Financial Times Europe - 23.03.2020

Risk Management

Financial Institutions

FT SPECIAL REPORT

MondayMarch 23 2020 http://www.ft.com/reports | @ftreports

Adventures in the wild

frontier markets

Some big names are

pulling back in the wake

of the ‘tuna bonds’

scandal

Page 4

T

obias Adrian, the IMF’s

head of monetary and

capital markets, has seen a

lot during more than 20

years of monitoring the US

and global financial systems for signs of

stress. But he is the first to admit that

the implications of coronavirus make it

a new phenomenon for him and his

colleagues as they contemplate the

potential impact on financial systems

from Shanghai to Seattle.

“It’s different on a number of

dimensions,” Mr Adrian says, speaking

from his Washington DC office. He cites

the temporary but severe nature of the

crisis, plus its highly personal threat and

uncertainty around that as reasons why

coronavirus is different from other

shocks that have assailed global financial

sectors in recent decades.

Markets have reacted strongly, with

bank stocks around the world falling in

February then plunging in early March,

when the coronavirus took a serious

hold beyond Asia. The falls were

prompted by fears of a slowdown and

that a pandemic could trigger a wave of

defaults. There were further concerns

that global economies will take the

Federal Reserve and Bank of England’s

lead, and that rate cuts — which are bad

for bank profits — will become the stock

response of policymakers. Bank shares

continued their fallinto mid-March.

In the US, the Federal Reserve

stepped in to prevent a liquidity crunch

by buying commercial paper — a form of

short-term debt — for the first time

since 2008. The Fed began buying assets

such as mortgage bonds and

encouraged banks to use its discount

window to keep their pipes flowing. The

European Central Bank is offering

cheap loans to banks. The big global

central bankshave joined together to

offer favourable terms on US dollar

swaps and cut interest rates.

“Central banks have shown their

willingness to act decisively to help

alleviate the effects of financial

tightening and to support growth,

including by cutting policy rates and

offering substantial liquidity support to

markets,” says Mr Adrian. He adds that

fiscal measures such as increased

government spending will also be

needed “to ensure that support quickly

reaches those who confront the most

pressing human needs”.

For all the difficulties, Mr Adrian’s

first message is one of reassurance. He

acknowledges that the impact on the

financial sector could be severe in the

short term, with defaults rising as

supply chains seize up, employees

cannot get to offices and factories, and

quarantined populations stop spending.

But, he adds: “In general, we think that

the banking system is well capitalised at

this point. [In many countries] that are

under stress now, very recently we have

found that these banking systems are

resilient, even to large shocks.

“While we don’t know how long the

shock is going to last, it is going to be a

temporary shock,” he adds. That means

struggling borrowers and their

economies should rebound.

With that in mind, banks could

consider “temporary forbearance” for

borrowers, he says. “We don’t know how

long it’s going to take but the medical

profession is telling us that this is going

to be resolved. Come the summer that

[forbearance] might be a smart

business decision and it might be

stabilising for the economy as a whole.”

As countries closed bars, banned big

social gatherings and imposed travel

IMF: crisis is severe but we are resilient

The fund’s markets

chief Tobias Adrian on

global coronavirus

threats and responses.

ByLaura Noonan

restrictions, banks across Europe and

the US unveiled a range of interest

waivers, payment holidays and other

supports for borrowers whose

livelihoods have been hurt by the virus.

There are risks around how markets

will work if traders are banished from

offices, since it would be difficult, if not

impossible, to comply with regulatory

standards from home. For months the

finance industry has been discussing the

need for waivers with regulators, which

have begun agreeing reliefs. Bankers are

optimistic of a sensible outcome.

Mr Adrian is realistic about the extent

of the difficulties ahead, and their

unpredictability. On March 4, the IMF

set aside $50bn for countries hit by the

virus and said its rapid spread meant

that global economic growth in 2020

would be below last year’s 2.9 per cent.

He stresses that “confidence effects

arecrucial” to the outcome. “Fear is a

powerful driver of behaviour, and that

can have economic consequences,” he

says of people buying up face masks and

stockpiling goods.

