Banks trying to maintain profit growth in an era of low interest rates and executives who refused to think the unthinkable were responsible for the financial crisis and crucial lessons remain to be learned, says the CEO of Equitable Life.
Speaking on the 10th anniversary of the collapse of Northern Rock, Chris Wiscarson, current chief executive of Equitable Life, which itself collapsed seven years before the financial crisis, says that lessons were not learned from the insurance company's 2001 downfall and that there are lessons the financial services industry must still learn.
He begins with a quote from March 2007 by Ben Bernanke, then chairman of the US Federal Reserve: "The impact of the broader economy and financial markets on the problems in the sub-prime market seems likely to be contained."
"This failure to think the unthinkable at the very pinnacle of financial governance is something that has to be addressed and, in truth, it hasn’t been," Wiscarson says.
Low interest rates
The era following the dotcom bubble saw interest rates lowered to multi-year lows and in many large economies they have never again reached the levels that were seen as normal in the 1990s or 1980s.
For Equitable Life, guaranteed annuity rates of 5% or more were unsustainable. For many banks, maintaining profit margins was equally difficult and the problem could only be addressed in one way: make more money.
Financial institutions had essentially three means of doing this:
- Sell more
- Charge more
- Cost less
Consumers don't take kindly to charges for services such as banking. Meanwhile, cutting costs in the ways then available to banks – closing branches – is hugely unpopular with the public.
This left selling more. Selling more requires innovation and innovation entails greater levels of risk.
“Complex products and risky business models were significant contributors to the Equitable Life and Northern Rock crises," says Wiscarson.
And, of course, it turns out the whole global industry was up to it. Once the US subprime mortgage market and its credit derivatives popped, most major banks were exposed and the biggest casualty became Lehman Brothers in September 2008.
Thinking the unthinkable
A typical response to history repeating itself has always been: "This time it's different."
This, says Wiscarson, was the mantra in the months leading up to the financial crisis.
A combination of poor governance, steadfastly secretive corporate culture and the lack of any experience in the financial sector of crisis management exacerbated and lengthened the crisis.
"For sure, the next crisis is different," says Wiscarson. "That is why we need to think the unthinkable, and that is why non-executive directors need to ask the executive team again and again: but what if?"
Lessons not learned
While it was complex products and risky business models that were the main contributors to the crisis, technological developments over the last decade have re-introduced complexity to the industry.
"Many financial services products are based on complicated and often impenetrable models," he adds.
Regulators such as the Financial Conduct Authority (formerly the Financial Services Authority) and its counterparts in Europe, the US, China and elsewhere have sought to address weaknesses in governance.
Risk managers, however, are never short of potential hazards that threaten the industry from the inside and out.
The new threats
While post-crisis regulations, such as the Basel rules on capital requirements and Mifid rules on transparency and regulatory reporting aim to minimise future systemic threats to the financial industry, the institutions themselves are not being proactive enough.
Recent cyber attacks on institutions across the globe – including the US defence department and the UK's National Health Service – show that some of the balance of risk has shifted.
Further risks to the industry have been added by Brexit and the approaching unwinding of years of quantitative easing and there are few, if any, executives in financial services that have experience of these.
It is important, therefore, that banks and other financial services companies respond. The executive team must learn all they can about future risks by attending seminars and industry conferences.
The industry needs chief executives who have a belief in what they are doing and who are able to convincingly disseminate their views, but they must also be able to take on board the views of junior executives.
“Every financial services board should have a non-executive director who is an IT professional, conversant with today’s technologies, and another who is a seasoned operator in crises," says Wiscarson.
He adds: "Executives will then have to demonstrate capability in ‘thinking the unthinkable’ about what may come to pass and how they might deal with it."