Imaginary kingdoms

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Are we in control of our own destinies? Companies like to believe they they are. In less than 12 months UBS has signalled $38bn of write-offs for credit losses and changed its chairman, chief executive, chief financial officer, and head of investment banking. The search for explanations for this disaster led to Monday’s publication of a post mortem, commissioned by Swiss regulators.

Many of the problems identified are generic to the industry: messy reporting lines; a dependence on statistical measures of risk; misunderstood hedges; a culture that valued revenue and downplayed risk; a board that relied on verbal reassurances from senior managers. To these can be added two UBS-specific factors. Hiving off some proprietary activities into Dillon Read Capital Management, an arm’s length entity, caused major disruption. UBS also allocated capital to divisions using the group cost of capital, rather than adjusting for that division’s risk. It is hard to imagine any serious industrial company being this primitive.

The report’s conclusion can be summarised as “must try harder”. But compared with other publicly quoted businesses, banks’ balance sheets may now be too big, and too leveraged, for senior executives to know what is really going on. UBS’s sub-prime exposure was $40bn in September. That sounds huge until you realise that represented 1.6 per cent of UBS’s assets. Perhaps a few hundred people were involved in subprime activities – out of a workforce of 84,000.

It would be nice if all banks could instil a culture of excellence that makes it safe to delegate. But not every institution can excel, and distinguishing excellence from luck is hard. The alternative is to split proprietary activity from traditional agency business and either ring fence it or close it. But that would contradict a decade of received industry wisdom and the self-interest of powerful employees. Most big bank executives will instead promise to “try harder”, and maintain the fiction that a handful of people around a board room table can understand trillion dollar balance sheets.

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