‘Banana Skins’ report identifies top risks facing banks

Consumers are in worse shape than most observers appreciate and will keep increasing their debt loan until they can literally borrow no more.

Turmoil in global financial markets has completely transformed the risk landscape, according to the latest ‘Banking Banana Skins’ survey conducted by the Centre for the Study of Financial Innovation, in association with PricewaterhouseCoopers.

The survey has also observed a sharp rise in concern over shortage in liquidity. However, in South Africa, this rated seventh in areas of concern.

The recent poll of global banking risk is dominated by concerns over current market conditions, notably the liquidity shortage and the crunch in the credit and derivative markets. The fear that these strains will lead to a global recession is high.

The poll is based on the views of 376 respondents from the financial world in 38 countries, including respondents from South Africa, and ranks 30 risks according to their severity.

Tom Winterboer, PwC SA Banking and Capital Markets Leader, highlights that two of the top three global risks – liquidity and credit spreads – have never previously appeared in the rankings. “This is an indication of how dramatically the risk scene has changed. The only non-financial risk in the top ten is the prospect of a regulatory over-reaction as politicians and regulators prepare to “fix” the problem.”

The intensity of respondents’ concerns helped drive the Banana Skins Index, which measures anxiety levels in the financial markets, to its highest point since 1998. David Lascelles, survey editor, said “Although some respondents thought there had been crisis over-reaction, the great majority were very pessimistic. This is the darkest Banana Skins survey in more than 10 years. The current liquidity concerns are on a par with the anxiety that accompanied the dot com crash in 2000.

Interestingly, the South African response on liquidity is somewhat different to the survey average, perhaps indicating our relative distance from the global crisis. It is of a much lower concern here, coming in at number seven, compared to being the top ranked risk by other respondents. Another difference between SA and developed markets, when it comes to credit risk, ranked as the number two concern, is that on the consumer side, our household debt to annual income ratio is more favourable. At 77%, the SA ratio lower than in the US where it stands at 110% and the UK at 125%”

The survey says that the crisis has exposed a failure of controls within banks due to many factors including the growing complexity of finance, distorted incentive structures and insufficient regard to risk management.

Hitchins, UK banking leader, PricewaterhouseCoopers LLP said: “While current market conditions dominate the survey, there is a marked drop in confidence over the quality of bank risk management processes reversing the trend of previous surveys.” Respondents clearly believe the credit crunch provides a wake up call for the industry to reassess the effectiveness of its risk oversight.”

Among the fast-rising risks are the threat of global recession, led potentially by a downturn in the US, and a collapse in over-priced global equity markets. Concerns about the macro-economic outlook were shared by all the major markets.

One essential part of managing risk, especially in such threatening conditions, is through experienced staff. But respondents in the survey indicated that there just aren’t enough experienced bankers around. In South Africa, Philip Wessels, chief risk officer of Nedbank, said that the main risk “is not the changed cycle per se but the fact that the favourable conditions have lasted for a long period, resulting in many managers not having seen or managed a negative cycle.”

The most striking declining risk was over-regulation, which headed the Banana Skins polls for the last two years but fell to 8th place this year. Yet, regulation is still seen as a major risk, particularly if there is a “knee jerk” reaction to the crisis.

Another declining risk was interest rate concerns, down to 9th place from 5th last year, despite unprecedented central bank activity globally on the monetary front. The SA situation is somewhat different as we have seen the SARB raise rates nine times in just 22 months.

The poll showed variations in the risk outlook as seen by different classes of respondents. Bankers thought market risks posed the strongest threats, notably sharp movements in the credit, derivatives and equity markets. Non-bankers, including regulators, put more weight on weaknesses within the banks themselves, particularly poor risk management and generous bonus systems.

Geographically, industrialised and emerging market economies had a similar focus on crisis-related risks, though the major economies worried more about the threat of over-regulation, and emerging economies about the cost and availability of funding.

South African respondents are more concerned than the norm about fraud and the sheer costs of fighting it. A risk executive from one of the four South African banks participating in the survey said that “the cost of implementing new technology to counter fraud in electronic payments and thus present safe payments infrastructure will become substantial”.

The volatile Rand also makes SA respondents more concerned over currency risks and they also face unusual technology and business continuity risks as a result of Eskom. We are also above the norm on concerns over the environment and overcapacity and increased competition in the banking space. But in South Africa’s favour is that there is less concern about the health of emerging economies relative to other risks.

The poll showed that globally only 24% of respondents (33 % in SA) thought banks were well prepared for the risks they identified compared to 64% in the previous poll.