Thursday, 15 September 2011

Trading losses and takeovers

It appears UBS has lost some money - about $2bn - due to unauthorised and highly risky trading on financial markets. Not for the first time, either.

As a result of this, there are now even more strident calls for UK retail banking to be ring fenced to prevent these sort of losses from impacting on retail customers. This tweet from the BBC's Robert Peston is typical:

"UBS's $2bn rogue-trader loss has not come at a great time for those who argue investment banking and retail banking should remain integrated"

This is, of course, a particularly stupid comment. UBS doesn't have a UK retail banking operation so wouldn't be subject to the ring fencing proposals anyway. But does the UBS experience strengthen the case for the likes of Barclays to be required to ring fence their retail operations?

I had a quick scan down Wikipedia's list of banks that have made serious trading losses. Now, admittedly, Wiki themselves say this list is not complete, so it may be that another major UK retail bank is lurking in the shadows somewhere. But the only one reported on that list is NatWest's loss of $0.19bn on interest rate options in 1997.

Now the NatWest loss is very interesting. This loss occured after a series of acquisitions and investments in its capital markets banking business designed to reduce its reliance on traditional retail banking and enable it to manage the business cycle better. Instead it fatally weakened NatWest.  After this loss it separated out its investment banking division and attempted to sell it. But the stock market was unimpressed and NatWest became a target for takeover, eventually succumbing to a hostile bid by the much smaller Royal Bank of Scotland (RBS).

A look at UBS's history reveals a similar pattern. In 1998 UBS made a loss of $0.55bn on equity derivatives trading. That loss, coupled with generally poor performance, led directly to its takeover by its fellow Swiss bank and competitor SBC Warburg.

You see, that's what normally happens to banks that make major trading losses. They get taken over.

And when the reasons for the losses are investigated, they always boil down to the same things - failure of internal management & control combined with an aggressive expansion strategy. It makes no difference whether the bank that is failing to manage its risks properly is an investment bank trading in exotic derivatives (UBS), an integrated bank so anxious to take over America that it fails to do due diligence on an acquisition (RBS), a household name going for broke in leveraged buyouts and private equity financing (HBOS), or a retail bank massively expanding its mortgage book by lending far too much to people who can't afford it (NR). The attitude is the same, and so is the result. A bank that is poorly managed doesn't deserve to survive as an independent entity.

But the fact is that the Wiki list indicates that only ONE UK high street bank has ever made investment banking losses large enough to impact retail banking - and that was nearly 15 years ago. If a ring fence was necessary, shouldn't it have been imposed then? And the UK didn't bail out ANY investment banks in the 2008 financial crisis. It bailed out three retail banks and a clearing bank.  So what exactly are these risks that ring fencing retail banking is supposed to save us from? 

7 comments:

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  2. This is an excellent point well made. I think that the ring fencing palaver is actually a blind. It fails to address the key issues in BOTH types of banking and in other FIs (AIG etc). At the functional level you rightly skewer the lack of the application of basic controls and a cavalier attitude to risk that would normally be associated with a greedy gambling addict (with an infinitely obliging parent holding ready cheque book).

    Sure it's right that an investment bank fails as a result of poor management but It's still not right that they should so easily arrive at that point which is why fraud charges are now involved at UBS.

    NOTE NO FRAUD CHARGES or even proper investigations have happened at ANY bailed out retail bank. In fact those we might expect to see in the Dock are off enjoying the fruits of lavish golden handshakes.

    So not only is ring-fencing useless it actually detracts from the FACT that at least a scapegoat or two normally end up in clink in the face of Investment bank fraud where as potential and even alleged fraud in TBTF retail banks is elided and the suspects walk free.

    This makes an utter mockery of the legal and regulatory requirements for probity and proper due diligence and in my view constitutes complicity on the part of Government and regulators.

    It is both a sham and a shame.

    @sysparatem

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  3. We need to look at these institutions globally. They are global and their regulated behavior should be analyzed as such.

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