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Most of us feel that auditors should indeed be worried now. After all, none seem to have been raising any alarms over the extent of bad loans accumulated by major financial institutions, or over risks that banks exposed themselves to through entering into derivatives contracts they claimed they understood but did not. And now many hold auditors at least partially responsible for the ensuing debacle.

For some audit firms, the time of reckoning seems to be approaching fast. However the degree of their concern over legal action will depend on where the firms are operating, and global or US-based firms are at greatest risk of coming under close scrutiny in the courts of law.

Read the rest of this entry »

Yesterday interest rates in the UK were slashed 1.5%, an unprecedented move which literally drew gasps of surprise from the City of London. At most perhaps 1% was expected.

Recapturing the initiative: The move was meant, the Bank claims, to be that decisive step in dragging the country out of the unfolding recession. But it seems that the investors were not impressed. UK shares continued falling on the day and the FTSE ended up 5.7% lower.

The Bank is seemingly trying to re-capture the initiative so that it is seen to be in control of the economy. It does not feel like it is in control, though, and the latest surprise interest rate cut feels like a knee-jerk reaction to events.

Economic outlook: UK interest rates have been quite high for some time and the Bank of England has been trying to micro-manage its inflation targets by fine-tuning its rates at 0.25% at a time. It lost track of the bigger picture long ago, being obsessed with inflation for way too long. Now the economy is shrinking, unemployment is on the rise, no-one is lending, no-one is spending, the markets are unstable and panicky and the financial system is in a mess. And they think they are going to be seen as leaders saving the day with a rate cut out of the blue? I don’t think so; too little, too late.

The rates should have been cut much earlier, then they could have had an impact when it mattered. That was at the latest at the start of 2008.

Retail banks’ response: One of the reasons this is not going to be an economic remedy that the Bank of England wants is to be is that retail banks are going to pass on as little of the rate cut as possible to their customers. Retail banks are in a big spot of bother themselves, needing to regroup after the credit crunch contraction set in and wiped out their balance sheets assets.

Being aggressive competetive profit-making organisation (= or fat cats as others will call them) that they are, they have no altruistic tendencies to help out consumers in need of cheaper credit – they are out to squeeze as much money as possible out of all of us.

We might argue it is socially irresponsible to act in this way when they ended the global economy in an unprecedented mess. But banks are exactly that – always have been – probably always will be – out for themselves. At best they will say they are serving their shareholders’ interests, although I have argued
before that often these are just lofty words of intent.

Yesterday’s interest rate cut will benefit banks which will now be able to secure cheaper credit for themselves at the time when credit is scarce. Banks are not going to willingly give all of this money away to its customers by correspondingly reducing their own lending rate and thus eliminating their chance of taking a profit, at the time when they are making losses on their past bad loans and derivatives transactions gone sour.

Lend me an umbrella: The confidence in making sensible lending decisions has been shattered by recent global events and it will take time for banks to start being cooperative once again. Remember the saying

“A bank is an institution that lends you an umbrella when the sun shines, only to take it away when it pours”.

We are seeing this process in action right now.

Low confidence is driving the recession: So if the government wants for retail banks to re-start lending, it is a bit like ordering the water to flow upstream. Lending policies are being drastically tightened, tolerance of customers in arrears is probably approaching zero, and rate cuts are not being passed on in a desperate bid to increase banks’ own profitability.

The promise of a recession is as ever becoming self-fulfilling, and we seem to have little control over this downward spiral at this stage – until we think we’ve gone far enough and confidence starts returning again.


Copyright 2008 by CuriouslyInspired

The role of stratospheric banking bonuses in encouraging the culture of greed and excessive short-term risk-taking by bankers has now been fairly widely publicised in the context of the financial meltdown of 2008. Is this the full story, however? Should bonuses be reduced, controlled, set differently, or abolished altogether?

Conflicting interests: The biggest problem that massive remuneration packages cause is the misalignment between the interests of bank executives, who want to maximise their year-end cash reward by any means open to them, and the companies’ shareholders, who are interested in long-term growth and stability of their investments. There is thus a different appetite for risk between these groups: bankers are risk-takers as incentivised by their pay structure; shareholders are much more risk-averse.

