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Six Triggers for the Next Financial Crisis


Banks are much safer now than before the financial crisis. Or are they? Certainly, if focusing simply on increased capital and liquidity requirements, and closer regulatory supervision. Yet close questioning of bankers, and regulators past and present, throws up six possible triggers for a crisis.

  1. CYBER-SECURITY. Imagine this scenario. A cyber-attack closes down a bank for a week; panicked depositors unable to access their funds form queues on the streets; the regulator is forced to close the bank permanently in a bid to avoid contagion; the strategy fails as queues form at other banks on (fake) news of their vulnerabilities. A former member of the Basel Committee on Banking Supervision believes this could be the most likely spark to trigger the next financial crisis. Another scenario is a cyber-security attack into any part of the wholesale infrastructure, say the estimated $542 trillion derivatives market, which would cause widespread panic as the global system shut down.

    In the words of an investment banker with knowledge of the subject: “Of course banks spend lots but as their IT departments are full of contractors and senior management is clueless, the spend is wasted. Their systems are weak, they don’t talk to each other, and are very vulnerable.  It’s impossible to trace where an issue has happened and to fix it.”

    Only big banks will be able to afford the enormous amounts needed for proper cyber-security. “Banks need military grade cyber,” asserts the former regulator. New ratings will emerge for a financial institution’s cyber safety. Those with anything less than triple AAA could find themselves frozen out of the wholesale markets. The inevitable consequence is consolidation: small banks will be gobbled up.

  1. TOO BIG TO FAIL. An ongoing theme in this column, on which I have been proved wrong. So far. Writing about The Precariousness of JP Morgan Chase in 2014 and suggesting readers should sell, was an abysmal stock recommendation. Yet further consolidation of the financial system in countries from Spain to the US – an outcome of the financial crisis and of the ensuing regulation – has concentrated the risk. The taxpayer will more likely have to bail out the giants, notwithstanding the tough regime for Global Systemically Important Banks (G-SIBs).

  1. RISK CONCENTRATION. Risk is also more concentrated now due to “significantly greater harmonisation on, for instance, the risk weighting of assets, the prudential rulebook and accounting standards…it means if something goes wrong, it goes wrong for everybody!” notes the Non-Executive Director of a bank. She points out that in 2008 it was the diversity of standards which helped reduce the problem in some countries. France, for instance, did not apply mark to market accounting, and Canada applied heftier capital standards.

    In the 2018 harmonisation recipe, lending to the real economy for investment has generally fallen, while another mortgage bubble in residential property has been created.  There has been a sharp drop in the diversification of business models. Excessive to overvalued property could yet again be the catalyst. Even more so if interest rates increase, unplanned for and unaffordable for many owners. We have raised a generation who think that interest rates of 2% are customary, notes a Dutch former regulator.

    Geographic shrinkage is another element in risk concentration and the lack of diversification. Regulatory bias has promoted more domestic exposure: banks like Citigroup of the US, or Unicredito of Italy, sold many of their foreign businesses post-crisis.

  1. GEOPOLITICAL JEOPARDY. Italy is a likely suspect. The country could blow up on the back of its bankrupt banks and the unstable government’s argument with Brussels, amid recent evidence that Italian households are no longer willing fools ready to finance government spending by buying its bonds. If Italy goes, so would the euro.

    There is also the more obvious imbroglio of Brexit and its unforeseen consequences, however much the Bank of England provides public reassurance on this front. Or China’s debt burden…The list is long.

    During the 2008 Beijing Olympics, at the height of the US financial instability, Russian officials made a top-level approach to the Chinese and suggested that together they might sell big chunks of their US Treasury holdings. The Chinese declined. The answer might be more nuanced today, amid heightened political tensions.

  1. JUDICIARY RANDOMNESS. A term first heard at a meeting of the G-30, this refers to multimillion fines which fall on banks after scandals such as mortgage abuse in Spain and product mis-selling in the UK. Danske Bank’s recent €200bn money laundering disgrace forced the newly nominated Chairman to speedily reassure the markets that the bank was not facing “an existential crisis” – and that is even before the US Department of Justice’s criminal investigation has reached a conclusion and consequent fine.

  1. REGULATORY MICRO-MANAGEMENT. The financial crisis put paid to the idea of principles-based regulation. However, the sharp pendulum swing to prescriptive rules-based regulation isn’t working either. To state the obvious, regulators are not bankers.

    “The jerks presume to tell us how to do our business, in extreme detail…you come to Treating Customers Fairly (TCF) – the man from the government has this 100% wrong, “complains an executive board member of a British bank. As he points out, “we are now obliged to treat disparate people the same – [despite the fact that] nature was not fair in how it handed out its gifts.”

    Form-filling and ever-larger compliance departments are the curse of the post-crisis world. “We have to write a ton of repetitive stuff for the regulator year after year which nobody can read, understand or apply usefully,” notes the banker. The real issue with “this stupid charade” is the resulting risk blindness – either complacency that every risk is covered or an inability to see the forest fire because measuring every inch of the trees is the new normal.

There are other possible catalysts to a financial crisis: from the pile up of debt; to shadow banking; to climate change; to the unimaginable. Two overarching factors could make the next crisis even worse than the last one.  The public’s trust in the financial system, high before the crash, is being continuously eroded from its low base with a repetitive litany of scandals, greed and technical incompetence – examples abound such as Goldman Sachs’s reported Malaysian corruption and TSB’s IT chaos.

Meanwhile, the international cooperation visible in the financial crisis, and ably described in former US Treasury Secretary Hank Paulson’s book On the Brink, is entirely absent. The idea that the Trump government would coordinate action to save the world is risible.

On this cheery note, Robinson Hambro wishes its readers very Happy Holidays