Absent Management in Banking

Frontmatter

Chapter 1. Introduction: Not Managed at All—How the Idea for This Book Occurred and What It Is About

Abstract

The idea for this book came from the massive losses incurred by the bank Christian Dinesen worked for during the 2008 financial crisis. The possibility occurred to him that banks may at times not be managed at all. As all banks do not fail in a crisis, it is management that makes the difference between survival and failure. Historically, management in banks developed much later and differently than that of non-financial corporations. Central themes in the book include regulation, incentives and the producer manager approach. The latter is where top management continues to produce, to be bankers, while also supposedly managing the bank.

Christian Dinesen

Chapter 2. The Medici and Renaissance Complexity: How the Challenges of Renaissance Banking Finally Defeated the First Multinational Bank

Abstract

This story begins as early as the fifteenth century, with one of the most famous banks in history, that of the Medici in Renaissance Florence. Many of the complexities related to a rapidly growing multinational bank were evident in the Medici Bank. The different banking products can be identified and explained. The risks of lending to sovereigns become understandable. The need to delegate management to capable and correctly incentivised managers was central to both the success and the failure of the Medici Bank. An early example of absence of management becomes apparent when Lorenzo the Magnificent was consumed by politics and abandons the management of his bank.

Christian Dinesen

Chapter 3. Rothschild, the Largest Bank in the World: How Multinational Family Ownership Overcame Nearly All Management Complexities When Others Failed

Abstract

The Rothschilds were the largest bank in the world in the nineteenth century. Their management structure was based on family and what a family! Internal communication, mutual criticism and intermarriages contributed to achieving banking dominance and fabulous wealth. Industrialisation, wars and revolutions almost brought down single Rothschild banks, but diversification and mutual support overcame all challenges. The Rothschilds were instrumental in saving other banks and banking systems, such as Barings and London in 1890. The absence of a family member willing to establish in the United States eventually caused the gradual decline, rather than failure, of the Rothschilds.

Christian Dinesen

Chapter 4. Less Regulation Means Greater Complexity: How Looser Bank Regulation Allowed Faster Growth, Greater Complexity and Contributed to Absent Management in Banking

Abstract

Regulation was important for the Medici with a ban on usury and for the Rothschilds with a ban on joint stock company banks. The devastating Great Depression in the 1930s resulted in significantly tightened regulation including the separation of commercial deposit-taking and investment banks in the United States. Combined with international currency regulation after Second World War this tightening regulation resulted in the only longer period in modern times with no banking crisis. From the early 1970s, continuously loosening of regulation allowed banks to grow and diversify. Some banks grew so rapidly and expanded so aggressively that they became overly complex and thereby unmanageable.

Christian Dinesen

Chapter 5. Complexity from Growth: Territory and Size—How Absent Management Occurred Through Growth by State, Country and Sheer Size

Abstract

Operating in more than one state or country makes an organisation more complicated to manage. Operating in many countries is very complicated. As the world opened up to increasing foreign investment, more banks followed the first multinational bank, Citi, and these banks became multinational with all the complex challenges this brought. Some believed that soon a few global banks would dominate, as had happened in other industries. The 1990s saw extraordinary acceleration of mergers amongst banks creating universal giants, including Citi, J.P.Morgan, Credit Suisse and UBS. No one questioned whether the management would be able to manage the complexities associated with this growth.

Christian Dinesen

Chapter 6. Complexity from Growth in Lines of Business: How Absent Management Occurred When Different Types of Banking Were Merged

Abstract

The rapid growth of banks included expansion into additional lines of business. This added to the complexity of managing multiline banks. The combination of commercial deposit-taking and investment banks, with much larger combined balance sheets, enabled significantly increased trading for the banks’ own account. The mergers were often paid with shares, and many banks not already listed on stock exchanges did so in the 1980s and 1990s. Large banks with extensive geographies and new business lines made management so complex that it was sometimes absent. One example was the failure of Barings Brothers in 1995, caused by absence of management of a fraudulent trader.

Christian Dinesen

Chapter 7. The Absence of Incentives to Manage: How the Wrong Incentives Resulted in Absent Management

Abstract

Incentives have been a central part of managing banks from the Medici to today. Bonuses were awarded for production, being successful banking, and not for management. When banks were mainly partnerships, one incentive for the partners was to keep the bank from failing. Once banks listed on stock exchanges, incentives became shorter term. They were about a high share price of the bank rather than its survival. Annual bonuses became path dependent and difficult to reduce because of the fear of losing hard-working and talented bankers. At times, incentives were so large that the recipients became financially independent within a few years and thereby unmanageable.