Banks’ top management will say all the right things about the duty they have to responsibly manage their shareholders’ investments. The truth remains, that if one’s banking bonus is many times the basic salary, in the heat of daily deal-making and profit-chasing it seems all too easy to forget this duty to the ultimate investor. It seems that presently, there is no 100% effective mechanism ensuring bankers are fulfilling their responsibilities to look after this money.

Ultimately, if a banker messes up and loses their firm a lot of money, they tend to be able to find another job elsewhere. And they might not feel strong pangs of conscience – as the money they gambled never felt like it was their own, duty to the shareholder forgotten, and their own assets retained. However if shares become worthless, shareholders feel the pain immediately as it was their own money.

Fancy words: Whilst banks’ management will all say (in AGMs, on their mission statements, in the press, etc) that they aim to maximise shareholder value, effectively they often allow more junior staff to do this with risky strategies that take a short term view despite being long term in their execution. This can backfire like it did with sub-prime mortgage investments in America: bankers who packaged these very dubious loans and sold them on as over-rated investment bundles only wanted to earn a bigger bonus in that particular year.  

Internal compliance and risk control departments – here to give comfort to senior management that all is well – cannot have kept tabs on such activities effectively, otherwise banks would not have gotten into trouble.

Thus we have a lack of accountability of the real deal-makers, plus a disconnect between senior management’s eloquent words of responsibility to shareholders and the reality. The few high-profile court cases where senior people were brought in before legislative bodies to answer for the negligent financial misdeeds of their firms are presently the exception, not the norm. And the real deal-makers are never being brought in to answer.

Banking bonuses in recent years: Let’s look at some recent numbers.

UK: In 2006, 4000 people earned more than £1m each in bonuses in the City of London.

In 2007, with the global credit crunch already in full swing, City million-pound bonuses seem to have been given to over 4200 people. In total, the City paid out about £14 billion in bonuses for 2007 to 1 million City employees – an increase of 30% on 2006 (2006 bonuses: $10.9bn. Source – Office for National Statistics (ONS) ).

Overall, bonus payments in the UK financial sector have more than trebled since 2003, when about £5bn was paid out (Source: ONS).

US: Wall Street bonuses were approximately $24 billion in New York City for 2006. In 2007, despite the credit crunch, mounting billion-dollar losses and write-downs on Wall Street, bonuses were $38 billion.

So, we can see that bonuses have been on the rise up until 2008, the year when the proverbial really hit the fan. Bankers have been heard justifying the increase in 2007 bonuses citing large profits of early 2007, before the credit crunch really hit. Yet again, it just shows bankers taking a short-term view of their activities.

Are bonuses to blame for the current crisis?  To some extent, yes, although there is a danger of over-focussing on bonuses themselves as THE only culprit.

We have seen how the promise of bonuses can encourage short term irresponsible risk-taking. But some trading strategies can yield large profits in a short space of time and not destabilise the bank.

What is really missing is the ability of management to assess the riskiness of activities of its deal-makers, and adjust their bonuses accordingly – not just look at the bottom line profit number earned in the current year.

For instance, if the effect of banker’s transaction can be felt over several years, rewards for its success should be deferred and spread over a number of years years and not paid immediately. So if a deal goes sour in the longer run, the individual will not get rewarded for it at all.

To encourage longer-term view of banking, more bonuses should be paid in shares or options rather than cash. Such share or option schemes can be sellable only several years down the line, encouraging the individual to stay with the firm, work hard and wait for their incentive schemes to come into force.

And I think that there needs to be more accountability by more layers of bankers – not just top CEOs and an odd rogue trader. Regulations should be watertight so that irresponsible behaviour is easier to spot and stop, and if need be taken to court.

Will bonuses be reduced? In the short term, definitely. 2008 bonuses are expected to fall 60% in the City.

However big bonuses are probably here to stay to some extent. This is partially because bankers make big investments to get top jobs (an MBA can set you back £100,000) – and give up their personal lives for their careers.

But crucially, I feel that the external regulators and internal risk controllers must step up their game and play a strong role in defining the guidelines and recommendations on how banking rewards should be set. The objective is to incentivise responsible risk-taking behaviour that takes a long term view.

