A joint PricewaterhouseCoopers / CSFI survey confirms the extraordinary shift in the risk landscape facing banks in recent times. Liquidity - which has never featured as a top 10 risk in the survey’s 12 year history - was identified as the number one risk.
According to the global ‘Banking Banana Skins’ poll, volatile credit spreads and a fear of credit losses rounded out the top three concerns among 376 bankers, observers and regulators.
But despite the global bedlam arising from the liquidity and credit crunch, Australia’s banks have fared relatively well.
Michael Codling, PricewaterhouseCoopers Banking Leader said, "Australia’s banking system proved to be more resilient than overseas, partly as a result of careful planning and good risk management practices introduced by regulators and banks.”
However, as several respondents to the survey said, a fundamental issue is that trust has been weakened across the industry, and it is likely to be a long and painful road to rebuild it.
Mr Codling said "There was plenty of concern about the lack of transparency of where residual risk was ending up, especially where securitised instruments are involved. This contributed to the loss of trust and confidence. The debate about the level of industry disclosure will continue for some time.”
The survey also revealed that banks are feeling more anxious about the general risk environment. The Banana Skins Index, an indicator of banks’ anxiety levels reached an all-time high, having now been tracked for ten years.
Mr Codling said "The nature and rapidity of the turmoil certainly shook the banks’ confidence and the markets remain jittery. I think we’re now in for a period of traditional conservative banking for the immediate future.”
Liquidity
The critical liquidity shortage in financial markets emerged as the top risk for Australian and global banks for the first time in the survey’s 12 year history. Respondents generally believed risk management systems and banking regulations failed to anticipate its devastating effect.
Mr Codling said: "Not surprisingly liquidity was the banks’ chief concern, given the survey was conducted during February and March at the height of the market crisis. But liquidity is not a new issue. In recent years international events such as the Asian currency crisis, September 11 and the London subway bombings triggered significant liquidity challenges across global financial markets.”
"Having said that, the risk landscape has changed dramatically in the past 12 months as illustrated by Northern Rock - the first run on a UK bank in over 150 years - and the US government bail out of Bear Stearns.”
Australian banks felt better prepared. According to the survey, more than half (53 percent) of Australian banks felt they were "well” prepared to handle the risks as compared to around a quarter (24 percent) of their international counterparts.
Mr Codling said "The relative optimism of Australia’s banks appears to have been well founded, given their most recent results. There is no doubt that our Australian financial system has responded relatively well.”
"Early stress testing by financial institutions and supervisory bodies encouraged greater attention on the banking system’s high dependency on wholesale and securitisation funding programs. Their investment in general resilience planning also paid off.”
"While we’re certainly not yet through the storm, it will be interesting to see how the banks and regulators respond to the learnings from this episode” he said.
Credit risks
Fear of heavy credit losses was the second highest risk identified by respondents in Australia. Mr Codling said "Again it’s not surprising given some of the high profile corporate collapses we’ve had in Australia. The consumer portfolios seem to be holding up well but there is considerable uncertainty over the impact of high interest rates and a slowing economy on business customers.”
According to the survey, the US sub-prime collapse will have long-lasting impacts on how loans are structured and distributed.
"There was more than one major flaw in the US sub-prime business model. Banks were way too far up the risk curve, lending to people who couldn’t afford to repay, and they really got caught when property prices dived” Mr Codling said.
"The way in which the loans were funded also meant that the banks had limited accountability for their actions. The risks they had originated were widely distributed to people investing in securitisation vehicles.”
A number of respondents to the survey are now predicting an end to the "originate-to-distribute” business model.
"This has significant ongoing ramifications for some of our banks” added Mr Codling "and it could be a while before the industry innovates and develops alternative business models.”
Too much regulation
Regulatory excess, which ranked as the number one risk in the two prior Banking Banana Skins surveys, fell to eighth and 10th place (global and Australia respectively) as more urgent concerns took precedence.
Many respondents, particularly bankers, still fear a ‘knee jerk’ reaction by authorities following the debt market turmoil.
"It is interesting to reflect how recent regulation and the responses of regulators and central bankers have helped banking systems through the current market turmoil. Financial institutions are not opposed to further regulation, so long as it is balanced and addresses the right issues” Mr Codling said.
"The key for future regulatory reform is understanding which regulatory levers were pulled and worked, what levers remain to be used and what additional levers will help in future”.
Very recent announcements by the Australian Government in relation to its current thinking on the regulation of mortgages, margin lending, debentures and property spruikers have been broadly welcomed by the industry.
Technology
Just shy of the top ten, technology risk was one regarded as a far more significant risk in Australia (11th) than globally where it ranked 15th.
"Our banks certainly have some significant technology challenges with their old legacy systems, but this is not unique to Australia. The relative significance given to technology risk in Australia reflects its front-of-mind importance to our banks who are now taking active steps to tackle these issues” Mr Codling said.
Local vs Global Banana Skins
The top 10 Banking Banana Skins identified by Australian bankers were:
- Liquidity
- Credit spreads
- Credit risk
- Equities
- Derivatives
- Interest rates
- Macro-economic trends
- Risk management techniques
- Hedge funds
- Too much regulation
The top 10 Banking Banana Skins identified globally were (previous ranking in brackets):
- Liquidity (-)
- Credit risk (2)
- Credit spreads (-)
- Derivatives (3)
- Macro-economic trends (14)
- Risk management techniques (10)
- Equities (12)
- Too much regulation (1)
- Interest rates (5)
- Hedge funds (7)
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