Total Pageviews

Monday, May 9, 2011

WALKING ON A STRING; Bank management in a world up side down


     It took about eighty years between the great depressions that started in the late 1920s to the other great recession of 2008. In between these two periods of time, there were tens of financial crisis that rocked the world of banking and finance. Banking world as we have today is a world that is Upside Down, ravaged by what many see as the great financial crisis since the great depression. This paper will look at management of banks during period of crisis. It will attempt a dissection of the sector by looking for what went wrong and where. It will provide suggested solutions and give directions to follow. The paper is divided into six part, part one is Introductions, part two A brief history of banking, three innovation and management in the banking industry, four re examining the banking practices, five the near future: applying Drucker’s ideas in banking, and six provided the concluding part.


      The most organized form of money saving to be found in the Western world before the advent of today's highly complex activities you called 'Banking' is the safekeeping activities of Goldsmiths in the early 15th century. “The association of the supply of transactionary money with the business of banking”, writes Tobin “was an unplanned historical development beginning in the fifteenth century in Italy and especially in the seventeenth century in England.” With passing of time Goldsmith realized they could lent out the money entrusted with them at interest without falling short of depositors request, hence the beginning of the association of gold smelting activities with banking. History of modern banking in the West cannot be completed without the mention of the role played by Jewish money lenders. “The house of Rothschild, which emerged as the world’s dominant financial power after 1810, was not only the first investment bank but also the first multinational company since the 15th century Hanseatic league and the Medici.” (Drucker, 2001). Today's modern Banking is of different type, starting with the Anglo-Saxon separation of commercial from investment banking, to European universal banking arrangement. Banks can be found in any country around the globe rendering services from ordinary provision of account services to giving advice on Merger and Acquisitions.


    The Banking industry is one of the most innovative of modern industries. Over the past decades innovation have become the yard stick by which progress in the industry is measured. The increasing sophistication with which new products evolve and business processes are re engineered is testimony to the depth of innovation in the industry. Because of the dramatic changes they brought, innovations simultaneously, break mold and give better result than obtain in ordinary business. The ease with which business is carried out in the industry as well as the increasing access to financial infrastructures have their roots in financial innovations. Many practitioners and academics are of the opinion that innovations, like the kind of derivatives in the last crisis, are at the heart of the problems bedeviling the banking sector. It is argued that the rate at which innovation in the industry is moving far outpaced the rate at which new regulations are been developed. This creates room for banks to Maneuvered there way out of existing regulatory frame work. “Increasing computerization”, writes Zanny Minton, “made it possible to create a dizzying array of derivative instruments, allowing borrowers and servers to unpack and trade all manner of financial risks”. Credit securitization was celebrated as one of the most important innovations of the last two decades, but instead of spreading risk it concentrated it, therefore, making the system open to shocks. The world wide monetary value of derivatives is put at many times the value of world GDP. According to Porter, Simpson and Mauskopf, financial liberalization and innovation were important factors accounting for the instability in the demand for money in the past. Despite their risk concentration capacity and instability generation, some innovations are good. They are credited with reducing the cost of capital, thereby allowing more people access to credit. Technological innovation, together with deregulation and increasing globalization of capital have made the last decades unprecedented in the history of finance. A period when time tested practices tried it out with the excesses of innovations.

   From one tail end to another, the banking industry continue to jump from one crisis to the next. It is estimated that between 1930 and 1933 some 9 000 bank failure were recorded in America alone. Of recent there was the Latin America debt crisis, the American savings and loan (S&L) fiasco, the Scandinavian property binge, Russian currency crisis, the Asian financial crisis and the mother of all recession the last global financial melt down. Work by Carmen Reinhert and ken Rogoff have shown that banking blow-out reduces out put growth per person by an average of two percentage points. The same work shows that it takes more than three years for growth to regain it pre-crisis level. The amount of psychological trauma caused by job loses and financial bankruptcy cannot be quantify, yet little after the crisis, bankers memories have started to take them back to the old good days. Bankers naturally have short memories. The problem of moral hazard, bankers greed that led to the speculative property lending, lax regulation on the part of supervisors, and the quest for exponential growth have intensify the level of uncertainty inherent in the banking industry. Global regulatory regimes like Basel capital adequacy requirements, and the fancy risk management systems at bank level, have yield little in the way of ensuring healthy financial system. Banks are past masters at finding loopholes in laws. The loose monetary policy especially the low interest rate have helped fuel the crisis by making money free in the economy. This in itself is not bad, but allowed during period of loose lending standard make the crisis worst. Usually, models developed to control risk are ineffective at tackling risk existing at a particular point in time. The most popular ones based on past price history, tended to underestimated how much new innovations were pushing the prices of securities up. The same models failed to notice the high concentration of risk in any particular sector. As the sophistication of the banking system continue up the ladder, high leverage ratios, reliance on short term sources of funding, with their mismatch between assets and liabilities and unethical practices have become the order of the day. Then enter the credit rating agencies, who both act as regulatory tool and means of verifying the soundness of a borrower. The system is loose at this point, an atomic bomb about to explode. The time it eventually made it final explosion in September 2008, the impact was devastating, leaving too many victims behind it.