Christian Dinesen

Chapter 8. Producer Managers: How Continued Focus on Banking Resulted in Absent Management

Abstract

When banks were small and simple, management was a secondary activity. In industry senior people stopped designing, making and selling cars and became specialist managers. In banking the local bank manager kept seeing customers and top management met with the largest clients or conducted takeovers and mergers. A senior Citi banker acknowledged that banking operations were not managed at all in 1970s. The lack of specialist management made absence of management of increasingly complex banks more likely. Incentives favoured banking over management. This producer manager approach contributed to absent management, bank failures and financial crises and made producer managers ill equipped to handle any of them.

Christian Dinesen

Chapter 9. Bank Failures Cause Crisis: How Absent Management in Banks Can Cause a Crisis

Abstract

Banking is based on trust. Trust that each bank will pay back deposits to customers and loans to other banks. If one bank loses the trust of its customers, or that of other banks, this can cause a run on the bank. Northern Rock became overly dependent on mortgage-backed securities and caused the first bank run in the United Kingdom for 150 years, because it lost the trust of the depositors who stood in queues outside the branches. When the United States housing market slowed, one of the first casualties was the unmanaged investment bank Bear Stearns, which lost the trust of the banks financing it.

Christian Dinesen

Chapter 10. Bank Failure: Triggering Crisis—How Absent Management in Banks Triggered the 2008 Financial Crisis

Abstract

After Bear Stearns was rescued by J.P. Morgan and United States government another unmanaged investment bank, Lehman Brothers, triggered the 2008 financial crisis. Lehman Brothers’ uncontrolled growth was financed by remarkably increased leverage. Its risk management had been trumpeted as a strength, but complexity was beyond management. Incentives were vast and awarded for achieving growth. When the government refused to support Lehman Brother and nobody would buy it, the bank failed and triggered the crisis. On the same day Bank of America bought and saved Merrill Lynch, in spite of Merrill Lynch having also abandoned management in pursuit of complex, unmanaged growth. The giant insurer AIG then also had to be rescued.

Christian Dinesen

Chapter 11. Bank Failures Cause a Global Crisis: How the Complexities of United States Mortgage Securities Devastated Banks and Made the Banking Crises Global

Abstract

The crisis transformed United States investment banks that received government support and became regulated like commercial banks. United States housing losses significantly affected European banks. Disruption in financial markets, including the inability of banks to sell additional mortgage loans onto investors, had dire consequences outside the United States. HBOS, Lloyds TSB and RBS in the United Kingdom all failed due to absent management. The Swiss universal bank UBS incurred the largest foreign loss of $38 billion from United States subprime lending. Absent management in Barclays and other banks had global impact with the manipulation of benchmark interest rates known as the LIBOR scandal.

Christian Dinesen

Chapter 12. The Cost of Financial Crisis: How Absent Management in Banking Became Costly

Abstract

When unmanaged banks cause a financial crisis the costs become truly astonishing. The 2008 financial crisis resulted in the Great Recession. The cost of rescuing banks resulted in reduced economic growth and increased government debt in the United States, and across the European Union, which also saw increased unemployment, reduced government spending and decade-long austerity in the United Kingdom. Additional possible effects were greater inequality, shorter life expectancy, reduced standing of the West and rise of populism. Immense stress was felt by millions because bankers did not manage. The cost of absent management can be so great it must be worthwhile to ensure that banks are always managed.

Christian Dinesen

Chapter 13. What Has Changed: How Little Has Changed in Terms of Complexity, Producer Managers and Absent Management in Banking

Abstract

Regulation following the 2008 financial crisis was about more of the same. Banks should now hold so much more capital that they could not fail. Banks were not simplified due to their successful lobbying. Regulation became more complex, which made it more difficult to implement and supervise. Some regulation was so complicated that it has still not been implemented more than a decade after the crisis. Complexity favoured larger banks with the resources to understand and take advantage of the regulation. J.P.Morgan’s investment losses in London, Danske Bank’s money laundering and Goldman Sachs’ Malaysian issues bear hallmarks of absent management. No one would manage that badly.

Christian Dinesen

Chapter 14. Conclusion

Abstract

Drawing together the themes and many incidents of absent management in banking, the conclusion is that only simplifying banks will reduce the likelihood of future absent management, bank failures and financial crisis. Regulation will be most important to achieve this. Until now banks’ lobbying appears stronger than the political will to simplify banks through regulation. There is some hope that shareholders will play a part by selling the shares of complex, unmanaged banks. Conglomerates have gone out of fashion in industry and perhaps banks will go the same way. Societies need to understand that sometimes some banks are not managed. We need to protect ourselves against unmanaged banks and their potential to cause devastating financial crisis.

Christian Dinesen

Backmatter