Bankers like to wring their hands every time a competitor is forced to report a big loss caused by a rogue trader or poor controls.
They shouldn’t. The banana skins that banks have a habit of treading on are entirely healthy. They are a sign that the financial industry is sufficiently creative and competitive. They also highlight to other institutions which dangers they too might face. And the banana skins are an efficient way of weeding out the poorly managed firms in the industry. Without small banana skins from time to time to keep the financial markets lean and efficient, a big disaster – with widespread systemic implications – would be much more likely.
Such thoughts are provoked by a recent survey from the London-based Centre for the Study of Financial Innovation (CSFI). The think-tank persuaded 149 bankers and other financial experts to discuss their pet fears for the financial sector. Unsurprisingly, “poor management” ranked as the clear winner (followed by Emu-related turbulence, rogue traders and excessive competition).
Most interesting was an accompanying article by Andrew Dobson, an investment banker, who argues that “in our competitive environment of adequately capitalized banks, there are bound to be bumps and bruises”. He welcomes embarrassments for individual banks as necessary Darwinism to keep the species fit. Systemic risk – rather than preventing individual accidents – is the more legitimate concern of regulators, he argues. And, as he points out, “as often as not, next year’s banana skin turns out to have been last year’s high fashion”.
The two foul-ups we report on prominently in this issue – the postponed Philippine yankee bond and the derivatives losses at NatWest Markets, should be seen in this light.
At root, they have similar causes: excess competition, and institutions which have become so complex that they are increasingly impossible to manage effectively.
Take the Philippines deal. The battle to dominate Asian capital markets has become cut-throat. This is the one area of the world not yet in the grip of a few global firms. With all to play for, banks will do anything to win key mandates – from cutting fees to bad-mouthing their rivals. And yet the challenge of bringing securities issues for Asian borrowers to the New York market 13 time zones away stretches the coordination skills of even the best lead-managers. Those two factors go a long way to explain why Salomon Brothers was forced to cancel the deal when market conditions became a little rough.
The problems thrown up by the NatWest derivatives loss are not dissimilar. Banks around the world have too much capital (proved by the fact that many are buying back their shares). That has led them to take greater trading risks (as well as credit risks). And this is happening against a background where the complexity of the derivatives business continues to increase, testing the control skills of even the most sophisticated institutions.
Is there an answer? There doesn’t have to be one, except the need to maintain competitive markets. In the end, seeing a few competitors taking the occasional flip onto their backsides will keep the industry on its toes.
