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Dubai: Same subject, different commentator; same horse, different jockey. The subject: banking failure.
Banks drive markets from a number of angles: they execute business within markets; they provide leverage; and their capitalised value dominates most indices.
Look at the UAE bourses, how big would they be without the banking system? Look at the Dow, the Nikkei, the FTSE, the Sensex and any other bourse you can think of and ask a similar rhetorical question: how can markets thrive without confidence in the banking system?
Commentary on the subject is endless, it's that important. The Financial Times, The Economist, The Herald Tribune, have had their say. For a "back-to-basics" perspective I spoke with Laura Bentley, former student of Chouiefat, sporting a first in Economics from Lancaster and currently doing the grunt-work for a Masters in International Business. What's her view from "academia"?
"Bank failure is not a new concept" says Bentley, "in fact, banks have been prone to failure for centuries, even when the only function of a bank was to hold onto depositor's money. Nowadays, banks are so diverse in what they actually do that the risk of failure is more diverse."
Back-to-basics
Nevertheless, to satisfy the "back-to-basics" approach, Bentley lists the sources of failure into three broad boxes. Box one "systemic risk", the risk that banks as a genre are taking too much risk; and if the nature of the systemic decision is poor, there would or could be a "contagion" effect spreading from one failure to another. Bear Sterns, Nothern Rock fit snugly into this box.
Box two might be fraud, "historically one of the more common causes of banking failure" says Bentley.
Box three is headed "operational risks" where we agreed that there might be a fine line between fraud and operational glitches; rogue traders - did they set out as "rogues" or did they just get greedy, then defensive, then abuse loopholes?
The "rogue" in the rogue trader is usually supported by weak governance which is why Bentley takes the view: "The way that modern banks operate increase the levels of operational risk in the banking sector simply due to the diversity of modern banking practices. Managerial decisions, the actions of individuals working in banks or even just technical glitches in the system can place a bank in a difficult position, and in extreme circumstances cause a bank to collapse", a box for Barings?
Something to worry about then? "Consumers should certainly be concerned about the behaviour of banks and their ability to take advantage of a lack of mutual information or moral hazard. Banking practices are for the most part behind closed doors, meaning the bank may be making decisions and taking risks that can easily turn into bank failure if market conditions take a turn for the worse.
The current financial crisis, which has placed banks on tenterhooks for fears of bank failure, is the culmination of loans being granted to individuals with no assets in the case of default. Unfortunately, that is exactly what has happened, and the high levels of interconnectivity between banks have caused a knock-on effect to banks all across the world" says Bentley.
Good points: banks use depositor's money without the latter's understanding on what the banks actually do. How many depositors at, say, Northern Rock, were aware that their money was being used as part of a "risk management strategy" that included loans to people with a high default risk? How many shareholders/depositors knew about Citibank and UBS (for example) bringing in the sovereign wealth emergency parachutes?
Sovereign funds
On the upside, Sovereign Wealth monies may be helping stem the "contagion" threat: what else can be done? "There is little that bank regulators or the banks themselves can do to prevent this negative contagion in the system spreading, instead they focus on damage limitation. Risk and panic are quickly dispersed around the world, and it is vital for consumers and investors to maintain confidence in the financial system, even in the face of financial crises because a problem may start in one place, then spread to another and eventually lead to the failure of non-related banks".
So which banks are most at risk in a "panic contagion" scenario? Bentley points to a connection between risk and scale: "the larger the bank, the less likely it is to fail. Panic drains the liquidity from banks and larger banks have more assets and the ability to provide more liquidity, however, even the largest of banks has the potential to fail".
Forcing a summary: how does Bentley advise consumers to regard the current banking "crisis"?
"Since everyone uses banks, the risks of bank failure are a general cause for concern, especially since the internal actions that banks make are not observable and in today's high-tech banking systems, the spread of risk is almost instantaneous".
Are banks at a bigger risk of failing today? For Bentley, bank failure is not a new concept. The best solution for depositors is to take the Tom Peters approach to business generally: "get big, get niche or get out". Niche banking service required? Pick a niche bank. Depositor service required? Pick a big bank.
- The writer is chairman of Mondial Financial Partners.
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