Why was the system unprepared for bank defaults?

It's with great disappointment I read that the US political system is so unprepared for a situation where banks default. Actually to be fair it is the whole global political system that is unprepared. I heard that a European central bank last week was having an exercise how to act if banks would start to default in that country. Now? Is it not a bit too late? How can the whole political system be so reactive only? How can they have relied on that the present bank regulation should assure that no domino effects would happen anymore?

Basel II has made the banks geared to collateralized lending (real estate and stocks). Since the first Basel Accord in the 80-ties we have experienced two major real estate bubbles and three major stock market bubbles. How can they not have seen?

I would have expected that the plans now being hammered out during weekends and nights in full panic would have been developed and refined since decades. Hopefully the politicians will learn for the future. We need to have preparedness for bank defaults. They happen on a regular basis in a fiat currency system, nothing strange at all. You just need to plan for it!

How have the harsh times affected RFP to banks?

My impression is that presently when doing RFP to banks there are now concerns on creating greater redundancy in the core banking group. Can you rely on only one bank for all your cash management business? How many banks shall you have to ensure that you always will have sufficient credit lines? Only a year ago I discussed with treasurers how you should limit the number of your core banks. It was a clear strategy to have fewer and more robust relationships but the credit crisis has changed that ambition. Now too many banks are reluctant to supply funds, struggling internally to ensure funding. We now discuss if we should allow for more banks instead. The decrease of banking relations will probably happen automatically anyway through mergers and acquisitions.

How shall you adjust the RFP to the new situation? Shall you have more than one cash management bank per region?

Plan for that banks will go bankrupt

I am following the financial crisis developing and all the panicky meetings and measures. There seems to have been very limited amounts of preparations for this situation. It is clearly obvious that the politicians rested assure that with the bank regulations (read: Basel II) the banks would never go bankrupt. A peculiar conclusion - I doubt if we will ever experience future bubbles bursting without any bank going bankrupt. It is obvious that the governments have not been prepared for this situation even though it happens every 10-20 years.

Again we are hearing voices for stronger regulation to avoid future bubbles. How can regulation manage that? What we instead need is preparedness for managing the domino risk from when banks do default, because they will continue to. I sincerely hope that the regulators and politicians have learnt anything from the past. We do not need any more social engineering of the banking sector; we need an environment where the banks are allowed to support the growth of corporations and forced to send all payments faster than one day.

Replication of the Swedish financial crisis

What we are seeing in the US presently very much resembles the financial crisis in the beginning of the 1990-ties in Sweden.

I do not think that everyone understood at the time how close Sweden was to default. The reason was built up under the 70-ties and 80-ties by a regime that believed welfare was built from consumption and investments on borrowed money. The whole tax system was built up to punish labor and incentivize borrowing. This created a giant debt burden at corporates and public and a real estate bubble in the last part of the 1980-ties that when it burst almost brought the whole society down. I had the good fortune to see and learn from this event very close. I was part of the executive management in the corporate division of the first bank that officially became insolvent.

Coming into work the early morning dealers told me that they could not rollover the O/N loan portfolio. All over our counterparties cancelled our lines refusing rollovers and demanding us to redeem the loans. I was confused and had not heard anything that could have triggered this so I called my manager who told me that they last night issued a press release informing that the bank was in “technical bankruptcy”. Without telling me! Anyway technical bankruptcy actually meant that the credit losses (mainly from real estate loans) had consumed more than 50% of the capital base. In Sweden a company has a grace period of 8 months to restore the equity levels or liquidate from that point.

This immediately started frantic activities at the Swedish financial supervisory level and also in the government. The following day the government officially declared a bank guarantee. And the financial markets settled with that guarantee. Wonder what would have happened if they had required wider guarantees?

In the following weeks and months we investigated our banks exposures and portfolios. We divided our customers in buckets of creditworthiness. In the beginning we kept the same account managers so in many cases one account manager could visit a “good” customer in the morning discussing to expand the relationship and in the afternoon meet a “bad” customer requiring him to repay his loan or else we saw no other option than to file his company for bankruptcy. After a while we realized that we could not go on like this. There are many differences in managing a “bad loan” portfolio and a “good loan” portfolio. The whole mentality is different, knowledge requirement of the staff is different and also the supporting systems need to be different.

Eventually the Swedish banking system together with the government decided to divide the banks (not every bank needed it) in a good bank that would remain as the original bank and spin off the bad part to a few large government sponsored bad banks. This was a good structure in that it helped the recovery and eventually the bad banks proved to be a profitable investment when the good times returned. The bad banks had all the mission to manage the portfolio to redeem the losses and thereafter dissolve.

Let us see how the competent Federal Reserve chooses to do. It will definitely be interesting to follow.

Basel II has shown its worth

As you will see on this blog, and in my 5 year old article "Regulation: Curbing Growth" among others, I am not a firm believer in the basis for the creation of Basel Accord and Basel II. Today we have probably seen the worst financial crisis in this generation with already three of the world's largest investment banks (Bear Sterns, Lehman and Merrill Lynch) in free fall.

Exactly this was what Basel II should have avoided. But the regulation has instead created a banking industry that follows each other into the same deep water finally creating a bubble bursting. Instead of survival of the fittest the banking industry has become the survival of those who conform.

It is time that the regulators and politicians take a deeper look into all the Basel Shadow Committees' work. In future regulations it must be more of a holistic view on what is best for society and not a siloed approach only focusing on the banks' welfare. Basel II surely has been a Hit and Miss.

I come to think of a funny but conspiratory book that all working in the financial industry should read; "The Creature from Jekyll Island" by G Edward Griffin. I do not say that he has gotten everything right but he surely has a different perspective well worth exploring.

The State of Corporate Treasury

We are now leaving the Summer, and for NFS I'm pleased to see new recruits already going in full speed, we've especially strengthened our financial risk management capabilities.

This Fall we will be examining the state of corporate treasury. I'm very much looking forward to our next meeting with the European Treasurers' Peer Group (ETPG), the 23rd of September in Nice. On the agenda are credit risk management, and methods and policies for cashflow forecasting one week and beyond. Very interesting presentations by the members are lined up.

The peers have also expressed great interest in treasury benchmarking, which one extra session will cover. Following the meeting we will do a wider treasury benchmarking study outside the treasury peer groups, should be announced in October how and when we do this.

Most of October I will spend in the US at client sites. In case you are in Los Angeles, watch me speaking at the world's biggest treasury conference, the AFP Annual Conference on the 20th October, with a presentation titled Achieving Treasury Excellence, under the Treasury Operations track.

All in all, an interesting Fall, which should spread some light on the state of corporate treasury.