The expression ‘excessive risk-taking’ became somewhat fashionable after the 2008 financial crisis, when the risk of total failure was taken too far.
Like many of the post-crisis studies, the Walker Review, published in November 2009, was damning in its analysis, concluding that governance breakdowns within banks “contributed materially to excessive risk-taking and to the breadth and depth of the crisis”.
Stateside, the Financial Crisis Inquiry Commission report quizzed the apparently invisible level of exposures created by Lehman’s 900,000 derivative contracts that were unmatched by the firm’s capacity to absorb the potential loss. Also, when AIG folded under the weight of CDS sold with sub-prime mortgage loan exposures of over US$61.4 bn (£39.1bn), it became apparent that risk-taking had been excessive.
In addition to poor systems of governance, the post-crisis inquiries intimated negligence and recklessness in risk-taking. Was this assessment fair?
Does excessive risk-taking arise from sheer recklessness, hubris and greed, or is it simply a judgement made with the benefit of hindsight? To avoid death by a thousand cuts, I am proposing not to revisit the causes of the crisis but to consider the practical implications of managing excessive risk-taking.
Naturally, no legitimate organisation would knowingly take unaffordable risks. By inference, excessive risk-taking must therefore arise either unknowingly or as a result of misjudgment of the potential risks.
Sadly, some recent revelations suggest that certain pockets of some organisations would knowingly take high bets on behalf of their organisations and their boards. It would appear that greed and hubris with a good sprinkling of bravado are effective in creating blind spots.
I refer to two recent events – the Libor rate-fixing scandal, and allegations of foreign exchange rate (forex) manipulation, which according to the FCA was “every bit as bad” as the Libor scandal.
The Libor and Euribor rate-fixing scandal exposed in 2009 related to unscrupulous practices by derivative traders in a number of financial institutions as early as 2005. The investigations into the integrity of the inter-bank lending rate resulted in fines by the FCA of more than US$9bn (£5.7bn) and the affected banks setting aside material reserves against the cost of potential litigation and law suits from both sides of the Atlantic.
The second event refers to the brazen and systematic manipulation of foreign exchange rates involving several major international financial institutions.
The allegations resulted in investigations by the Serious Fraud Office into the collusion by traders in the rigging of rates in the £3trn-a-day forex market between 2007 and 2013. Fines totalling some £10bn have so far been levied by regulators in the UK, US and Switzerland on firms including Citibank, JP Morgan Chase, Bank of America, UBS, HSBC, RBS and Barclays.