Another concern is how the non-

banking sector will cope. New forms of

financial intermediaries such as bond

funds and leveraged loans houses have

been spawned by large issuance of

leveraged loans, high-yield bonds and

emerging market debt.

“We don’t really have the experience

of going into crisis with these

instruments yet... The expectation is

that they will be resilient, but there’s

certainly some degree of uncertainty

around that. Since the global financial

crisis, we’ve made tremendous progress

in terms of having more capital and

more liquidity and better resolution

regimes for the bank system,” says Mr

Adrian, “but less progress has been

made for the non-bank financial

institutions”.

He and his team will watch events

from Washington DC, where IMF

central staff are hunkering down after

the fund cancelled swaths of country

missions in favour of teleconferences to

avoid spreading the coronavirus.

“We hope for the best but we prepare

for the worst,” he says of his team’s

approach. “This is the way to address

this crisis. There are lives at stake as well

as financial markets, financial stability

and economic activity.”

Monday morning, February 24, was the

moment when a thoroughly somnolent

market, after a decade of steadily rising

prices and accommodative central bank

policy, awoke to the fact that corona-

virus would have serious implications

for the world economy — and that, at the

same time, almost every asset was

priced for perfection.

How did the market become so san-

guine? Why were the red flags missed?

These are questions not just for traders

and investors, but also risk managers in

businesses of every kind, who must fight

the human tendency to believe that if

yesterday was a good day, tomorrow is

sure to be a good one, too.

The penny seems to have dropped on

February 24 because it became undeni-

able that the virus would not be confined

to Asia. The previous Friday, US bond

yields had risen as investors read of four

deaths from the virus in Iran and a small

but rising number of cases in northern

Italy. By Monday, Italy was locking down

towns and the sell-off was on.

Since then global stock markets are

off by one-fifth. The Vix, which looks at

derivative markets to determine how

much volatility investors expect, has

spiked to highs last seen in the financial

crisis of 2008. The “spread” between

government bond yields and those of

risky corporates has blown out, too.

But well before February 24, some

were raising the alarm. In a prescient

blog 10 days previously, Scott Minerd,

chief investment officer atGuggenheim

Investments, wrote: “The cognitive

dissonance in the credit market is

stunning... yields are low, spreads are

tight, and risk assets are priced to perfec-

tion, but everywhere you look there are

red flags.”

The coronavirus, he notes, had been in

the news since early January and looked

more dangerous than Sars, its predeces-

sor. “This will eventually end badly. I

have never in my career seen anything as

crazy as what’s going on right now.”

The question is how organisations can

maintain Mr Minerd’s level of vigilance.

Brian Moynihan, chief executive of

Bank of America, raised a further con-

cern in a recent interview with the FT.

He said that companies “now have a

substantial amount of our employee

base that weren’t [adults in the 2008

financial crisis]. You have to think

about how do you get those teammates

to understand all of what happened

without appearing to be, you know, lec-

turing them.”

Risk and portfolio managers agree

that — other than a healthy paranoia —

strong processes and habits are the key.

Make a risk-control plan and stick to it.

Have a sensible risk strategy and repeat

it constantly. Ensure that channels of

communication are open, so if anyone

picks up risk signals, they are heard.

Max Gokhman, head of Asset

Allocation atPacific Life Fund Advisors,

offers a simple definition of compla-

cency. It is “when markets shun all the

bad news and only focus on the good

news”. He became aware that markets

were complacent when there was little

response to the US killing of Iranian

General Qassem Soleimani.

Cultivating a contrarian element to

your thinking is also important, he adds:

“When sentiment becomes extreme,

consider taking the opposite position.”

Quantitative models that track a wide

variety of sentiment indicators help him

follow changes in investor attitudes.

His next rule of thumb: “Have a plan

in place before an event occurs.” Having

decided in advance how to respond to a

range of scenarios helps avoid getting

caught up in emotion as an event un-

folds, allowing traders to “focus on the

facts” rather than market sentiment.

