The following is the fifth in a series of articles on bank risk culture. The previous articles can be accessed here or by clicking the HOME tab on the blog.
No discussion of risk and culture is complete without examining the role of leadership in defining both. This week’s article will demonstrate that poor leadership is the single biggest source of risk to an institution. It is also a source of risk which no amount of risk management or focus on risk culture can overcome.
Thus far, we have been able to establish that it is impossible to separate a bank’s risk culture from its overall institutional culture. In the previous article this was demonstrated by looking outside of banking to the example of Toyota. By focusing on its organisational culture and creating a production system the world now knows as Lean, Toyota was able to produce a high quality product while significantly reducing both product and operational risk.
In contrast, the story of banking and investment banking in particular, is one in which poor leadership has created a culture within organisations which actually guarantees failure in a number of different ways.
Size, The Quintessential Male Obsession
Much has been written about the subject of male egos and the idea that it is because bankers believed that bigger is always best that so many banks became unmanageable, highly risky and doomed to fail.
What many may not understand is that one of the main reasons why banks adopt what I call Death Star (“may the force be with you”) strategies is because it is an article of faith in the banking industry that the top three providers of products and services to a customer get the lion’s share of that customer’s business.
However, given that so many banks imploded like the Death Star while trying to compete head on with their peers, simply growing larger and offering as many products and services as possible is clearly not a good thing. In fact banking failures along with the rise of Too Big To Fail or TBTF are a consequence of two very major failings of leadership within banks.
The first is an inability to think independently and the second is an inability to understand the logistical consequences of their decisions.
Herd Mentality And An Inability To Think Independently
The very nature of leadership suggests an ability to go places and do things and create strategies which are separate and apart from the competition—strategies which in the end distinguish the fortunes of one bank or institution from another. Unfortunately, the history of financial crises over the past 30-40 years is also the history of banks displaying a herd mentality—something which is the complete antithesis of good leadership.
The LDC (Lesser Developed Countries) debt crisis of the 1970s and 80s was about banks competing fiercely for Arab petro dollars and then even more fiercely in the lending of those dollars to developing countries. Afterwards, the banks all suffered together, losing billions of dollars on their LDC debt portfolios.
This was herd-driven behaviour and it was predicated on the herd-driven belief that countries don’t go bankrupt. This was a most painful lesson and given the travails of some EU economies it is obviously one that banks are yet to learn.
During the next ten years, the 1980s to early the 1990s, the leadership within the banking industry had two more opportunities to fully display their herd mentality and they did not disappoint. Thus, even before the LDC debt crisis had drawn to a close, banks chased junk bonds on the basis that a company’s level of debt did not matter (the old Modigliani Miller or MM theory) and then Japanese equities on the basis that Japan was going to dominate the world forever. Both of these episodes ended in crisis and disaster.
The subprime crisis is thus merely the latest in a series of episodes within banking where leaders have run with the herd on the basis of some false new paradigm—in this latter case the seemingly magical qualities of well diversified mortgage portfolios of dubious quality.
Forget about risk management, risk culture, corporate governance, internal controls and all the rest of it. It is not that all these elements are not important because they are very important as well as very necessary. However, what we can clearly see is that until and unless the leadership within banks, that is the Board, CEOs and senior executives, develop the capability to think and act independently of their peers, then banks will always be imperilled and all these other elements will be subverted and rendered irrelevant.
This is irrefutable proof, if ever any was needed, as to why it is impossible to talk about a separate risk culture within banks.
History is speaking to us very loudly and most convincingly. It is telling us that independent thinking—the creation of business strategies, product strategies, competitive advantages and customer approaches that distinguish a bank from its competitors is the single most important quality of leadership and by default the management of risks within the banking industry.
There is one other very important lesson that Boards, CEOs and senior executives within banks need to learn and that is how their decisions make it increasingly difficult not only for traditional product and market risk management but also for operational risk management.
Great Generals Think Logistics
One good thing about banks is something that is commonly known as a “can do culture”. Whether it is a new customer, product or service, the best institutions will always maintain the belief that they can deliver whatever and whenever.
However, this aspect of banking culture is also a major source of the industry’s weakness. This is because one of the greatest shortcomings of major banking organisations has been their inability to properly develop and/or integrate IT and systems that match their business ambitions.
CEOs will make decisions about what products and markets they want to cater to and what acquisitions should take place in order to support their objectives. It is often the case that in these discussions, no one tells the CEO that integrating the IT and systems post acquisition will be an almost impossible task. In any case he (it always is) would not accept no for an answer.
In my over twenty five years of experience within the industry both as an employee and as a consultant, there is probably only one bank I have ever walked into that appeared to have good IT & systems. In some instances the IT and systems infrastructure were simply unbecoming of a major institution.
Many banks now rely on large numbers of systems run on PCs rather than mainframes in a strategy euphemistically known as End User Computing or EUC. This is because banks have largely placed strategy and tactics before logistics.
There is an old saying that poor generals think about tactics and strategy while great generals think about logistics. US General, Robert H. Barrow, Commandant of the Marine Corps put it another way:
“Amateurs think about tactics, but professionals think about logistics.”
Ignoring the logistical challenges of their ambitions, particularly in relation to IT and systems, is a common failure of leadership within the banking industry. It not only increases operational risks but also undermines market and product risk management due to problems with the accurate and timely flow of information. If the information flow is not good then risk culture truly becomes irrelevant.
Now that we have developed a better understanding of the true sources of risks within banks it positions us to better understand precisely what happened during the last financial crisis and why the overemphasis on bank risk culture and governance will not safeguard the industry’s future. That will be the subject of next week’s article.
Jonathan Ledwidge is the author of the book Clearing The Bull, The Financial Crisis And Why Banks Need A Human Transformation (iUniverse).