Banking cannot prosper within a culture of fear

If recklessness can be harmful, so too is a culture of fear Keystone

Taking risks is an essential, even admirable aspect of doing business. This has been understood since biblical times; in the Parable of the Talents, the two servants who risked their master's money were rewarded, while a third who nervously hoarded his coin was flung into the outer darkness.

In today’s economy few characters deserve as much praise as the entrepreneur who stakes all in pursuit of opportunity. It takes risk to turn a technical breakthrough into a blockbuster product, to crack a new market or invent one where none stood before. Without risk taking, there can be no growth.

 As is so often the case these days, banking appears to make an exception to the rule. Not so much the dauntless entrepreneur, the phrase “risk-taking banker” summons a callow twenty-something, heedlessly speculating with others’ cash and livelihood. In light of the opprobrium that such financial types attract, it is striking that Sergio Ermotti, the chief executive of UBS, has been so bold as to urge his staff to embrace risk-taking again. 

Mr Ermotti is right to make this call, but first it is important to remember why his industry does merit different treatment. Being highly leveraged, banks’ speculative investments do indeed put others’ money at risk. The deposits they take are guaranteed by the state, explicitly through guarantee schemes or implicitly, in anticipation of how governments are forced to step in when the bank topples over. Banks have come to epitomise “moral hazard”, where a party taking a risk does not bear the full consequences of it going wrong. Too much moral hazard and risk-taking mutates into recklessness. The lesson of the global financial crisis is that bank failures, however skilfully resolved, are damaging to the rest of the economy. But if recklessness can be harmful, so too is a culture of fear.

 Mr Ermotti’s words were aimed at a private audience, with the interest of UBS uppermost. Few if any banks have taken as determined steps to reduce risk of failure, in particular by attaining a common equity ratio higher than that of any competitor. UBS has withdrawn from many lines of business, including much of its fixed income trading. This cautious strategy has left staff with fewer opportunities, and a greater need for entrepreneurial verve if shareholders are to receive their due reward. 

More intrepid bankers are also good for the economy. There is now too facile a belief in a simple division between good and bad risk-taking, which pitches what bankers do squarely into the latter category. No such clear dividing line can be drawn. Banks seek out exposures that others wish to shed, and transfer them to investors happier with the risk. Their activities are less about the creation than the management of risk. Well-run banks often retain a significant slice of the investment. Rather than standing apart from industry, innovation or commerce, they are tightly enmeshed in all. And when they pull in their horns, customers at both ends of the bargain get a worse deal. 

For banks that are well capitalised, it is the shareholders who stand at the front of the queue for any losses. No doubt they are often blindsided by the actions of the companies they own – investors in UBS have had to weather billions in losses from rogue trading and fines for market abuse. But this is a matter for corporate governance, not specifically banking. 

The “negative exceptionalism” that tarnishes banking can be taken too far. It is not the only sector wrestling with principal-agent dilemmas and wonky incentives. Any company structured with limited liability can be tempted into unwise risks. Just ask an investor in Volkswagen.

 

Copyright The Financial Times Limited 2015