If this line is taken and successfully implemented, then surely rewarding some exceptionally hard working bankers will not be such a big deal – as long as we know they are taking good care of our finances?

Then I would suggest the answer becomes – bonuses should to some extent be controlled through following new regulatory guidelines and should be set using different methods and types of incentive, but not abolished or reduced on a whim.  

… but the culprit goes unpunished today: What hurts most is that even as the global credit crunch is unravelling this year, bankers who caused it and earned their massive bonuses in recent years are currently in the Bahamas sunning themselves not knowing how to best spend their money.

Apparently there is a real shortage of luxury accomodation in exotic tropical destinations.

And that really shows that we are letting the real culprits get away with it today.


Copyright 2008 by CuriouslyInspired

As the BBC reports,

Iceland has suspended trading on its stock exchange in an attempt to prevent further panic spreading throughout the country’s financial markets.

Iceland’s stock markets will be shut down at least until start of next week. The reason for this unprecedented move is to give the government some breathing space to decide what to do next, and attempt to take the panic out of financial markets by simply keeping everyone away for a while.

This leaves Iceland in “good company” with Russia, whose stock markets were shut most of Wednesday due to huge falls in share prices, and for at least an hour on Thursday. In contrast to Wednesday, Russian stock markets were temporarily closed due to massive gains. Lucky them (but will it last?)

Collapsed banks update: Iceland is in a total financial mess with all its top three banks either nationalised or in receivership. Glitnir, which the government was aiming to part-nationalise earlier, is now in the hands of liquidators, as the government realised it was in too much trouble for the state to take on. Now Kaupthing, the largest bank of the three banks most in trouble, has been nationalised in addition to others.

Cause of troubles: I wrote about the causes of Iceland’s troubles very recently. “Troubles” is a bit of an understatement. People in the capital Reykjavik have already staged one demonstration this week and there is bound to be more civil unrest to come. Iceland might not have money left to import food stuffs for starters, so the collapse of the financial sector will have a very real impact upon everyone.

War of words with the UK: Gordon Brown and the Iceland’s PM Geir Haarde are engaged in a bitter battle of words at present. The UK has large investments in Iceland accumulated over the period of the Icelandic financial market boom. Now that the bubble has collapsed and banks have gone bust, Gordon Brown wants some guarantees that Iceland will honour UK savers’ deposits in collapsed Icelandic banks, as UK taxpayers will otherwise have to foot the bill in addition to bailing out British banks. Usually Iceland would have offered a guarantee of $28,400 per account but this has not been forthcoming in this case for the UK investors. The UK Government froze Iceland’s top bank Landsbanki’s financial assets in the UK. Icesave, the online savings bank with 300,000 UK customers, is a subsiduary of Landsbanki.

Geir Haarde is retaliating by saying, as Bloomberg reported today, that

the U.K. government is to blame for triggering the crisis when it used anti-terrorism laws to seize the assets of Icelandic banks in the U.K.

Iceland is also extremely unhappy that none of its usual Western partners have been forthcoming to lend it any money to help in its current crisis. It has had to look to other partners, including Russia and the IMF (International Monetary fund), to obtain money.

The row between the two PM’s is not serving to calm the panicked markets. The UK share prices is in freefall today and the pound is also falling against many key currencies.

Icelandic Currency collapsing: Iceland’s currency, the krona, was pegged to the euro before the crisis hit, at a rate of 131 krona per euro. Now that the government has stopped attempts to support the falling currency and formally abandoned the peg as unsustainable, trading conditions before markets shut down indicate that the currency is now worth about 255 krona per euro. That is a 91% drop in the value of the krona over the course of less than 2 weeks.

Bankruptcy: What is happening is pretty unprecedented for this country: Iceland is now facing bankruptcy. It is not in a position to repay the debts its banks have clocked up.


Copyright 2008 by CuriouslyInspired

There’s lots of hot debate at present as to why the US Government is supporting the Bailout plan in its current format. The people I’ve chatted to over the past few days all strongly disapprove of the plan. We keep coming back to the same question: why is the Bailout progressing in its current shape and form, whilst there seem to be alternative proposals out there – which are not being publicly debated?

