News from Cass Business School

Return to core values needed to avoid another financial crisis

Financial services industry needs to address breakdown in trust

Friday, 30 April, 2010

A return to core values is necessary if the global financial system is to recover sustainably, delegates to the third annual conference of the Cass-Capco Institute Paper Series on Risk, were told. The event, which took place on April 19, 2010 at  Cass, was chaired by Rudi Bogni and attended by some of the world's top business and academic leaders.

The event's five key findings were:
1. All financial services organisations need to imbed core values in order to effectively consider risk. This will help to address the severe breakdown in trust which has occurred between the financial sector and its stakeholders.
2. There is a major danger that the bitter medicine that politicians will administer to the sector, in response to public outrage, will prove to be counter-productive. More regulation will not necessarily lead to more effective oversight, and it could prove counter-productive if pushed through without effective consultation and analysis. For example, curbing derivative activity could deprive markets of liquidity and therefore increase the cost, and decrease the efficiency, of financial transformation.

3. There is no magic bullet to ensure the global economy will not suffer another financial crisis. There are a number of measures which minimise the risk of this occurring, including: improvements to the framework for analysing operational risk; aligning the analysis of systemic risk at the macro, as well as micro level; and technical improvements to modelling related to the effects of collateral changes and rating changes.

4. There was consensus that the financial crisis was not due to flawed financial technology, but to a breakdown in values, common sense and to policy failures. There were no innocent parties: government policies around the world flooded markets with liquidity, depriving savers and promoting home ownership, beyond affordability, for political reasons. Investors showed no restraints in their pursuit of yield improvement and everyone succumbed to moral hazard.

5. Mathematical models developed by academics hardly played a role in the crisis. The models used by the most important operators were both proprietary and differentiated, so it is likely that the systemic threat came from herd instincts and the psychology of mass behaviour. Both academics and practitioners recognise the implicit weaknesses of models. The abuse of models and the over-estimation of their capabilities occurred when they were made integral part of the regulatory system, therefore institutionalising them.

In the years preceding the financial crisis, leading institutions lost sight of their core values and did not effectively evaluate risk, said Peter Schurau, Head of Capco Europe.  The sector needs to rebuild trust and show that it has learnt some important lessons. In return, governments need to ensure that regulatory response is properly considered and proportionate.

Richard Gillingwater, Dean of Cass Business School, said:  These insights into the cause of the financial crisis are welcome and show how damaging this period has been to people's trust of financial institutions.  Now is the time for governments and regulators to make radical challenges in order to assure the general public that another crisis is not around the corner.

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