Climbing Out of the Credit Crunch

Root Causes of the Credit Crunch

Key factors

We believe that excessive short–termism, coupled with a lack of accountability both within financial institutions and between management and shareholders, is at the heart of the problem. This has meant:

  • failure of institutions to appreciate and manage the inter–connection between the risks inherent in their business activities and management and remuneration incentives
  • remuneration structures/bonuses of banks being characterised by excessive short–termism. This neither supports prudent risk management nor works in owners’ long–term interests
  • risk management departments in banks which did not have sufficient influence, status or power and
  • weaknesses in reporting on risk and financial transactions.

Secondary factors

Further contributory factors were:

  • over–complexity of financial products and lack of management understanding of the associated risks — including the fact that, currently, there is no genuine market for certain asset–backed securities
  • over–dependence on debt and an assumption of a continuing low cost of capital environment
  • scale of issuance of securities and the interconnectedness of financial institutions, especially between retail and investment banking
  • human weaknesses: a failure to appreciate the influence of cultural and motivational factors such as rigidity of thinking, lack of desire to change.
  • An attitude of ‘it is not my problem’, inappropriate vision/drivers and, perhaps most importantly, human greed
  • lack of training to enable management to understand underlying business models, leading to poor managerial supervision
  • lack of rigorous challenge by non–executive directors possibly caused by poor understanding of the complexities of the business and
  • bad habits and complacency after a prolonged bull market.
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