Pressure for any solution: I put an opinion forward that there was pressure to adopt a solution, any solution, because the world economy is in unchartered territory (an unprecedented mess), economists don’t know what policies to adopt that work best in this situation, and there is panic in governments from not knowing who to turn to. Quick action of sorts is seen as better than inaction.

Merits of inaction: Inaction might have its merits, although it is an election loser in the USA. I wrote at length recently about why absence of any Bailout might actually be an option (a very painful one, indeed, possibly an equivalent of entering another Great Depression) – compared to a lengthy, expensive, painful, AND untested solution of the Great US Bailout.

Theory on Government paying off financiers: More interesting speculative thoughts as to why the US Government might be keen to rush into the Paulson plan was presented by Dandelion Salad on the 2nd of October. Quoting them –

What is happening is that the Bush administration is engineering a massive raid on the Federal treasury to pay off the people within the financial industry who have been operating the housing scam because the politicians told them to do it. This is hush money.

The people in the financial institutions who are getting the money will be passing it on to the big banks that leveraged their criminal lending practices. The giant sucking sound you hear is almost a trillion dollars of future taxpayer earnings going into the vaults of the nations’s biggest banks, such as Citibank, Bank of America, and—the pet bank of the Rockefeller family—J.P. Morgan Chase. Much will also go into the vaults of foreign investors such as the Bank of China.

A scary thought, isn’t it? I don’t think this is exactly the whole story of what is happening, but read the whole article – it’s a pretty interesting read.

Further slump in US stock markets: As a closing thought, a comment about current stock markets. Despite the Bailout plan being adopted in the US on Friday, US markets actually closed lower last week than they started on Friday, having temporarity risen during the day.

The newest shares slump reflects fears that the $700bn Bailout package might not be sufficient to provide enough liquidity in the markets to prevent a US recession. In economic speak, “expectations of the Bill being passed were already incorporated into stock markets” so once the Bill was adopted, the market looked to new information to respond to – and this came in the shape of rising unemployment figures.

Whatever happens next, we’ll have to try and keep a cool head, tighten our belts and ride out this storm. There are no miracle pills to take that might make this landing any softer.


Copyright 2008 by CuriouslyInspired

I did not know much about the economy of Iceland until 2 days ago and confess I still only know the basic facts. And unless you are from Iceland or have a specialised interest in North European economies, you are probably in the same boat, my reader. However this issue captured my interest yesterday in light of my recent note an outside chance of US Government bankruptcy linked to the bailout – as I was trying to contemplate its impact.

A small economy: Sure, Iceland is a very small economy, but it is – or was? – a well-off country. Its population is about 300,000 as of mid-2007 but boasting a (purchasing power parity) GDP of $40,400 per head of population. It compares very well to UK’s $35,000 and US’s $45,800 per capita GDP. (source: CIA statistics referred to in Wikipedia, 2007 estimates). For the number-crunchers amoungst you, this is a GDP of $12bn. Another figure quoted sometimes is £20bn. This is calculated using a different method – using an official exchange rate – but is also a valid number.

Days of plenty and the outcome: In the past few years the Icelandic economy has been undergoing a huge boom fuelled by the financial sector. Iceland paid high interest rates so was very attractive to investors. Its banks were finding it easy to borrow heavily from low interest rate countries, and then re-invest in foreign business opportunities (mainly the UK). The BBC described this phenomenon as the carry trade. This development can be seen as a manifestation of the global credit bubble finding another outlet to develop over the past few years.

Huge debts: As the result, Icelandic banks managed to accumulate $120bn worth of liabilities. Depending on the method of calculation, this is either 6 or 10 times the GDP amount and it is a catastrophically high figure. Why is this a problem? Because Iceland does not have the income to service interest payment on such a colossal figure, let alone repay it. So the Government will not be able to bail out everyone who needs a helping hand.

Just a few days ago, the 3rd largest bank Glitnir has been nationalised. The other 2 largest banks are currently running the risk of bankruptcy with no bailout to rescue them.

