While I have been (fairly) consistent in my criticism of the regulators, it should also be noted that there have been some serious failures at some banks, as well. In this sort of context, it is fairly obvious that the failures have either been in the risk management departments, with senior management or both.
Leaving aside the sorts of groupthink that Steve Edney identified in an earlier comment, the fact remains that banks have not had enough liquidity in reserve. Note that I have not said capital – most of the banks had enough1. Once the rumours started (and Lehman’s is a good example) the banks’ reactions seem to have been first to disbelieve that anyone could believe the rumours and then go into panic mode, seeking bailouts.
This is where liquidity risk has not been managed well – risk management have not been running scenarios that included this situation, management have not been demanding that this situation be tested and there have been insufficient contingency plans drawn up. “Run” scenarios have not been tested.
None of this is exactly rocket science – and it is certainly less difficult to run a few of these scenarios through your plans than it is to deal with this sort of outcome – seeing your entire life’s work suddenly shunted into another bank because rumours started. The rumour does not have to be factually based, either. Risk management should not be only about making sure the truth is covered.
From management’s point of view there should be plans already in place.
- Staff should already know exactly what to do – and should be reassured regularly that the bank has enough to see it through. This should already be happening now – the weekly staff meetings should have accurate and timely information about the bank’s position.
- If you are using outside people to deliver cash to the branches, make sure they are included in your contingency planning. Ensure they have enough trucks to deliver to all your branches quickly. Nothing will spread faster than the news that one of your branches has run out of cash.
- The media must be on side. Journalists that can contact you – and you have already contacted – will be the most ready to help in a crisis of confidence. Make sure you know the local news journalists well. They may print the rumour, but if they can get hold of you and they have believed you in the past they are more likely to discount it in the articles they write.
- Make sure you have contingency lines. Big ones at the moment.
- Dry run the tests – do simulations. They may not be exactly match any actual scenarios but if everyone knows their part panic is less likely to set in.
- Now is not the time to hunker in your bunker. Disclose more. Let your customers know on a fairly continuous basis what your reserves are. Fear is what causes panic. Do not let it even begin.
If you have good liquidity models in place, use them. Unlike a year ago, there are now plenty of examples of runs developing – check which ones you could deal with and which you could not. It is the arrogant banks that think “this could not happen to me” that get caught in the headlights.
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1. I am not aware of any banks that have failed recently because they had a negative net worth as a going concern – or even below the Basel (I or II) limits. Please fell free to correct in comments. Even if there have been one or two, most of the failures have been liquidity based.
4 comments
28 October, 2008 at 22:35
Andrew
Are you really serious that banks like Lehmans that failed did not fail because they were seriously damaged by over leverage and holding toxicity on their books at inflated imaginary values while simultaneously adhering to levels of reserves that by any measure of prudence seem dangerously low?
You seem to be arguing that because Basle 2 enables a bank to over lever then banks that fail were well managed and were unlucky?
Are you really saying that or am i taking you out of context?
Thanks
28 October, 2008 at 23:13
Andrew
In Lehman’s case have a look at the piece in the Economist.
Basel II does not allow banks to “over lever”, in fact it is quite conservative in the leverage ratios allowed. In the US at the moment, however, they are still on Basel I, which is much more primitive.
29 October, 2008 at 14:09
graemebird
Notice that capital requirements were useless in this case and the only thing that matters is the implied RAR.
Also notice the real reason that they let Lehman drop and not the others. Lehman was bringing its leverage down and coming within the restrictions of legality under the supervision of the SEC. Hence it could be trashed without worrying that someone would go over the books down the road and start throwing bankers in jail by the bushel. Then they had that big hearing. Thats one way to wear people down. Have all these hearings where nothing is going to be found.
Whereas if they had allowed a bunch of other characters to come under court scrutiny it would reveal a trail of dodgy behaviour that lead in all directions.
The performance of Paulson and Bernanke is a disgrace. Because when there is a run on the banks the place is supposed to close down and the books are supposed to be opened in bankruptcy court. THIS HAS NOT BEEN ALLOWED TO HAPPEN. These bankers were supposed to be too frightened to shell out money. But look what happened to Washington Mutual!!!!! The books were never opened. The doors never closed. Instead another bank suddenly finds out it is flush with cash and can afford to make the sudden purchase of Washinton Mutual without knowing whats in its books. This implies massive stealing on the part of Bernanke and Paulson in the form of gigantic cheap loans or worse. Lehmans shareholders are ripped off and yet almost no-one is fired.
Never have we seen the deterioration of standard principles of law and transparency as we have seen in the last few months. Its a total disaster. An orgy of thieving.
29 October, 2008 at 17:34
Andrew
Odd, Graeme. Something I do not entirely disagree with you on. Overstated perhaps – and I am not sure about the thieving bit.