InvestmentsSep 19 2013

Five years after the banking meltdown

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This event was widely seen as a tipping point in the global economic crisis and since September 2008 there has been wide-ranging reflection on what went wrong. Some of the most important – but often overlooked – reforms have been in the organisational dynamics of the banks.

How far have we got with organisational reforms and are they making banks safer?

Strategy

Before the financial crisis most banks emphasised the goal of maximising shareholder value, particularly in the short term. This led banks to focusing on actions that would lead to rapid increases in share price. Often these decisions would have disastrous longer-term consequences. Many of the large UK retail banks no longer emphasise short-term shareholder value as the only goal. Instead a broader range of stakeholders is part of corporate goals. Grade: B

Business models

In the past, there had been a variety of business models in the banking sector such as local banks, co-ops and corporate banks. In the lead-up to the financial crisis there was consolidation around one business model – the large integrated corporate bank. This meant when the business model of one bank failed, the others that were similar were also likely to fail. Following the financial crisis, we have witnessed an increasing diversity of business models in banking with state-owned banks and the increasing popularity of co-op models. However, in the past year there have been signs of a return to a business model monoculture with the push to re-privatise RBS and Lloyds and the listing of the co-op group. Grade: C

Structure

In the run-up to the financial crisis, banks adopted structures that brought together investment and retail banking operations. This meant the deposits of ordinary savers were being used to finance complex and risk ventures on the financial markets. If these risk adventures failed, it meant that it was not just wealthy investors who lost out, but also savers – and ultimately the taxpayer. Banks have tried to address this issue by cutting back on some of their more risk activities and ‘ring fencing’ their investment banking activities. This might mitigate these structural problems, but it does not eliminate them. Grade: B

Decision making

One of the big failures was how banks made decisions. There was significant autonomy for market makers to make decisions, there was a higher appetite for risk, a reliance on third-party assessments and willingness to turn a blind eye to inconvenient information. This created a perfect environment for poor decision-making. The banks have taken some significant steps to address these problems by tightening systems but still have more to do to discourage willful ignorance and functional stupidity on the part of decision makers. Grade: B

Resources

In the past, banks had traditionally relied on depositors and investors to provide their core resource – capital – which they would then lend out. Prior to the financial crisis the banks became increasingly reliant on borrowing to raise capital that they in turn would lend out. This meant that if loans went bad (which they did), they would not have resources on their balance sheet to absorb the shock. Following the financial crisis, the banks have been under pressure by regulators to hold more high quality capital on their balance sheet. Basel 3 requires banks to hold at least 3 per cent tier one capital on their balance sheet. Many commentators think this number should be much higher. Some such as Lord (Adair) Turner (the ex-chief of the FSA) suggests up to 20 per cent. Grade: C

Leadership

Banks have traditionally been led in a sober and boring style. They were often accused of being excessively bureaucratic. In the run-up to the financial crisis, an aggressive strain of transformational leadership took over many of the banks. Senior executives often presented themselves as self-styled supermen who were on a mission to transform sleepy institutions into global players. This often came with a large dose of hubris. The result were leaders who took significant risks and often would ignore or even punish those who disagreed with them. Following the crisis most of the banks have replaced their top leadership. Charismatic heroes are out. There has been an increasing accent on a more staid and ‘authentic’ style of leadership. Many chief executives now come from retail banking backgrounds rather than investment banking. Grade: A –

People

Traditionally the banking fraternity in London had been largely the preserve of a small public school educated elite. Following the ‘big bang’ of 1986, the financial markets rapidly expanded and the financial workforce in London exploded. This new breed of financier were much more diverse – more international, more women and more people from a non-public school educated background. However, particular sectors of the workforce remained quite homogeneous. Following the financial crisis, there is a recognition of the need to make the financial workforces less homogeneous, and in particular masculine. This has led many banks to put additional effort into their programmes around social mobility and gender equality. It is early days, but the banks do remain largely male dominated. Grade: B

Culture

Traditionally, UK banks had conservative organisational cultures. In the 1980s this began to change as an entrepreneurial culture took hold. The result was that the guardians of our money became risk hungry sales people. Making a deal with little concern for the longer term consequences was aggressively encouraged at all levels of the banks. Following the financial crisis, some attempts are being made to change the culture within the banks. There is a renewed emphasis on social responsibility. Being careful about risks is also becoming important. Despite what many chief executives say, the culture of extreme entrepreneurialism remains well rooted among many employees in parts of the UK banks. Changing this will take some time. Grade: C +

Incentives

A driver of crisis in the banks that has been singled out for excessive attention is bankers’ bonuses. Many have pointed out that incentive structures in the industry led people at all levels to be rewarded for taking excessive risks and not to be punished for negative consequences. Retail bank employees would be rewarded for selling loans to customers who were poor credit risks. Traders would be rewarded for pursuing deals that might pay off in the short term, but would sour across a longer time horizon. Regulators have sought to address this issue by pushing banks to begin changing their incentive structures. Bonuses should make up a smaller proportion of the overall rewards package. The time horizon that these bonuses are calculated on is now much longer. Banks are also looking to non-cash incentives such as a more positive and supportive workplace. Grade: B

Ethics

Some have claimed that at the heart of the financial crisis was a deeper moral crisis. This was due to the declining role of systems of values and ethics in broader society as well as the financial industry. Values of self-interest had taken over from values such as service and prudence. This meant many people in the banks lacked a moral compass, or did not have an opportunity to use their own. Many of the banks have recognised this problem, and are beginning to take steps to address it. These initiatives are an important step, but it is important that bankers have the support and courage to put their newfound ethics into practice. Grade: B

André Spicer is professor of organisational behaviour at Cass Business School

Key points

* The fifth anniversary of the collapse of Lehman Brothers offers an opportunity to take stock of how key lenders have approached reform.

* In the run-up to the financial crisis, an aggressive strain of transformational leadership took over many of the banks

* Values of self-interest had taken over from values such as service and prudence.