This was expected: Concerns have been voiced over the past few years over the unsustainable nature of the financial boom and many have been warning this was a bubble that was bound to burst in a nasty way. Well, it has now, triggered by the collapse in confidence following September events across the global stock market. The Icelandic currency, the crona, has now fallen 20% against the dollar in the past few days. Inflation is expected to spiral shortly and shops in the country already warned they won’t be selling imported goods anymore. The impact will hit foreign investors if their loans are defaulted on. In particular, UK investors are vulnerable.

On the plus side for Iceland, its Government finances are healthy, and its the non-financial sector is reported to be solvent. How this small nation will weather an unprecedented global financial storm that has broken over its head in the last few days remains to be seen.

Comments and thoughts on this post welcome.

Copyright 2008 by CuriouslyInspired

I stumbled across a great article this morning which explains very well how Central banks (the Fed, the Bank of England, etc) operate on the money markets to inject liquidity into the system in order to stabilise it. This prompted me to consider the bigger question why money and credit is important in an economy.

Central banks and monetary policy: Typically Central banks aspire to maintain a certain target interest rate, and tighten credit (reduce it) when rates are too low, or increase the money supply when the rate is too high when rates are too high. This does not mean printing money: purely issuing notes and coins without reference to economic conditions can and does lead to inflation which, when excessive, is very damaging to the economy (it is outside the scope of this note to consider what is deemed “excessive” or what drives inflation in the first place, although some degree of inflation seems inevitable and healthy). Instead Central banks buy or sell short term Treasury bonds to primary banks (the likes of Goldman Sachs) to manipulate liquidity.

Central banks thus influence available credit through its dealings with primary banks and not small regional banks. If primary banks ceased to exist, e.g. if they went bust, Central banks would lose this existing tool of influencing available total money in the economy.   Read the rest of this entry »

Yesterday, the US Senate backed the financial bail-out bill amounting to $700bn (£380bn). The essence of the plan is to buy up bad debts in order to try and stabilise financial markets through restoring confidence that no other institutions will collapse as the result of existing debts. The ultimate objective is to to keep banks lending – so that the global credit crunch does not take an even stronger hold and completely paralyze the economy.

In order to become effective, the Houe of Representatives have to approve the bill as well. Earlier, this bill failed to pass the House of Representatives vote. Since this first failure, extra modifications were added to make it more palatable to the public, such as additional guarantees of the amount of savings US will guarantee, and tax breaks for smaller businesses to encourage the economy.

At the next hurdle, the bill might still be rejected. There is of course pressure (or strong encouragement) from President Bush and both presidential candidates for it to be passed, which might sway the vote to some extent. But what could the outcomes be of the bill being (a) passed – or (b) rejected – on the markets in the longer term?

Bill passed: The US government will effectively become the owner of devalued assets of the financial firms, rescuing the latter from the mess they were responsible for in the first place. 2 side effects might occur:

  • Whilst the bailout might create greater confidence in the markets of no more imminent banking failures, the US state will be saddled with a huge amount of non-performing (but not completely worthless) assets and hence some degree of increase in its budget deficit. This increase will be particularly large if the US housing market slumps further, making these assets even less valuable. The increase in budget deficit will filter through into the real ecomony and might trigger interest rate rises, deterioration of the economic climate and a deepening of the recession which is already starting to take hold in the US. The recession can be quite protracted and painful as the government might resort to helping banks further, even the technically bankrupt ones (kind of like keeping a dead patient on a life support machine for the sake of preserving appearances). This brings to mind a parallel with the protracted recession in Japan in the nineties where (to the best of my knowledge) the government’s continuous intervention to prop up firms just prolonged the economy’s problems.
  • The bailout reinforces the perception that banks can behave totally irresponsibly and take any unjustified risks, since they will be rescued nevertheless. So the problem will occur again in future – because no-one ever learns! And we will pay for it again.

Damned if you do?…

Bill not passed: The crisis of confidence will resume but magnified many-fold. There will almost certainly be more high profile bankruptcies. The impact and the shock of it will be severe and harsh with wide ranging negative ecomonic implications for the US and the world alike, and it is bound to be very challenging on the people living through it, with an increase in unemployment just for starters. The global credit crunch will squeeze everyone even more strongly.

