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Western EuropeSeptember 30 2007

Sheep herding

Are the ‘irrational’ clients of Northern Rock the kind of customers rival banks should be opening their arms to, asks Joe DiVanna.
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In September, the UK witnessed its first 21st century run on a financial institution. Northern Rock’s savings business is small when compared with its mortgage lending business and to meet the demand of borrowers, it depends on obtaining funds from the wholesale credit markets. As credit markets around the world become more conservative in their lending attitude in the wake of the subprime market collapse in the US, Northern Rock needed additional supply.

Thus Alistair Darling, chancellor of the exchequer, authorised the Bank of England to provide a liquidity support to Northern Rock to make safe transition through its current liquidity problems.

When manufacturers produce a defective product, they issue a recall. Consumer confidence is damaged and if confidence is not restored, the world has one less manufacturer. If a financial institution loses the confidence of its customers, a run on the institution occurs thus scratching the nation’s social veneer.

Simply, the difference is that unlike manufacturers, who provide products, banks provide a nation with social financial cohesion. When banks fail and people fear losing their savings, customers quickly associate this with a wider sense of lost confidence in the banking system, the economy, the currency and the financial health of the nation. Historically, a run on one bank acts in a domino-like fashion to destabilise a nation’s financial system, a condition not often equated with a thriving modern economy.

In the past, the world has seen numerous bank failures which have resulted in panicked bank runs. For example, between 1890 and 1908, several major bank panics occurred in the US (September 1890, May 1893, December 1899, May 1901, March 1903, and October 1907, with 15 minor panics also during the same period). Bank runs were almost commonplace and customers often kept money under their mattress.

This same lack of trust by customers can be seen in many developing nations today, as cash-based societies convert their earnings into tangible valued things such as gold or cattle. When customers heard the news of financial strife at Northern Rock, they immediately formed images of yesteryear’s bank failures and clamoured to withdraw their savings.

The fear of losing money can be similar to the fear of physical pain, according to a brain scan study at Rutgers University. Monetary fears and our perception of financial stability (or instability) are primary factors that regulate the amount of financial risk people are willing to take, ranging from conservative savers to high-risk stock market speculators.

The science of fear

Fear is contagious, irrational and often debilitating. The feelings of Northern Rock customers in queues from September 14-18 was reminiscent of past customer sentiments: “If I don’t stand in line to get my money, someone else will”; “Everyone else is getting their money, there might not be any left for my account”; “I saw the line, went home found Northern Rock’s internet site not working, so I ran back and got in the line”; “They say there is nothing to worry about, but I don’t believe them”; “They will close soon, I have to go back and tell my partner at least I tried to get our money”. One thing was clear from a line outside a Northern Rock branch: the age of the customers, more than 200 of them, and very few under 40.

According to US bank Wachovia, women in general are more concerned with the fear of losing money (risk) than the chance of gaining it (return). Women often blame themselves when investments lose money, while men blame weak markets, bad advice or bad luck. The big question for banks welcoming the Northern Rock exodus is: are Northern Rockers the kind of customers you want at your bank? Are they a liability in the making?

Bank management teams must ask themselves, can this happen to us? The break of trust in Northern Rock was caused by the bank’s overlooking the fundamentals of managing customer expectations. A trinity of underestimation by Northern Rock, the Financial Services Authority and the Bank of England acted to undermine the confidence of the nation at a time when financial acumen is needed in world markets.

So are there lessons in crisis management to be learned from other industries? In hindsight, Northern’s management team should have taken a proactive approach to setting customer’s expectations that their deposits were not in immediate jeopardy. Other industries have learned that the damage to consumer confidence is minimised by a strong communication offensive and erodes quickly as companies scramble to communicate defensively.

Another strategic consideration for banks is financial literacy, which centres on understanding basic concepts of numeracy, compound interest, inflation, time value of money and monetary gain. Few customers can actually explain their banking activities, how interest is calculated, what are capital gains or how much of their total mortgage repayments over their lifetime is principle or interest.

Understanding customer behaviours such as wants, needs, desires and fears is the key ingredient in developing a lasting value proposition for any financial institution. Bank customers often make irrational investment decisions or adopt lifestyle-based spending habits that undermine their long-term financial goals. Myopic loss aversion is the fear of losing money, occurring when customers become fixated on short-term events.

The key lesson learned from the Northern Rock experience is that the management team must be proactive in managing both their retail and wholesale customers’ expectations. To do so, a bank must really get to know its clients and develop an understanding of customer behaviour.

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Read more about:  Digital journeys , Western Europe , UK