A look at the underlying issues of the recession and some of the far-reaching changes that need to happen within banks to bring lending back on track
The collapse of the banking industry over the past 18 months has highlighted that fundamental changes need to take place. Given the widespread corporate culture in the past decade, where the prevailing atmosphere was one of fast growth and special fast-track treatment for what some knew were risky deals, risk managers would have found it hard to stand in the way of their superiors. This is not to say they did not have proper risk management processes in place. The news about HBOS getting rid of its former head of risk, and subsequently becoming one of the highest-profile victims of the credit crunch, clearly brings to light a culture that was going too fast and was a serious risk to financial stability.
The risk managers such as Michael Gelband at Lehman Brothers, who advised against a huge buying of a collection of sub-prime mortgage lenders within Lehmann, were recently put into the spotlight, emphasising a need for financial institutions to adopt a more holistic approach to risk management moving forward. As such, banks and corporates need to move beyond merely implementing new risk management tools and move towards an enterprise-wide approach to risk management.
A contributing factor to the severity of the credit crunch was the total collapse of confidence in the banking industry's risk management. A lack of confidence in the quality of the data basis for the risk evaluation and in the evaluation models, along with a lack of transparency and lack of ability to document their risk profiles, made it impossible for even the sound banks to obtain funding in the interbank market. Trust is an absolute must for any business and when a lack of trust affects a whole industry it is devastating. It is therefore crucial to regain the confidence in the banking sector by demonstrating fundamental changes in the whole risk management system.
Rather than just blaming individuals, it is more appropriate to call into question the entire risk management system. This includes regulators who failed to exercise proper control, treasury officials, ministers, financial institutions, as well as the risk management tools, as controls seem to have gone out of the window. Banks will need to ensure they gain an enterprise-wide view of all operations rather than the siloed approach to risk management that contributed to the current crisis. This includes applying technology at a business level rather than in isolation.
Banks have already begun to look at systems that can streamline administration and help achieve operational excellence. Whilst risk managers should be given greater prominence within the organisation, there must be a provision to capture the process structure that has to be followed through the full loan lifecycle. This will make the firm less dependent on people, reducing the risk of human fallibility as well as increasing transparency and auditability.
A recent survey of 334 executives by the Economist Intelligence Unit shows that improvement of data quality and availability is likely to be the key area of focus in the management of risk over the next three years, as cited by 41% of respondents. Furthermore, strengthening risk governance is a key area for 33% of respondents.
Risk management, led by people and senior managers, needs to become more integrated with business decisions right from the start and risk managers should be given the back-up to play a bigger part in a banks’ lending strategy and supported by solid business practices. This approach, in combination with the right technology, will also help banks to better manage a more heavily regulated landscape, not least as risk regulations will attain greater importance in the future.
The European Commission’s response to the financial crisis has already involved a series of actions in April 2009 to tighten financial regulation in the European Union (EU). In ongoing efforts to strengthen financial regulation and prevent a recurrence of markets slumping into a recession due to the mismanagement of the financial system, the EU’s initial proposal contains tougher rules for hedge funds and private equity funds. Moving forward, these would be subject to appropriate authorisation and registration requirements if they want to operate in the EU. At the same time, the EU is also pressing hard for tougher financial rules on a global level. Furthermore, the Financial Services Authority (FSA) is in the process of signing up one of the UK’s leading audit firms to assist in an investigation into the conduct of banking bosses and their attitudes to risk management which will be reviewed by the FSA’s senior enforcement and supervisory staff.
While the industry has failed in its mission, with widespread consequences for the society, history has shown that culture has a tendency to change. The financial industry has begun to restructure its risk management practices and realise that a sound culture and professional individuals, combined with relevant risk management tools, are important assets for a bank. There are indications that the political leaders, together with the regulators, are keen to impose stricter controls and supervision. But for the banks themselves, by applying an enterprise-wide approach combined with the right tools, it is possible to implement appropriate risk management strategies and achieve considerable efficiencies, in addition to greater quality and transparency - all of which are greatly required in the present market.