A part of me keeps coming back to this thought though – in this case, although the resulting downturn will undoubtedly be very severe, maybe it will not be as prolonged? Maybe with careful macroeconomic management after all the bankruptcies have happened, the US economy will actually have solid foundations on which to build long term recovery?

The collapse of the financial system might be a price too high to pay for this though.

Damned if you don’t, then.


I welcome people’s feedback and comments on the above.

Copyright 2008 by CuriouslyInspired

It’s pretty scary out there in the world of finance right now. Apocalyptic predictions of further meltdowns are rife and, to be honest, even if we ignore the scariest over-the-top forecasts we know that we are in for a tough ride.

I was getting carried away 2 weeks ago commenting on the events in the banking world as they were unfolding, but taking several days off temporarily cured me of this obsessive watching and recording of the crisis. I might come back to that in due course, but meantime I wanted to refocus instead on my own perspective of events, which really is the purpose of this blog – in this case to talk about bad staff management techniques I have seen in the banking industry.

I spent 10 years working in banking in various support roles, most recently in project management and IT. It was great around 2000 – money was abundant and life was fairly easy. Maybe not 9 to 5, but looking back it feels like we got paid quite well for doing an average job and not straining ourselves beyond sensible limits. To be honest there seemed to be a fair number of people around who were getting away with not doing anything much and still got paid. What we did was a skilled job, of course, requiring knowledge of finance, accountancy, or IT, and there was of course a degree of stress attached to delivering things correctly and on time, but generally it was a time of plenty – of money, bonuses, opportunity, and jobs all easy to come by. But then it got a great deal harder. Read the rest of this entry »

Yesterday two major investment banks suffered a steep fall in their share prices following a continuing slump in investor confidence. To survive, banks need to raise a large amount of cash, something that is extremely challenging at present due to the credit crunch – no-one is prepared to lend money to troubled institutions.

The problem with Goldmans took most by surprise as its trading results have been strong. However rumours about Morgan Stanley’s large bad loan portfolio have been circulating for a while.

The two banks are the only remaining institutions that focus entirely in the investement banking business, with currently no involvement in commercial (retail) banking.

Separation of investment and commercial banking: In the 1930s, the Glass-Seagall act was passed in the USA which separated commercial banks (which take deposits and make loans), from investment banks (which trade securities). The investment banks were allowed to do business with less oversight, while commercial banks were tightly regulated. This law was repealed in 1999, and as the result commercial and investment banks started merging their operations.

Cause of the Credit crunch: It’s a simplified story, but here goes: Increased competition between banks in the last 10 years put pressure on profit margins and forced investment banks to start getting very creative with complex and risky financial instrument strategies. Credit derivatives were born and exploded exponentially as the major growth area in financial markets. At some stage recently they started getting packaged up into complicated bundles of credit instruments, the risk on which was incorrectly assessed by the market. When bad debts on the US mortgage market started mounting up due to customer defaults in the last couple of years, banks started seeing the complex credit instruments sitting on their books turning worthless and becoming bad debts on a major scale. As banks were all exposed and started suffering from the same problem, they all grew reluctant to lend spare cash to each other, preferring to hold onto it in case of further trouble. This effect rippled right through the system and resulted in retail banks being reluctant to lend money to customers like you and I. The Credit Crunch was born.

Morgan Stanley strategy: Both Morgan Stanley and Goldmans, and other investment banks were heavily exposed in their credit investment portfolios. As the result of yesterday’s share price falls of 24%, Morgan Stanley is now seeking a merger to secure its survival. It is now in talks with Wachovia bank and also with Chinese sovereign wealth fund – China Investment Corp (CIC). CIC already owns 9.9% Morgan Stanley. Reportedly, Morgan Stanley has $120bn of “toxic” mortgage assets on its balance sheet. A merger with a retail bank will diversify Morgan Stanley’s pure investment banking focus.

Goldmans Sachs is denying that it is looking for a merger. The FT has some good commentary about Goldman’s opportunity to consolidate its strength in the investment banking sector, if it somehow manages to raise capital and weather the storm without resorting to a merger: see link


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