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Banks: What Lies Ahead?

Posted by Larry Doyle on May 12th, 2009 7:34 AM |

If the major money-center banks are neither going to be nationalized nor fail, at least for the time being, then what does the future hold for these institutions? Uncle Sam has provided massive backstops via a number of programs, but a socialized banking system is not consistent with free market capitalism.

Fed chair Bernanke addressed the three major risks — operational, liquidity, reputational — for these institutions moving forward. Let’s address each individually.

1. Operational: While Uncle Sam (Fed and Treasury) has done a lot (some would say too much) for the large banks, he can’t literally run the banks. With no “shadow banking system” (please read “All The King’s Horses and All the King’s Men“), reluctant consumers, and defensively postured corporations, how do the banks manage their increasing level of loan defaults? On top of that, how do they actually grow their business when, by necessity, they are forced to cut their own expenses?

Banks can only “massage” their numbers via the relaxation of the mark-to-market accounting rule for a brief period. While a few of these institutions have large capital market businesses which have recently provided solid returns, those are high risk operations and earnings from that division are volatile. Underwriting fees for new issues of debt and equity were at record lows in the 1st quarter 2009.

Will banks be able to manage their traditional “bricks and mortar” operations (underwriting and holding quality loans) and generate long term growth in this sector? Good question and a real risk.

2. Liquidity: Without Uncle Sam backstopping the short term markets, will banks be able to source sufficient daily liquidity to manage and grow their business units? Bernanke is setting the stage for the time when the Fed needs to drain liquidity from the system so the inflation monkey – if not the hyperinflation monster – does not spin out of control. (please read “Putting The Genie Back Inside the Bottle“)

In layman’s terms, how does the Fed wean the banking system from the drugs that have kept it alive? Will some of the banks be zombie-like, if not outright brain dead? Would we have been better off letting certain institutions fail? If banks can’t source their own liquidity to “live a healthy life,” perhaps Uncle Sam has been more of a benevolent old man when a strict disciplinarian was more in order.

3. Reputational: If banks are challenged to grow and source liquidity without Uncle Sam’s assistance, will they start to cut corners, and once again push the envelope out of desperation for earnings? Please read, “The Greatest Risk,” a recap of the risks undertaken by Bear Stearns, which played a major role in that 100 year old firm’s downfall. Desperate people do desperate things and similarly desperate institutions will also do desperate things. We have already seen ample evidence of extreme measures taken by banks to jeopardize the reputation of the institution in pursuit of the almighty dollar. In this realm, who will be watching? What type of regulations will be implemented and enforced?

On all these fronts, the risks faced by the banks are significant. The risks faced by consumers are also significant. If there is one thing we have learned throughout this ordeal, it is the fact that we can not blindly trust what executives of banks, as well as other institutions, lead us to believe. We must probe, look beyond the numbers, and seriously question the integrity of the data. If we don’t, then we increase our own risks as we navigate our own personal economic landscapes.

LD






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