Ghosts of crises past

“What is it about banking that sees us making exactly the same mistakes all over again? Why do we find it so difficult to learn the lessons of the past? These are questions,” the FSA Chairman LORD TURNER told the Institute’s Chartered Banker dinner in Edinburgh, “about the very cores of banking. They’re questions that bodies like the Institute can help us answer.”

We need to Rediscover the policy tools which we had 30 or 40 years ago – and then threw away. We need to return, in some respects, to the absolute basics of good banking – exactly the sort of issues which would have been discussed at the Institute four decades ago.”

When Adair Turner, the UK’s senior financial services regulator, took the Institute and its 500 dinner guests on his tour of the banking crisis last month, he defined several challenges for the Institute itself.

Both in his keynote speech and in his interview with Chartered Banker, Lord Turner examines the failures of banking practice and risk management that were among the dominant characteristics of the “ghosts of banking crises past” which had returned to haunt this one.

“One of the things I’ve been struck by is that quite a lot of what went wrong across the world, but particularly in the UK, wasn’t all that complex. It was plain old, standard, banking problems all over again. Let’s be blunt, what went wrong often wasn’t a heavy involvement in complex trading activities, structured credit and credit derivatives.

“What went wrong lay, first, in the arena of commercial real estate lending – not in a securitised form, just as classic on-balance sheet lending – and, second, in an over-risky reliance on wholesale funding.

“The core of many of the problems in the UK system – Northern Rock, Bradford & Bingley, HBOS and part of the story at RBS – wasn’t about fancy new complex derivatives traded in London and New York.

“It was actually plain old banking – it was about good lending and sound liquidity policies. And one of the striking things about this banking crisis is that the ghost at the feast of all past banking crises – Japan’s and Sweden’s in the early 90s, the US savings and loans crisis in the 80s, the UK secondary banking crash in the 70s – that same ghost was here again: that’s commercial real estate lending.

“If you look at the losses being faced across the world but particularly in the UK….the percentage of the total losses which come back to commercial real estate lending is really quite startling.

“So, one of the things we have to ask ourselves is this: in addition to the new things we got wrong this time, why is there something about banking which sees us making exactly the same mistakes all over again? These are questions that bodies like the Institute can help us answer.
They’re questions about the very cores of banking – why do we find it so difficult to learn the lessons of the past?”

In his interview with Chartered Banker, Lord Turner stresses the importance of changing the culture of banking, but doubts whether this can be accomplished by the regulators alone. “I think we may have some ability in our supervisory inquiries to identify banks which have an over-strong sales culture, a culture too much focused on short term results. But it will be very imperfect. Issues like culture are very difficult for top management to get right, but even more so for an outsider like a regulator to make much difference.

“The Institute ought to be able to help. The issue is whether, in its training programmes and Continuing Professional Development, it identifies what we really mean by ‘culture’ and ‘professionalism’.

“There are some fundamentals. When you’re selling products, for instance, do you truly know in advance what the customer’s needs are? That was one thing that went wrong. People were sometimes selling things which either they knew were potentially toxic or, if they didn’t know, they were equally culpable for not knowing. Most, I think, had simply not worked out what the consequences of these products were – and clearly didn’t care.”

His definition of banking professionalism, he adds, means “making sure you serve your customer’s needs, even when you could make money out of not serving those needs. That’s a really important bit of professionalism and, in some important respects, that’s what broke down.”

Other aspects of professionalism are about what he calls “classic, traditional banking virtues – a degree of caution about the way the world is rather than allowing yourself to get overcome by the hype. This is not an area where we as a regulator have a clear set of answers, but we’d certainly welcome some careful thinking from organisations like the Institute.”

As banks work to restore the trust of the public and customers, Lord Turner agrees there is as large a need to restore society’s trust in the regulators themselves. “We’re trying very hard to restore trust but it’s not an easy environment because, when things go wrong, people will look at the regulators as well as the banks and say: ‘You did it wrong. You must have screwed up.’

“Now, we’ve been completely honest. In our internal audit report on Northern Rock, we set out the mistakes we made in its supervision. And, in the Turner Review, we’ve explained that a lot of our philosophy of regulation – the over-reliance on free markets, our over-confidence in innovation – was over-simplistic and has to change.

“We have made mistakes and we’re in the process of putting them right. We hope that will slowly restore confidence in the regulators. But we realise that, once you lose trust, it takes a hell of a lot of time to win it back, however hard you try.”

On customer protection and fair treatment, says Lord Turner, “we’ve all ended up – banks, regulators, customers – being very dissatisfied with the history of the last 20 years in which, frankly, there’s been a mis-selling scandal virtually every 2-3 years – personal pensions, endowment mortgages, structured products like split capital trusts and now there’s concern about payment protection insurance. “

And, in each of these we’ve played the role of forcing the industry to sweep up after the challenge, requiring customer redress often running into hundreds of millions of pounds. This just isn’t any way to develop trust. So we need to have enough engagement with how firms design and sell products to make sure these things don’t happen – rather than sweeping up the mess afterwards.”

But he doesn’t see the need for a more proactive and inherently more confrontational regulatory approach as a purely UK phenomenon. “Steadily across the world throughout the last 25 years, there was a rising belief among central banks, finance ministries, regulators and in academia that we could trust the financial system to be self-correcting; it would all work out OK. “

And, even if some things looked a bit concerning because we didn’t really understand them – like the explosion of credit default swaps or structured credit – we just knew as an axiom of economic theory that the free market was bound to make it all OK.

“That was the Greenspan doctrine, and it was wrong. It had a pervasive effect in many countries and it came to grief in the crisis of 2008. Alan Greenspan, in his testimony to the Senate, told how shocked he was to discover what he called a ‘flaw in his thinking of the last 30 years’. Well, he was right. There was a flaw!”

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