Whose responsibility is it anyway?

The most recent edition of Economist has a very comprehensive coverage of the current credit crisis. In particular the view on bankers’ responsibility and accountability was most interesting. Not because I am one of the many in the world who make a living thus, but because I see myself agreeing to quite a bit of what was written. At some point I do think bankers need to take responsibility for their actions and look beyond the short term P&L and compensation. Difficult though it might be, some balance has to be struck.

Banking as an industry is ferocious. There is cut throat competition to reign supreme. Most bankers want to out do their peers by doing bigger and better deals, both in terms of money and glamour. In some ways the thrill of the chase and the pleasure of the kill keep the momentum up. In pursuit of this hunt many a times bankers start believing that it is their duty to “deliver what the client wants”. With this skewed perception when bankers take on deals, they are bound to be overtly aggressive and dig holes for themselves and many other innocent coworkers.

In line with this theory, it can be said that bankers have engineered the present situation. While the world speaks of sub-prime, in my view, the problem is that of credit markets in general. Banks have not been prudent even with corporate credit. In the hay days they dished out credit lines to small, unrated and non-profitable corporations at ludicrous levels. In many instances these facilities did not have any security or even financial covenants. Bankers who could monitor credit were too busy signing deals and investors who should have done due diligence were too busy trying to milk all available deals. So yes, to some extent the investor community is also a cause of what the world is facing. Does this absolve the corporates at all? Not in my opinion. Corporate clients have expectations which are far removed from reality. They push bankers and investors alike to meet their terms. While some say no there are other bankers who succumb. As deals are lost the one upmanship game amongst bankers starts. Corporate clients love to exploit this weakness of bankers without realizing that if markets shut down (as they have now) in future, their funding requirements will not be met down the line. So I guess it is collective responsibility.

A very interesting example of collective responsibility is the current derivatives crisis in India. Indian capital markets are still young and derivatives are still not main stream products. While larger corporations have the infrastructure and know how to use these instruments, the smaller guys are still novices. However, in an attempt to be “cool” a lot of the smaller fish signed derivative contracts. When the going was good no one complained. However, as the tide turned, CFOs started pointing fingers at bankers, claiming that the contracts they signed had not been clear. Bankers in turn pointed fingers at the regulatory authorities stating that regulations were weak and faulty.

Can there be something more ridiculous than this circus? Firstly, in my opinion, it is the responsibility of every CFO to understand the financial contracts he is risking his balance sheet to. All doubts should be cleared and the worst case scenario should be well thought of before any legally binding contract is signed. Secondly, bankers should be transparent in their dealings and explain the worst case scenario to the client. Now what if the poor banker does not understand the product herself? She should not be entrusted with the job. That is the responsibility of the line managers. Thirdly, the regulator (especially in India) needs to ensure that instead of drafting complex guidelines which are unnecessarily restrictive, they should consult bankers and CFOs (to understand the products and their use first) to structure rules which can minimize abuse of structured products.

I guess I am looking at things a little too simply and this might not be real. The bottom line, however, in my view remains that there has to be some amount of realism that needs to sink in at all levels. Banking community in particular should take note and prevent a similar crisis from surfacing another decade from now. After LTCM and sub-prime we should have learnt our lessons well enough. If we can be financial innovators and geniuses, I am sure we can quite easily learn from these two last disasters. The question that remains to be answered, however, is – do we want to learn?