The fascinating world of investment banking knows no ends when it comes to identifying risk. All banks have a ‘Risk’ department, but the identification of risk is at the heart and soul of every investment banker. From credit risk to market risk, gap risk to basis risk and now this week, ‘mortality risk’, the average investment banker has to deal with a minefield of categories of risk as he or she goes about his/her daily job.
In fact, the story of risk management in investment banking is a game of storytelling, reduced to numbers. The very basis on which decisions about deals are made depends upon rates moving, companies defaulting, or even in my most recent case, people living or dying more than expected – “should we capture this risk, and if so, how do we ‘model’ it?” “Can we ‘hedge’ such a risk…?” These are some of the frequent questions asked when analysing the risks involved in structured transactions.
This endless obsession with risk is prudent in today’s post-financial-crisis banking world. Regulators (and the rest of society) demand it. After all, it was the hidden, unidentified sources of risk such as ‘model risk’ that brought the world’s biggest investment banks to their knees. In an era of infinite complexity and greater regulatory oversight, it is amazing to observe the complexity and the different types of risk that the modern banking professional must take into account. I call this phenomenon ‘mindless mindfulness’.
‘Mindless’ in the sense of the often esoteric and surreal nature of the discussions. Let’s take a recent example.
“If the SPV defaults on its loan to the Bank and regulation requires us to assume that the German government bunds held by the Bank as ‘collateral’ default at the same time too, then the Bank’s loss would be…”
Possible, but highly improbable.
‘Mindful’ to the extent that one has to take into account so many factors and risks when working on a deal. The ultimate result is often endless discussions – at worst, paralysis and paranoia – over risk factors that are either remote, unobservable, or simply that regulation requires you to consider.
Sometimes these risks are systemic, setting off a chain of events that has a domino effect throughout the industry. The next source of the financial crisis may well be the result of attempts by regulators to over-regulate the industry, as ill-conceived regulations create the wrong incentives for risk-taking and increased volatility in financial markets.
Don’t get me wrong, prudent risk management is an essential part of running a successful and safe bank. A bank that is well capitalised and managed and contributes overall towards society. However, the story of modern banking today is one that presents significant challenges and also creates risks unheard of many a year ago – the task of managing the ever-growing list of financial (and non-financial) risks seems endless…complexity becomes an industry in itself as industries are born attempting to make sense of and advise on it all.
Sometimes the modern yogi in a bank just has to sit back and observe all of this…The day that ‘shit hits the fan’, as it did in 2008, when not even the best of minds saw the crisis coming, all we can do is just acknowledge the part that we play in this game – a game that we all play in the corporate world, all in the name of earning a living.
Is this what it is really all about?