How IT can help prevent another banking meltdown

The banking crisis of 2008 could have been prevented, except that no-one in authority could believe the information they were getting, according to an expert in financial risk management

The banking crisis of 2008 could have been prevented, except that no-one in authority could believe the information they were getting, according to an expert in financial risk management.

Dilip Krishna, a partner with Canadian consultancy North-East Financial Services, said the two main reasons for the "near death experience" of the world banking system were that first, the banks didn't use the information technology already at their disposal.

Second, the information they needed was dispersed, stored in "technology silos", and not integrated enough to provide a true picture of the banks' risk or indeed anything that they needed to run their businesses coherently.

"Technology can't save banks from themselves," he said. "It is just an aid to decision-making, not a replacement for it."

Krishna also blamed misaligned incentives, poor monitoring and "regulatory capture" (whereby ex-bankers were asked to regulate their former colleagues) for making a chaotic system worse. "It was the riskiest banks, not the best banks, that did best," he said.

He was sharply critical of bank reform to date, saying it was too narrow and proceeding at a "glacial" pace. This was due mainly to banks lobbying against it, but also to a lack of political will and possibly understanding.

Krishna said he, Teradata and others were working with the authorities on the main problem, namely the murkiness of bank deals. This lack of transparency with respect to the legal and trading risk positions of all the players was why Lehman Brothers' collapse effectively brought down a house of cards.

If everyone could see the explicit links back to the original mortgage before the subsequent derivative transactions took place, the deal on the table would be much less risky, and the world was unlikely to face another multi-trillion-pound bank bail-out, he said.

"Sunlight is the best disinfectant," he said, quoting the renowned US judicial aphorist Brandeis. Such transparency would drive a lot of good behaviour from bank managers, he said.

It is too soon to declare a new dawn, but Krishna believes there is grey light to the east. The US's new Office for Financial Research (OFR) and Financial Stability Council, which has the OFR's support, will be important in ensuring that financial risk is seen as an economic and industry risk rather than a problem for an individual bank, owing to their mutual interdependence, he said.

Key to the change is a proposed data warehouse of all the banks, their trading partners, the products they sell, and the terms and conditions of each transaction. This would expose the linked relationships in a trade and allow parties and counterparties to assess its risk, both at a transaction level as well as aggregated to bank and industry levels.

This information would be available to all parties to a trade, and to third parties. Each could then judge the risk relative to their own positions, and act accordingly.

The data flow from final transactions is already enormous, often too much to collect and consolidate in a trading day. But the proposed system would expose reckless traders and bankers, Krishna believes.

It would allow even a bank such as Lehman Brothers to fail, but without the unforeseen and catastrophic consequences, or the need for emergency government action, he said.

This would act as a self-correcting mechanism on the market, he said. Not only would a bank's share price reflect the market's assessment of the bank's overall riskiness, but more importantly, it would be harder for a risky bank to find people to do business with. "That is probably the most important incentive of all to behave better," he said.

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