranches would not be held by the bank itself, and there was such a growing tendency to pass on credit risk that the screening standards and contractual safeguards at the initial stages of lending weakened. In this sense, a large portion of responsibility rests with the originators, who caused this moral hazard. A focus on high profitability along with overconfidence in a particular business model is dangerous, and the commoditization of credit risk in particular has its limits. The evaluation and assessment of credit risk, one of the primary roles of a bank, should always be performed in a disciplined manner.

We expect that the financial institutions of the world’s leading countries will now focus on management strategies that emphasize return on equity, with the aim of restoring soundness to their balance sheets. Securitization markets where the value of the asset-backing of securitized products lacks transparency are likely to disappear. There is a strong chance that banks will distance themselves from complex structured finance. We expect to see a broad trend to refocus on corporate finance and retail business, which are more closely linked to the actual economy.