The head of risk management at a

large US bank — who did not want to be

named — echoes Mr Gokhman’s pre-

scriptions and adds some of his own.

He says the job of a risk manager is to

ensure everyone in an organisation can

“take that hard look in the mirror and

be honest”. For him, that starts with

reminding everyone that the bankers

who made terrible mistakes leading up

the financial crisis were just like them.

“Those people made decisions that

they truly believed were going to create

shareholder value... people will

[always] start to think they have it all

figured out.” Again, he thinks the

coronavirus is the perfect example: “All

the information was always out there,

and until February 21, risk managers all

over the world were just ignoring it.”

To stop people thinking they have it

all figured out,he follows a few simple

guidelines.

First, give people enough autonomy

that they think like the owners of their

part of the business. “You say to every-

one: ‘If you were the owner of this little

part of the business, would you run it this

way? Are you waking up... thinking

about what you might be missing?’ ”

Second, when people answer those

questions, listen and act on it. This re-

inforces the ownership mentality.

Third, before big decisions are taken,

go through a thorough risk identifica-

tion process. Write down everything

that could go wrong, “all the ways you

can win or lose”. When a decision does

go wrong, go back to the list. If the risk

was not identified, determine why not.

Last, repeat your risk principles to

everyone in the organisation. “You

know it’s working,” he says, “when peo-

ple repeat the same stuff back to you.”

Virus outbreak

highlights danger

of complacency

Reaction

Why were markets slow to

react to red flags — and how

might they better prepare?

ByRobert Armstrong

‘While we don’t know how

long the shock is going

to last, it is going to be a

temporary shock’

Tobias Adrian

Uncertainty:

Coronavirus is

reshaping the

global economy

Getty

About two decades ago, one of Sweden’s

biggest banks was quizzed by an analyst

on the source of higher-than-expected

costs in itsquarterly results. The answer

was something that analysts had not

included in theirmodelling.

“People were basically driving trucks

into ATMs and branches, smashing

them, taking the money... and disap-

pearing,” recalls Ronit Ghose, head of

global banks research at Citigroup, who

was on the call.

Technology has sincelowered the risk

of physical robberies at banks’ branch

networks, many of which no longer

have muchcashto steal now that most

money is moved digitally.

New technology has also offered

banks billions in cost savings, as cus-

tomers moved from expensive

branches to digital models. It allowed

banks to grow by serving people far out-

side their physical networks and using

big data to understand how they can

lend to non-traditional borrowers. But

technology also brings its own dangers.

“Financial services are becoming

increasingly digitalised, broadening the

attack surface for possible cyber

events,” according to an IMF report in

February, which urged regulators to

monitor cyber risks more carefully.

The reportwarned that the volume of

sensitive information held by banks

makes them one of the “most highly

targeted economic sectors for data

breaches”. Risks are amplified by the

rise in internet traffic and the number

of devices connected into banks, as well

Continued on page 3

Tech advances broaden

scope for cyber attacks

Technology

Banks among most highly

targeted sectors for data

breaches, saysLaura Noonan

Inside

Floods raise pressure

over climate change

Insurers and banks face

threat from extreme

weather and fossil fuels

Page 2

Gender climbs agenda

in risk management

Women are coming to

the fore in a changing,

male-dominated field

Page 2

The antisocial side

of social media

Banks have been slow

to tackle the online

danger to reputation

Page 3

Ransom attackers go

‘big game hunting’

Hackers buy malware on

dark web to extort ever

larger sums from victims

Page 4

Target: US bank Capital One was hit by a cyber attack last year— Alamy

Despite big falls on exchanges such as the NYSE, Tobias Adrian of the IMF offers realism and reassurance— Getty

‘Financial services are

increasingly digitalised,

broadening the attack

surface for cyber events’

Deciding in advance how to

react helps avoid getting

caught up in emotion

MARCH 23 2020 Section:Reports Time: 3/202019/ - 17:12 User:jerry.andrews Page Name:RMX1, Part,Page,Edition:RMX, 1, 1