   The shout of bonuses, fees, or fat margins is what you heard when the going was good. At a time when shareholders were getting little on their investments, depositors paid insignificant interest on their deposits; bankers were going home with fat pay packages. The world of excesses is here to stay; excessive pay package, over excessive credit lending, excessive risk taking, excessive leverage, the list continue. At the height of the euphoria no one listen to the lonely voices calling for stop to this madness. At difficult period like this one, mistakes and bad judgment are common despite their dangers. Good management and having the right people at right places is what matters. But how many banks cared about good management that will, after all, restricted them to making small profit when they can drank their way to high profit. Control and planning departments were usually put at the back bench. The fashion for merger and acquisition at the expense of internal growth increases banks exposure and make them difficult to control. These made it difficult for bank to strike balance between centralization and decentralization. These were further complicated by the wide spread adoption of universal banking without recourse to internal and external supervisors capacity to control them. The time tested virtues of honesty, prudence, and sticking to plan were thrown to the dogs. Over the years banks have forgotten the old virtue of know your customers (KYC) that allowed them to build up information about their customers. Securitization makes this even difficult with it widening of gap between the original borrower and the last person who bought the security. Many studies have shown that lending standard tend to fall when loans are securitized. Here, as mention some where else, innovation was given more importance over time tested virtues. This brought us to the next important issue, managing change. Should bank go for incremental change or the revolutionary kind of change? As in the past in period before economic bust, the fashion is for exponential growth, high product and process innovation, IQ over experience, and bit of creative accounting over honesty; while the reverse is the case after a bust.

   Successful organizations that survived recessions are those with strong commitment to planning, functioning system of control and follow up, low cost production, simplicity as well as love for action and results. Their mode of operation being simple made them flexible and full of speed in true Sun Tzu tradition to allow them to size any opportunity when it arrives. They are very open to collaborations, and pay more attention to building partnership. They are prudent, consistent, focus and can go to any length to protect their brand equity. The organizational architecture of many banks needs fundamental changes to make them suit the present circumstance. Today banking environment is completely different from what obtained in the past; to survive you have to be in the right shape. Organizational structure can be your critical success factors as in the case of phenomenal success of Air Bus. Balancing between the composition of geniuses and experience in your organization is important. Enron is a good example of an organization that failed to balance the composition of geniuses and experience. Despite its armies of MBAs the company collapsed at it tried to cheat it way to success. As the saying goes there is no short cut to success. Over time banks have neglected their core competences in pursuance of size and growth. Successful companies tend to focus on their core competencies and spend on that particular area to get market share. For any bank to be successful it has to go for number one position in it area of competency, or not be there at all. According to Gerry and Kevan (1997) “long term competitive advantage” should “be secured by continually shifting the ground for competition.” In dynamic conditions, bankers need to consider the environment of the future, not just of the past. No strategy is obsolete or old passion. It depends on the circumstance you found yourself. A strategy that was used in the past can be return if it suit present circumstance and need. At any particular period in time strategy should depend not only on the internal working of the corporation but the capacity and the immediate and the wider global environment in which it operates. Banks should continue with their tradition of financial disclosure, improve on their lending standard and developed their risk management strategies. Bank managers have to be very watchful of the next shock to come whether in term of banking crisis, regulatory policy, emerging competitive threat and opportunities. I am part of the league of people calling for the reforms of credit rating agencies, deposit insurance schemes, existing regulatory frame work that allowed banks to beat them, as well as drawing line between commercial and investment banking.


