Salz Review - Wall Street Journal

25
Salz Review
An Independent Review of Barclays’ Business Practices
The Roots of the Crisis Facing Banks
3.15 Although many will see the context for this Review as being the events since the
beginning of the financial crisis, as well as the period leading up to it, the cultural
challenges faced by banks today have their roots spreading back well over 20 years
and can be linked, from a UK perspective, to the ‘Big Bang’ deregulation of the
financial services industry in 1986. Deregulation was a catalyst for growth in the
financial services sector and attracted significant investment from foreign financial
institutions to the City of London. It broke down the barriers between different
types of financial institution, bringing together large listed companies with smaller
specialised businesses to create ‘one-stop shops’ for financial services. It brought to
the UK the customs, skills and energies of Wall Street. Many of the smaller firms
swept up in this process of consolidation had previously been run as partnerships.
Their leaders tended to exhibit a sense of ownership natural to their positions as
owners. And their liability for losses tended to make them sensitive to risk. Today
some argue that the sense of ownership has remained for senior executives of banks
without the same sharing of risk.
3.16 For 20 years across much of the Western world, the combination of deregulation,
massive increases in liquidity and shrinking interest rates drove a search for higher
yield – which came at the cost of higher risk. Leverage ratios increased while lending
standards decreased. Simultaneous changes in accounting rules did little to cool
things down. 23 And the use of derivatives expanded rapidly. 24
3.17 As asset prices rose, the banks came under pressure from shareholders and analysts
to maximise returns and to make efficient use of their balance sheets. This was far
from just a UK phenomenon in an increasingly globalised world. It was conveniently
summed up by Chuck Prince, Chairman and Chief Executive of Citigroup in his now
famous comment: “When the music stops, in terms of liquidity, things will be
complicated. But as long as the music is playing, you’ve got to get up and dance.
We’re still dancing.” 25 That was in July 2007. Things quickly unravelled once
confidence in the markets faltered when assumptions about continuing house price
growth proved wrong. As banks realised that the vast quantities of sophisticated
investments they had created were not worth anything like their face value, they lost
confidence in the creditworthiness of other banks with the result that they were
reluctant to do business with one another. In terms of liquidity, the music was
stopping.
3.18 Across Europe and the US, some banks – large and small – failed while others
needed considerable support to continue operating. Many of the banks which
experienced the greatest difficulties seem to us to have suffered from a combination
of control and risk management failures, exacerbated by cultures favouring aggressive
growth, and often compounded by governance weaknesses. Underpinning these
23 The changes permitted, or even required, ‘fair values’ to be used to value assets and prohibited loan-loss
provisions, unless the losses had been incurred.
24 The Bank for International Settlements (BIS) reported that use of over-the-counter (OTC) derivatives
grew 32% per annum over the three years from 2004 to 2007; see: BIS, Triennial and regular OTC Derivatives
Market Statistics, November 2010.
25 Financial Times, “Citigroup Chief stays bullish on buy-outs”, 9 July 2007.