David Hodgkinson, group chief operating officer at HSBC, talks about the credit crisis, and how the banking industry is likely to change going forward.
Few top-tier banks have yet emerged from the global banking crisis unscathed and HSBC is no exception. Like many of its peers, the bank – which was the first to flag up subprime-related losses – has written down bad debts totalling more than $15bn. Nevertheless, the global giant remains relatively robust while its peers falter and seek government-backed recapitalisation. Group chief operating officer David Hodgkinson says HSBC has always maintained a conservative model: “Being truly international, we cannot rely on any one country to bail us out. So we’ve had to model our business as if there is no lender of last resort.”
Some blame the failure to manage the growing internationalisation of banking businesses for exacerbating the crisis. Contagion has spread from the US to Europe and has seen near bank runs as far flung as India; as such, regulatory and risk controls have badly lagged behind rampant globalisation, say critics.
Mr Hodgkinson rejects this analysis. He argues globalisation per se has not been the problem but rather has served to “dramatically” broaden the base of investors that were able to buy into poor-quality credit products based on underlying assets found in a single market.
The global reach of the crisis illustrates a more fundamental issue, he says – the dangers of investing in unfamiliar markets. “As soon as you start investing cross-border you are investing in a market about which you will have less immediate knowledge than your own domestic market,” he says. “So investors need to be a lot more careful: they need to put in mechanisms whereby they do get market knowledge so that they understand the risks they take cross-border.”
More conservative
Like HSBC, banks that operate across multiple global markets will almost certainly have to operate more conservative models in the future, he adds.
Although Mr Hodgkinson is an advocate of a more globally co-ordinated regulatory response, he rejects the suggestion that the regulators, who have been widely accused of outright negligence, deserve the criticism heaped upon them. “To some degree, innovation will always lead regulation,” he says. “Basel II has been the response to what’s going on and it has taken a long time because banking is complex, but they have been moving in the right direction.” Following recent unprecedented events, the industry will undoubtedly receive a “Basel II and a half”, as the banking chief puts it. This will be more restrictive where customer deposits are at risk, and where systemic risk is evident.
Mr Hodgkinson agrees, however, with the popular view that banking compensation schemes are in need of restructuring. “But the reality of compensation in free markets around the world is that it only takes one company and one person to say ‘I am going to pay more’ to create an environment of upward pressure on compensation. So this is a very tough thing to regulate and I think it’s the responsibility of boards to get this right.”
He adds: “It’s tough for regulators to do something unless they all – and I mean all – work together.”
If bonus schemes have been found to encourage risk taking, it is only another example of how the industry’s entire approach to risk management has come unstuck.
Basel 2.5
Although Mr Hodgkinson believes that the predominant method of risk analysis – quantitative modelling – remains extremely useful for examining isolated events, it has failed to account for the interconnected nature of risk. For this reason, he argues that future risk management must be undertaken at the very top of organisations, where data on a range of risks – including country risk, instrument-type risk, political risk and future economic outlooks – can be aggregated and the potential outcomes assessed. Robust risk management, he says, requires “a lot of scenario work and not just relying on quantitative analysis”.
As the world’s banks undertake the complex task of scaling back the “quite dramatic” amount of additional leverage they have taken on in the past five years, the impact on the world’s real economies – particularly in the credit-hungry West – will be keenly felt. Echoing the sentiments voiced by many a politician in recent months, he stresses that the ‘fundamentals’ of the UK economy – inflation and interest rates – remain positive, particularly when contrasted with the notoriously bloated interest rates of the 1980s. “Many companies and businesses have strong balance sheets and order books and, while this is a slowdown, it doesn’t have to become an economic rout,” he argues, adding the now familiar refrain: “We shouldn’t talk ourselves into a deeper hole.”
