“Know thyself,” goes the Delphic maxim. You might think it superfluous advice for the world’s biggest banks – that the executives responsible for global finance would insist on a complete picture of the risks they’re running. Yet the crash almost a decade ago showed they didn’t know enough. And even now, their investment in self-awareness falls short.
When financial markets came under stress, the banks lacked timely and reliable information on their exposures to major counterparties. As a result, neither they nor regulators fully could understand the risks posed by the Lehman Brothers bankruptcy, or the extent to which the financial system was linked to a single London-based unit of U.S. insurer AIG.
Since then, global regulators have been striving to put this right. In 2013, the Basel Committee on Banking Supervision published a set of standards: Systemically important banks should be able to collect timely, complete and accurate data on their risk exposures at an enterprise-wide level, and provide concise reports to executives and supervisors.
On the face of it, that was like telling a pilot to keep an eye on the controls. Did it really need saying? Apparently, yes – because almost five years on, most banks still can’t do it.
Earlier this year, the Basel committee reported that only one of 33 banks had fully complied. A separate survey by McKinsey and the Institute of International Finance found that, on average, they actually were slipping behind. Notable weak spots include bad data entry and a lack of buy-in at the very top. Many data systems are incompatible, especially at institutions that have merged. Different units of the same bank might have different codes for the same client, or work with subsidiaries they don’t recognize as part of the same company.
That’s the state of affairs within individual banks. Add to that the regulatory challenge of compiling and making sense of international data. If, for example, a large European bank were heavily exposed to China via investments in a number of third countries, how would anyone be able to see the whole picture? Years of low interest rates have encouraged a buildup of risks worldwide, making an effective early warning system all the more necessary.
Regulators already have the powers they need to compel progress. They can bar noncompliant banks from paying dividends to shareholders, for instance. In extreme cases, they could break institutions into smaller, more manageable entities – although it should never have to come to that. Ultimately, better data management would benefit the banks themselves, and not only by averting disasters. Consolidating information would help identify opportunities and speed up lending.
In this case, patience is no virtue. Regulators shouldn’t have to wait for the next crisis to expose the risks in the financial system. They should act now to ensure that they and the banks know what’s going on.