Top of the list is that markets assumed that bank debt, bank deposits and in effect banks themselves were guaranteed by government. Why did these investors underestimate the risks? Three possibilities: 1) they did not understand the risks banks were taking 2) they listened to sell side analysts who did not adjust for risk or 3) they thought they would enjoy the ride while the music was still playing and be smart enough to exit before it stopped. Still, the investment community writ large happily held on to such shares. Why did investors not adjust for risk? Actually, many did, witness the fact that in the two years preceding the crisis the bank share index sharply underperformed the broader market. Why did some bankers not adjust for risk? Three possibilities: 1) they did not understand the risks they were taking 2) they understood the risks but prudence was not in their personal interests or 3) Investors egged them on. Why? Because those concerned did not adjust for risk. Have such targets produced attractive shareholder returns? No. Has the quest for high RoE produced it? No. Let me explain.īanks target Return on Equity (RoE). The result: considerable western wreckage.
This is what investors and board directors have done. Give regiments of global bankers the wrong target and we should not be surprised by a similar outcome. Give an artillery commander the wrong target and the result is likely to be collateral damage. Robert Jenkins is a member of the Financial Policy Committee of the Bank of England.
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