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Slip-ups to come: respondents to CSFI’s annual bank risk survey ranked too much regulation as their biggest worry but also pointed to the dangers of banks’ exposure to hedge funds |
Risks of hedge funds, currencies and commodities are preying much more heavily on the minds of bankers this year than before, claims a report by CSFI, an independent City of London think-tank. The survey, Banana Skins has run for 10 years and is based on responses from 440 banking industry players in 54 countries. Hedge funds, currencies and commodities all moved up more than nine places in the rankings of banking risks compared with the 2003 results.
Respondents ranked hedge funds as the fifth-largest risk to the banking sector, with many seeing unhealthy links where banks offered prime brokerage services to hedge funds including preferential trading arrangements and credit. According to CSFI, one economist described prime brokerage as the “crack cocaine of the financial markets” adding that, “when the Fed bubble bursts, we will discover where the leverage is concentrated and which institutions have managed risks correctly”.
There was some disparity of rankings by types of respondent. Regulators and observers put hedge funds in first place, fund managers ranked them third, but they didn’t reach the top 10 of bankers.
Currency risk rose 11 places in the rankings. Dependence on the dollar leaves banks in an awkward position, and concerns about a violent swing-back were raised by respondents. Diane Coyle of Enlightenment Economics in London says: “When currency realignments occur, they’re big. Recall that the dollar went from $2.40 to $1.05 [to the pound] in 1981-85.”
Too much regulation
Commodities rose 12 places on the back of oil and gold concerns to reach the 14 spot. “There was a widespread view that while commodity markets are likely to be more rather than less volatile in the years ahead, people have a good grip on them so the risks are limited,” says the report.
The top banking risk put forward by bankers, CEOs, chairmen and risk officers, however, was “too much regulation”. Unsurprisingly, regulators themselves disagreed, ranking “too much regulation” twentieth. Cost and compliance risk were mentioned among the reasons, but Hans Geiger of the Swiss Banking Institute at the University of Zurich believes the issue of regulation is causing an unwarranted amount of attention. “Bankers and regulators seem to be obsessed with implementation of the Basle 2 framework. In reality the major risk to financial stability will not be the capital adequacy of individual banks but rather the business cycle and issues around the liquidity of markets and institutions,” he says.
Whether institutions are ready to handle these risks depends on their nationality. Emerging-market and EU accession country bankers expressed concerns, says the report, although there was a definite awareness of the need to update risk controls.
Respondents from developed countries were generally upbeat about the efforts they had put in to deal with risk, but admitted that a downturn would prove the real test. One Swiss banker is reported as saying that time bombs are still ticking away in the investment departments of insurers and pension funds, and in the treasury departments of sophisticated banks. But “..only a violent downturn in the stock markets or a dramatic rise in interest rates will trigger this. A dull market going sideways for years to come is the most benign scenario. Thankfully, this seems to be the common view.”
