Do Banks Learn from Crises?

Do Banks Learn from Crises?*

Crises are a regular event in financial markets. But do banks that have been hit particularly hard in one crisis learn from the experience and suffer less in future crises? This column suggests not. It shows that banks particularly hard hit by the 1998 financial crisis were also badly affected by the recent financial crisis. It blames the high-risk business models on which these banks rely.

On 17 August 1998, Russia defaulted on its debt. This event started a dramatic chain reaction. As one observer put it, “the entire global economic system as we know it almost went into meltdown, beginning with Russia’s default” (Friedman 1999). As Russia defaulted, a number of investors, including banks, made large losses. For example, the market capitalisation of both CitiGroup and Chase Manhattan fell by approximately 50% in the two months following the Russian default.

Initially, the impact of the Russian default was limited because there was hope that the International Monetary Fund (IMF) would step in to bail out Russia. When it became clear that this would not happen, prices of emerging-market securities fell sharply, and stocks across the developed world soon followed suit. As security prices fell, the capital of investors and financial firms eroded, liquidity withdrew from markets, and volatility increased. These developments led investors and financial institutions to reduce their risk, and caused a flight to safety. The president of the Federal Reserve Bank of New York testified before Congress that “the abrupt and simultaneous widening of credit spreads globally, for both corporate and emerging-market sovereign debt, was an extraordinary event beyond the expectations of investors and financial intermediaries”.1

The financial crisis that started in 2007 would eventually be described as the biggest financial crisis of the last 50 years, supplanting the crisis of 1998 for that designation. The comments regarding the 1998 crisis are not different, however, from comments made about the recent financial crisis. In particular, during the recent financial crisis investors made large losses in securities that had been determined to have a minimal amount of risk, and the unexpected losses in these securities led to fire sales, a withdrawal of liquidity from financial markets, and a flight to quality.

A strong return correlation across crises

The similarity between the crisis of 1998 and the recent financial crisis raises the question of how a bank’s experience in one crisis is related to its experience in other crises. In our recent paper (Fahlenbrach et al. 2011), we examine this question.

If an organisation and its executives perform poorly in a crisis, they might learn to do things differently and consequently cope better with the next crisis. Further – and perhaps more importantly – an unexpected adverse event could lead an institution to assess payoff probabilities differently, as has been argued by Gennaioli et al. (2011), or to reduce its risk appetite. Therefore, one hypothesis, the learning hypothesis, is that a bad experience in a crisis leads a bank to change its risk culture, to modify its business model, or to decrease its risk appetite so that it is less likely to face such an experience again. There is anecdotal evidence that executives claim they learned from the 1998 crisis. A recent book on AIG describes one Goldman Sachs executive as having “never silenced that desire to do something about the next 1998, about never being dependent on short-term funding again” (Boyd 2011, p.192.) The book goes on describing how that executive obtained authorisation in 2004 for Goldman to lengthen the maturity of its funding. Credit Suisse performed relatively well during the recent crisis and one senior executive told one of the authors that the explanation is that they learned a lot from their difficulties in 1998.

Another hypothesis, the business-model hypothesis, is that the bank’s susceptibility to crises is the result of its business model and that it does not change its business model as a result of a crisis experience, either because it would not be profitable to do so or for other reasons. For instance, recent work by Adrian and Shin (2009) shows that broker-dealers increase their leverage in good times. Such an outcome may be the result of them having the best business opportunities during credit booms, but it also makes them more vulnerable if a credit boom is followed by a crisis. Under this hypothesis, crisis exposure exhibits persistence, so that a bank’s experience in one crisis is a good predictor of its experience in a subsequent crisis.

Our paper empirically tests these two hypotheses against the null hypothesis that every crisis is unique, so that a bank’s past crisis experience does not offer information about its fate in a future crisis. We find evidence that is strongly supportive of the business-model hypothesis. We show that the stock market performance of banks in the recent crisis is positively correlated with their performance in the 1998 crisis. This result holds whether we include investment banks in the sample or not. Our key result is that for each percentage point of loss in the value of its equity in 1998, a bank lost an annualised 66 basis points during the financial crisis from July 2007 to December 2008. This result is highly significant, both statistically and economically. The economic significance of the return of banks in 1998 in explaining the return of banks during the financial crisis is of the same order of magnitude as the economic significance of a bank’s leverage at the start of the crisis!

Is it executives?

