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Forget the profits: some banks may be dead men walking

David Troman
The Times
10 November 2009

Superficially, government intervention appears to have saved some key banks from disaster, with many now declaring large profits. The reality is different: many banks are still in the twilight world, only half-alive and struggling to rebuild their balance sheets.

There are potentially huge losses, of the order of $3.4 trillion, in the financial system that could yet unfold. The banks still have significant exposure to toxic assets, including commercial property and consumer and business loans. If they were forced to recognise these huge losses, the question of their solvency would re-emerge. Many small and medium-sized banks may yet disappear under the weight of that exposure. All of which means the sector remains very fragile.

Regulators are clearly trying to minimise risks, but have the conflicting aims of preventing a similar crisis in the future and not undermining the financial sector. Whichever path they choose, new regulation will bring significant change. We could see a world in which retail operations are separated from “casino” ones, and all may have far higher capital requirements than in the past. Bonuses look set to be constrained and systemically important banks will pay a risk-weighted premium for their “too big to fail” status.

At the same time as grappling with these constraints, banks need to tackle their risk-management policies. In the past, few understood how far and fast things could deteriorate. Traditional risk models simply failed to cope with an interconnected world characterised by complex financial instruments. The problem is that new models, and the associated governance, have yet to emerge to replace the discredited ones. Banks will continue for some time to reinvent their approach to risk management — a move that is needed to restore credibility and to win back the confidence of their stakeholders.

The other big issue for banks is trust, now that customers have been snapped out of the inertia that once stopped them moving their deposits. This presents an opportunity for new competitors. Well-known companies such as Tesco are entering the market, wielding strong brands that make them an attractive option for consumers. This is in contrast with the existing banks, which have to live with damaged reputations and apply tighter approaches to lending. The established players are finding it hard to regain the trust of customers and deliver a positive experience at the same time as dealing with the consequences of previous poor lending decisions.

The combination of all these factors means that banks, despite appearances, are only limping along in a half-alive state. Their ability to lend and to fuel economic growth will remain compromised for several years.

As a result, the financial crisis will haunt the wider economy for some time yet. We shall all learn to live with zombie banks.

David Troman is head of financial services at PA Consulting. This article is the second of five based on a new book, The Zombie Economy: Leadership in times of uncertainty (PA Consulting, £12.99)

To see the original article from the Times Online, please click here.

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