Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Learning from Crises

Last week, Anwer S. Ahmed, Brant E. Christensen, Adam J. Olson and Christopher G. Yust posted a summary of their research on how banks with leaders experienced in past crises fared in global financial crisis (GFC). Their conclusion is:

We find that banks led by executives and directors with past crisis experience had significantly higher ROA before and during the GFC, fewer failures during the GFC, lower risk-weighted assets in the GFC, less exposure to real estate loans both before and during the GFC, timelier loan loss provisions in the GFC, and more persistent earnings before and during the GFC.

There are two ways of looking at this result. At the micro level, organizations should try to recruit managers with such experience. More important in my view is the macro level implication: it is good for society to have a large pool of managers with past crisis experience. That would ensure that the entire financial system copes better with new crises. But for that to happen, we need crises (at least mild crises) to happen with some degree of regularity.

Already, a decade after the GFC, I think a whole generation of traders and bankers have entered the financial system who have no first hand knowledge of dealing with a crisis. All that they have seen is a financial market numbed by ultra loose monetary policy and policy-puts. Their experience so far is that large economic and geo-political shocks (Brexit or the US-China trade war) have very mild and transient effects on market prices and volatility. The complacency of this generation is probably balanced by the battle scarred veterans who dominate the senior ranks of most banks. But over a period of time, many of these crisis-experienced leaders will retire or leave. It is quite likely that when the next big crisis comes along, there will be a shortage of crisis experience in the trenches.

Outside of finance, it is well understood that preventing small crises is a bad idea: frequent small earthquakes are better than an occasional big one; periodic restricted forest fires are preferred to one rare but big conflagration, and so on. In finance, there is a reluctance to permit even small failures. Regulators and policy makers are rewarded for moving swiftly to “solve” mini-crises. The tragedy is that this leaves institutions, individuals (and even regulators) ill equipped to cope with the big crises when they come.

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One response to “Learning from Crises

  1. JB March 28, 2019 at 3:36 pm

    Anti-fragility

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