Investments  

Five years after the banking meltdown

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

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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