The Rise Of Business Risk In Banking

This article first appeared in Financial News.

Bank failures have historically been caused by risks that are specific to the industry – or, at least, that are of much greater consequence in banking. The savings-and-loan crisis of the 1980s in the United States was a case of risk arising from the maturity-mismatching characteristic of banks’ balance sheets. The collapse of Barings Bank in 1995, caused by Nick Leeson’s “rogue trading,” was a case of event risk, to which banks are also highly exposed. And the financial crisis of 2008 was a case of credit risk, of which banks carry more than any other kind of business.

The next bank failure in the US or Europe is as likely to come from a loss of customer business as from an explosion of bad debt or other financial shock

Barrie Wilkinson, Partner, Oliver Wyman

The major risk that most businesses face – that demand for their services will collapse, perhaps because increased costs drive up their prices or because more efficient competitors steal their customers – has been of little concern to banks.

And rightly so. Banks have enjoyed advantages which minimize their business risk (as it is commonly called). The large fixed costs associated with banking have acted as a barrier to entry for potential competitors, as has the time and expense of creating a trusted brand. The cost of shopping around and switching has made bank customers sticky. And the vast quantity of customer data that banks naturally collect gives them an advantage in understanding the risks presented by customers, in designing products for them, and in marketing to them.

But new developments in technology and regulation are eroding these advantages and thereby increasing the business risk faced by banks. Failures arising from business risk unfold more slowly than those arising from the characteristic banking risks. But the risk is no less serious for that. The next bank failure in the US or Europe is as likely to come from a loss of customer business as from an explosion of bad debt or other financial shock.

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