Banks, knowledge and crisis: a case of knowledge and learning failure
| Published date | 11 May 2010 |
| Date | 11 May 2010 |
| DOI | https://doi.org/10.1108/13581981011033961 |
| Pages | 87-105 |
| Author | John Holland |
| Subject Matter | Accounting & finance |
THEMED PAPER
Banks, knowledge and
crisis: a case of knowledge
and learning failure
John Holland
Department of Accounting and Finance, University of Glasgow, Glasgow, UK
Abstract
Purpose – Regulators such as Turner have identified excessive securitization, high leverage,
extensive market trading and a bonus culture, as being major factors in bringing about the bank
centred financial crisis of 2007-2009. Whilst it is inevitable that banks adopt procyclical business
strategies, not all banks took excessive risks and subsequently had to be rescued by taxpayers.
The paper examines the extent to which individual bank outcomes can be attributed to systematic
differences in banking knowledge concerning the primary risks and value drivers of their
organisations by bank board directors and top management.
Design/methodology/approach – The paper reviews a wide range of theoretical, historical and
empirical literatures on banking models and detailed case analyses of failing and non-failing banks.
A framework for understanding the role and application of knowledge in banking is developed which
suggests how banks, despite their pro-cyclical business strategies, are able to institutionalise learning
and actively create new knowledge through time to improve bank organisation, intermediation and
risk management.
Findings – The paper finds that a lack of basic knowledge of banking risks and value drivers by the
boards and senior managers of the failing banks were implicated in the banking crisis. These
knowledge problems concerned banks’ understanding of their organisation, intermediation and risk
management in an active market setting characterised by rapid economic and organisational change.
Thus, the failing banks ignored or were unaware of this knowledge and hence experienced acute
difficulties with learning the new knowledge needed to address the new problems thrown-up by the
financial crisis.
Practical implications – The analysis suggests that addressing this knowledge gap via the
institutionalisation of banking knowledge ought to constitute an important element of any sustainable
solution to the problems currently being experienced by the banking sector. By ensuring greater bank
learning, knowledge creation, and knowledge use, governments and regulators could help reduce
individual bank risk and the likelihood of future crisis.
Originality/value – In contrast to the claims made by some politicians and banking insiders, the
analysis indicates that the banking crisis and its severity were neither unpredictable nor unavoidable
since some banks, by institutionalising banking knowledge and history of past crises, successfully
avoided the pitfalls experienced by the failing banks.
Keywords Banking, Knowledgemanagement, Risk management,Intellectual capital
Paper type Research paper
1. Introduction
Turner (2009) summarised the reasons that led to the bank centred financial crisis in
2007-2009, as including, massive growth in securitised credit, securities trading,
leverage and excessive dependence on short-term capital market funding. It seems that
The current issue and full text archive of this journal is available at
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Banks,
knowledge
and crisis
87
Journal of Financial Regulation and
Compliance
Vol. 18 No. 2, 2010
pp. 87-105
qEmerald Group Publishing Limited
1358-1988
DOI 10.1108/13581981011033961
both the ratings agencies and the “sophisticated” mathematical risk management
models seriously under-estimated the risks associated with such a strategy and the
“bonus culture” and high leverage greatly encouraged excessive risk taking by
rewarding apparent success (luck) but not penalizing failure. However, the core idea of
this paper is that knowledge and lack of it was also deeply implicated in the crisis and
in many of the above problems, and hence addressing these issues will be part of the
solution.
In Section 2, it is demonstrated that much was known long before the crisis about
how effective bank intermediation and risk management worked, about problems with
these mechanisms and of previous crises in banking markets. Application of this
knowledge alone in the failing banks would have significantly reduced the chances of
bank failure. Section 3 explores how evidence to the UK Treasury Select Committee in
2009 and other sources revealed that much of the available prior knowledge was
ignored or its relevance not understood at the top of the failing banks during the
2001-2007 period. Unsurprisingly, relative to the more knowledgeable and cautious
banks, their resulting high-risk business models proved to be appreciably more
vulnerable during the 2008-2009 crisis.
Section 4 develops a more general theoretical approach to understanding how banks
can formally create and manage knowledge in a dynamic process through time to
improve intermediation and reduce vulnerability. This conceptual frame is based, in
part, on existing developments in universal banking (UB) practice (Holland, 2009),
and in part, on developments in the literature concerning knowledge as the “learning
organisation”, knowledge management (KM), “intellectual capital” (IC) and theory
concerning knowledge-based competitive advantage. Working examples of these
theoretical ideas are also discussed as they are connected to each other and to
conventional ideas of bank intermediation and risk management functions. Section 5
summarises the paper and, using the conceptual frame developed in Section 4, argues
that, to minimise the chances of future crises, governments and banking regulators
ought to focus on improving learning, knowledge creation and knowledge use in
banking.
2. Intermediation and risk management knowledge prior to the 2007
financial crisis
Much was known long before the crisis regarding how bank intermediation and risk
management worked and about problems with these mechanisms. There was
considerable knowledge about the risk spreading and sharing capabilities of wholesale
markets, and general principles of market efficiency. Much was known about the
causes and anatomy of previous crises in banking markets (Kindleberger, 1996),
about the “freezing” of interbank markets and about previous problems of “toxic”
loans. Application of this prior knowledge would have reduced the chances of bank
failure during the 2007-2009 crisis.
Knowledge of specialist forms of bank intermediation and of risk management has
long been available in the literature (Lewis and Davis, 1987, Buckle and Thompson,
2004). Retail banks intermediaries spread their deposit withdrawal risk and loan risks
across liability and asset portfolios, and employed cash reserves and “adequate” equity
capital to absorb these residual risks. Wholesale banks spread withdrawal risk and
bad debt risk by sharing large risks in the inter-bank and syndicated loan markets and
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