Archive: September, 2008
If there’s one lesson from the failure of Lehman Brothers, et al, it’s that ignorance is not bliss and what you don’t know can hurt you. This seems especially true when you’re handling financial weapons of mass destruction. Because playing with WMDs is risky business, and miscalculating the risks can bring a multi-billion dollar business to its knees.
At the heart of the Wall Street woes is a basic failure to measure and manage risk. It started with subprime mortgage lending where banks and brokers sold mortgages on the back of very patchy data about the creditworthiness of the borrowers and their capacity repay. The flames of risky lending were fanned by mortgage backed securities which brought more investors and fresh capital into the market. Investors may have known at a high level that these loans were risky, but with limited visibility into the details of the underlying loans the risks became more opaque. And then it went nuclear with derivatives.
Thanks to OTC derivatives such as credit default swaps (CDS), investors holding risky investments could shift the risk of default to someone else. And with attractive fees on offer for taking on those risks, the CDS market proliferated. It was a nice little earner, as long as you understood and managed the underlying risk. The problem was, many didn’t.
Only a crazy bank would try to innovate during a recession, right?
Wrong, according to Clayton Christensen’s firm Innosight. It might be tempting to batten down the hatches, cut spending, and focus on incremental improvements to your core business. But a failure to keep innovating will hurt your ability to compete in the longer term. In the words of Amex CEO Ken Chenault, “A difficult economic environment argues for the need to innovate more, not to pull back.”
That doesn’t mean you should blindly pour big dollars into huge “boil the ocean” projects. It’s important to keep your projects diverse, and to prune out “zombie” projects so that resources don’t get tied up in things that clearly aren’t working.
In other words, focus on specific, practical projects, some of which can deliver quick wins. When you find a winner, expand the project and reap the rewards.
So, what are the right innovations for banks and lenders in these times of economic uncertainty?