Haldane on banking: “No change is not an option…”


Andy Haldane addressing the – Parliamentary Commission on Banking Standards

The first line of defence has to be risk management within the firm. We have seen a significant scaling up in both the resourcing and the influence of the risk management function in banks over the last 4 or 5 years… There are very few, if any, global banks who can conduct effective, consolidated, across-the-whole-balance-sheet risk management. Many of their systems simply make that if not impossible then certainly unsure. There is still work to be done to put IT systems and risk management systems on a wholly different footing that have been in the past. The systems are not in a state of health that allow this holistic across the balance sheet aggregation of risk. Of all the shocking things that I have come across in the last 4 or 5 years, among the most shocking, was the inability of the biggest banks in the world to simply add up the numbers. The IT spend that has occurred has tended to be focused on business lines. It hasn’t allowed a joining up of data, core data, across the whole balance sheet. It is a pre-requisite to the essential building block of effective risk management. It does not exist at present in too many big firms”.

AH is very assured, knowledgeable and speaks with great clarity on some very complex issues. This is well worth watching. Just in case my own comment doesn’t make it through the approval process, here it is!

Andy Haldane’s "Systems Thinking" approach to resolving so many of the issues at, or as close as one can realistically get to, source is a welcome breath of fresh air. The only thing that HAS been lacking is the means to measure (and therefore) manage both complexity and resilience of individual firms i2o [inside to out]. Creating more regulation and adding more cost to TREAT SYMPTOMS makes no sense.

“Adding complexity to cope with complexity is a seriously flawed approach” McKinsey. http://wp.me/p16h8c-yU

Basel III: Why bother when the prequel was a flop: “…complexity breeds complexity, and is subject to diminishing returns. Eventually the costs of increased complexity exceed the benefits” Prof John Kay http://wp.me/p16h8c-yj

KNIGHT or NINJA?
Reducing "flexibility" through partitioning or "ring-fencing", when AGILITY is a prerequisite for every business in the Digital Age, could only make sense to career regulators, lawyers and politicians intent upon ignoring the “law of Requisite Variety”. The era of the Medieval Knight is long past and a "suit of armour" may mask but won’t change culture!!!

In the words of Dave Snowden "Practice without sound theory will not scale".

Acceptance of the inability to build mathematical models…to mislead all-and-sundry…and of (Knightian) Uncertainty should be the start of a cultural change that, with the ability to measure the inherent (but currently ‘hidden’) complexity risk, enables transparency – whilst protecting sensitive commercial information – and the process of (re)building both system and systemic resilience. Ninja warriors live by a strict code and act with great agility.

Even when the DNA is similar “we can’t fix today’s problems with yesterday’s tools” http://wp.me/p16h8c-18g

 

Banking: “culture” a greater threat to ROE than Basel


When the obvious conclusion is “politically sensitive” it is best for firms such as McKinsey to talk in terms of what returns investors want from the future banking model. But isn’t this part of the problem?

(McKinsey)…estimates show that if banks maintain their existing business models, their average return on equity (ROE) would fall to 7 percent by 2015, from its current level of 11 percent, against a cost of equity projected to be more than 9 percent.

Investors want to see the management teams of banks propose credible, far-reaching plans to close this gap. The message that investors are now sending—shares of banks will be valued at levels implying that they will not earn their cost of equity—has profound implications for a US economy dependent on a healthy banking system to support recovery and fuel growth.

Of the three threats, the most significant comes from the Basel III requirements, proposed by the Basel Committee on Banking Supervision. Without mitigating actions, they could reduce the ROE of some banks by as much as five percentage points. While the details are still being determined, we estimate that the US banking system will need an additional $500 billion in retained earnings or new equity to meet the new capital adequacy standards (assuming the current asset level and mix).

The second threat is the continuing deleveraging of consumers. The history of the past 100 years suggests that when excessive borrowing is a principal cause of a recession, consumers and businesses spend the next seven to eight years rebuilding their balance sheets…

Basel III: Why bother when the prequel was a “flop”…


…and the warnings weren’t heeded?

The prophetic words in this extract weren’t written post crash but in 2001! The full report can be read here. Of course this was not the only warning.

image

Well before the banking collapse, the US National Academies/National Research Council and the Federal Reserve Bank of New York collaborated on an initiative to “stimulate fresh thinking on systemic risk”. The main event was a high-level conference held in May 2006, which brought together experts from various backgrounds to explore parallels between systemic risk in the financial sector and in selected domains in engineering, ecology and other fields of science. The resulting report was published late 2007 and makes very interesting reading.

So if the warnings were ignored…why and why have those who ignored them not been punished alongside those who, knowingly, flouted regulations in relentless pursuit of personal and Corporate reward at the expense of all else? 

WHO in their right mind thinks for one minute that more, different, regulation is ever (ever) going to be the answer???

More regulation is more complexity, more cost, greater fragility and less customer value…

Black Swans: A Corporate Governance “blind spot”

“…complexity breeds complexity, and is subject to diminishing  returns. Eventually the costs of increased complexity exceed the benefits” Prof John Kay

Regulators v Barbarian hordes

BP Report: Black Swan …or just a bird covered in oil!?


Does complexity guarantee “system failure”? (revisited)

Even before this event became highly politicized it was shaping up to stand as a 21st Century monument to a culture of Corporate mismanagement: Economy before ecology! The incentives to “cut corners” were simply too great. I have argued before that, all too often, sound risk management comes a poor second to generating profits.

It tends to be “dressed up” as compromise…until it hits the fan!

Anyone care to draw a line?: Global financial meltdown – Toyota – Gulf of Mexico spill – ???

This was/is a hugely complex operation requiring enormous financial and human resource. A tight chain of command communicating and coordinating across several companies. Undertaking a range of interdependent functions as part of a feat of engineering that would not have been possible just a few years ago. NO SCOPE TO TAKE CHANCES, TO CUT CORNERS OR TO BE ABLE TO CONTEMPLATE GAMBLING WITH THE ECOSYSTEM OF A VAST AREA.

Even a company like Toyota (Lexus), whose reputation for quality was well-deserved, were tempted by the lure of $100m per annum savings! I’m sure someone better informed than me has already worked out what their direct financial losses have been, in addition to fines, settlements and the long lasting reputational damage for a proud brand.

BP said in a statement that the report, like its own investigation, had found the accident was the result of multiple causes, involving multiple companies.

Read more of this post

Does complexity guarantee “system failure”?


According to one journalist, whose speciality is deconstructing accidents, it does (see below). Naturally we at Ontonix would like to respond to this statement:

When complexity reaches the point of “critical complexity” system functionality is lost and failure can ensue.

System  complexity can be managed…that is what we do! More Complexity Facts from Ontonix


Nevertheless this is an interesting and worrying observation. One that, when taken in the context of Global Financial Services, begs the obvious question: Read more of this post