It is 500 years this year since the Florentine diplomat Niccolò Machiavelli first distributed The Prince. While many criticise Machiavelli for dubious morality, The Prince is a foundational masterwork of realist observation and prescription. Machiavelli’s principal point is that we should see the world as it is, not as we might wish it to be; we should respond to the reality, not to the preferred perception. We often see the world as we are or as we are conditioned to see it. Regulators and regulation are not neutral; they play a material role in how banks and people in them see and make sense of the world in which they operate; they ‘condition’ people’s perspectives. Getting regulation right matters. Regulators need to try harder and more realistically.

The global financial crisis, which began in early 2007 and then amplified with interbank credit squeeze following the decision by the US Treasury not to support Lehman Brothers in September 2008, has not yet even nearly played out. The effects of the medicine – central banks’ so-called ‘quantitative easing’ – may end up being almost as bad as the disease it is intended to address. While banks’ balance sheets are in better shape than they were pre-crisis, European banks, especially, are still blighted by vast swathes of underperforming assets. Worse, the managerial adjustment that should have followed such a crisis has been attenuated by central bankers’ interventions and further distorted by some frankly nutty legislative responses, especially in the EU. We are no closer to understanding interconnectedness and network propagation of risks or at being able to respond to them to avert crisis.

One of the functions that came in for profound criticism during the early post mortems of the financial crisis was banks’ risk management. Many commentators held that banks’ risk management functions had focused on the wrong things – that they missed the real risks in markets and instruments that were building over the course of the decade as economies bounced back from the crash of the dotcom boom at the start of the decade. That is, undoubtedly, partly true. But, crucially, when it comes to thinking about what to do next, partly untrue; it mis-apportions the real blame.

Jan-Mar 2014 Issue

Paradigm Risk Consulting