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29 Mar

Post-crisis, bank risk on rise again

General

Posted by: Mike Hattim

A term as emblematic of the heady pre-financial crisis days as “covenant-light” is not something one expects to hear these days from a high-ranking official at Canada’s top financial watchdog.

But that’s exactly the term used on Sunday by Ted Price, assistant superintendent at the Office of the Superintendent of Financial Institutions, to justify a push for more action by regulators even as a recovery appears in flight.

Covenant-light, which refers to lending with few strings attached and therefore more risk, is one that has been mumbled darkly in recent private gatherings of business heavyweights. In these circumstances, executives will acknowledge that less than three years after the worst financial meltdown since the Great Depression, risk has been repriced yet again — and back to the levels before the crisis set in.

In some cases, they say, the strategy is being employed to push off the inevitable — a non-payment of debt — while ensuring that minimum monthly payments continue to trickle in for as long as possible.

Peter Nerby, a senior vice-president at Moody’s who is responsible for the ratings of Canadian financial institutions, said he is worried about the apparent relaxation of loan agreements and the appearance of increased risk-taking at some North American financial institutions.

“It absolutely is making a comeback,” said Mr. Nerby, who is based in New York, adding it is “appropriate” for the regulator to draw attention to such behaviour.

While Mr. Nerby said it would be an “extreme case” where covenants are so light that a default is virtually impossible to be triggered, even anecdotes of such cases are a chilling reminder of an infamous pre-crisis statement by Citigroup chief executive Chuck Prince. In 2007, just before the liquidity dried up and forced markets around the world into turmoil, Mr. Price said his job as head of one of the world’s biggest financial institutions was to continue to dance as long as the music continued to play.

In a speech delivered Sunday at the Latin America Economic Forum in Calgary, OSFI’s Mr. Price likened the phenomenon of increasing competition, diminishing returns and increased risk appetite to a replay of a bad movie. And he urged more regulatory intervention because, he said, the unhappy ending will not miraculously change without some purposeful editing.

The repeating cycle has brought back other pre-crisis instruments such as structured derivatives, this time based on volatile commodities, he said.

“If we want a better outcome, supervisors and business leaders had better do something different this time around,” Mr. Price warned.

He did not restrict his warnings to the behaviour of bankers and their regulatory supervisors. Indeed, his comments extended into the boardrooms of financial institutions.

“Boards need to ensure that effective risk management is truly part of their business culture,” Mr. Price said. “Businesses that take the lead in improving their risk management systems will be better prepared for the next phase in the cycle, when those around them are acting out of fear.”

OSFI officials on Monday declined to elaborate on Mr. Price’s comments.

Banking analysts said it is difficult to envision what specific regulatory interventions could be put in place to control the behaviour Mr. Price highlights.

“As Mr. Price suggests, the vicissitudes of risk appetite are very difficult to contain – being tied, as they are, to human nature,” said Peter Routledge, who tracks Canada’s banks at National Bank Financial. Among the challenges for regulators, he said, will be to pinpoint the primary sources of the increased risk appetite.

“Given the much intensified scrutiny of, and restrictions on, regulated financial institutions, one might be more likely to find excessive risk appetites outside of regulated financial institutions,” Mr. Routledge said. “That is not to say regulators should decrease their scrutiny of the regulated sector, but that they may have to increase their scrutiny of sectors or players not presently under the regulatory umbrella.”