  The sage and management guru peter Drucker is our main concern here; we will apply some of his thinking to the contemporary crisis in the banking industry. The next society according Drucker “will be quite different from the society of the late 20th century, and also different from what most people expect. Much of it “he continue “will be unprecedented. And most of it is already here or is rapidly emerging”. (Drucker, 2001). Peter Drucker main theme on the future society centered on the following:
1- Demographic changes
2- Global competitiveness
3- Emergence of knowledge workers
4- The next ownership structure
5- Disaggregation of the labour market
6- Management of the future corporation

    Because of demographic changes, the homogeneous market existing before in rich world will be split between middle age mass market and smaller youth determine market. Instead of the youth driven market of the past the future market will be middle age and old driven. Financial markets in America have already started to move inline with this reality. Banks also need to develop other new products that will purposely serve this market. The future work force will also split into two distinct camps: the under 50s and the over 50s. The future HR planners of any bank can only forget this at their own peril. Because of the continue grow in information technology that made outside knowledge easily accessible, Drucker sees a future where global competitiveness will be very vital for the survival of organizations. Here too banks, in advanced countries are doing well, but they need to do more because of the unexpected changes. Knowledge workers are phenomenon that Peter Drucker continue to talk about. Even the term “knowledge workers” was coined by Drucker around 1960s. He called them the new capitalist because of their domination of the means of production. Continue education of knowledge workers is one big grow area that already start to generate money for higher institutions of learning. The financing of this area will be as lucrative business as any lucrative business we have in the past. Future organization will be held together by strategy instead of what obtains today where they are held by product or service. The type of ownership that will be prominent, especially with multinationals, will be alliances, joint ventures, minority stakes, know how agreements and contracts. Bank managers should move their organizations along this line.

   The management of the future organization will be unlike the management of today organization. It will be multi tasking and very challenging. “one of the most important jobs ahead for the top management of the big company of tomorrow”, writes Drucker, “and especially of the multinational, will be to balance the conflicting demands on business being made by the need for both short term and long term results, and by the corporations various constituencies: customers, share holders (especially institutional investors and pension funds), knowledge employees and communities. (Drucker, 2001). The most important task for the management of the next organization will be to establish their organization unique personality, observed Drucker. In the next corporation the top management is the company; every thing else can be out sourced. The most effective way to manage change successfully is to create it – Peter Drucker. Thus today and future banks must be agent of change in their own ways or perish. The main goal of top management in today and next banking organization should be to balance the three dimension of the corporation: as economic, a human and a social organization. “The central feature of the next society”, concludes Drucker “as of its predecessors will be new institutions and new theories, ideologies and problems” (Drucker, 2001). This is what is needed in the banking industry; new banks, new theories, new ideologies to challenge new problems.

   To strike a balance between continuity and change or innovation and time tested practices is one issue that will continue to dominate management thinking in this century. In the banking industry the question of how to control derivatives and what to do with them will continue to give sleepless nights to regulators. But one thing is for sure managers must find new ways to manage the ever increasing risk of leaving with new and untested financial products. Honesty is one time tested practice that should not be relegated to the back bench, because banks want to pursue profit. A lot of advice and recommendations were provided throughout this paper; it is hoped, as little as they are, they will assist managers in running their banks effectively.


1-      Cox, Simon, “The long climb: A special report on the world economy”, London, The Economists, October, 2009.
2-      Drucker, Peter, “The next society: A survey of the near future”, The Economists, November, 2001
3-      Giles, Martin, “The domino effect: A survey of international banking”, London, The Economists, April, 1996.
4-      Hindle, Tim, “Back to Basics: A survey of management”, London, The Economists, March, 2002.
5-      Hindle, Tim, “The new organization: A survey of the company”, London, The Economists, January, 2006.
6-      Johnson, Gerry and Scholes, Kevan, “Exploring corporate strategy”, London Prentice Hall, 1997.
7-      Minton, Zanny, “Saving the system: A special report on the world economy”, London, The Economists, October, 2008.
8-      Peters, Tom, “The circle of Innovation”, London, Hodder and Stoughton, 1997.
9-      Tobin, James, and Golub, Stephen, “Money, Credit, and Capital”, Boston, Macmillan, 1998.
10-  Valery, Nicholas, “Eureka: A survey of Innovation in Industry”, London, The Economists, February, 1999.
11-  Wansell, Geoffrey, “Tycoon”, London, Grafton Books, 1987.