A natural question to ask is whether the correlation we document is affected by cases where the executive in charge during the financial crisis was also involved with the bank in 1998. It could be that personality traits of the executive, rather than the bank’s business model, are responsible for the bank being positioned similarly for both crises. We investigate this possibility and find it does not explain our results. Another possible explanation for our results is that banks remember a different aspect of the 1998 crisis. Banks recovered rapidly from the 1998 crisis. Investors who took positions in more risky fixed-income securities at the bottom of the crisis made large profits. It is possible that banks that recovered strongly from the crisis remembered that experience subsequently and found it unnecessary to change their business model as a result of their strong rebound. We do not find evidence supportive of this explanation.

Towards an explanation of the return correlation

What could then explain such a systematic crisis exposure? We analyse characteristics of banks that performed poorly in both 1998 and 2007/2008, then compare them to characteristics of other banks that performed better. The results of this exercise suggest that the correlation between returns during the 1998 financial crisis and the recent financial crisis is at least partly due to a business model that relies on higher leverage, more short-term funding, a larger proprietary trading desk, and stronger asset growth during the boom preceding a crisis.

Given our main result, some of the events subsequent to 1998 that have been argued to have played a key role in the performance of banks during the financial crisis have to be put in perspective. The Gramm-Leach-Bliley Act (GLBA) was signed into law in November 1999. GLBA repealed central provisions of the Glass-Steagall Act that restricted bank holding companies from affiliating with securities firms and insurance companies. The strong return predictability of 1998 crisis returns for the financial crisis of 2007/2008 suggests that part of the performance of banks during the recent crisis can be attributed to factors that already existed before the enactment of GLBA or other regulatory decisions such as the Commodities Futures Modernisation Act or the SEC’s amendments to the broker-dealer net capital rule.

Overall, our results show that financial institutions that are negatively affected in a crisis do not appear to subsequently alter the business model or to become more cautious regarding their risk culture. Consequently, the performance in one crisis has strong predictive power for a crisis which starts almost a decade later.

What Exactly Is A Business Model?

What Exactly Is A Business Model?*

Everyone in the tech world talks about business models. But I’ll bet that if you quizzed a random sample of these people, you’d find that they really don’t know what a business model is. I did just that with my students at UC-Berkeley. Most raised their hands, and MBA student Blake Brundidge’s attempt to answer the question was a valiant one—but none of them really had a clue.  The only one who got the answer right was Lionel Vital, a Stanford student gatecrashing my iSchool class.

The reality is that a business model is like the old saying about teenage sex: everyone talks about it all the time; everyone boasts about how well he or she is doing it; everyone thinks everyone else is doing it; almost no one really is; and the few who are are fumbling their way through it incompetently. (Yes, I know things have changed.)

I’ll tell you what a business model is, in case you are quizzed by your investors.

But first, let me answer the big question that is surely on your mind: what is a Stanford student doing at Berkeley? It may be that our classes at Berkeley are much better than those at Stanford. That is probably why Lionel approached me at the beginning of the semester and begged to be allowed to audit my class. To Lionel’s credit, he scored better than any of the Berkeley students. So perhaps some Stanford kids are a little smarter, but Berkeley students get better education? I know that our students certainly have a lot more fun. You just have to visit the campuses to note the stark difference.

Now let’s discuss business models. Sorry, the teenagers reading this will need to get their sex education somewhere else. I teach only entrepreneurship and globalization.

Step one in building a successful business is to learn what products or technologies your customers really need and are willing to buy. This is an iterative process that I explained in this piece. The vast majority of technology startups fail because too few customers buy or use their products. So don’t underestimate the importance of validating and testing your ideas.

Developing the right product is hard. But what is harder is building a good business model. Fortunately, there’s nothing magical about a business model. It’s simply the nuts and bolts of how a business plans to generate revenue and profits. It details your long-term strategy and day-to-day operations.

Entrepreneurs put together elaborate business plans showing optimistic market-share projections. Even 1% of a billion-dollar market seems lucrative, right? Wishful thinking is great, but when it comes time to create your business model, you need to be realistic. The challenges differ from industry to industry, but here are seven basic components of a business model:

1. Reaching customers.

Ralph Waldo Emerson famously said, “Build a better mousetrap, and the world will beat a path to your door.” The reality is that even if you did, no one would find you. Even when you know who your prospects are, it’s usually difficult and costly to reach them. You have to find them via the Internet and e-mail, or the old-fashioned way—through broadcast media, print ads, direct mail, telemarketing, or references or by cold-calling. And these potential customers are not likely to be waiting to hear from you and may not respond to you. So be sure you know how you are going to find and reach them.

2. Differentiating your product.

You think you’ve got the very best solution, but so does the other gal (or guy). There’s always competition, whether you realize it or not. Smart marketing executives know how to develop unique product-positioning strategies that highlight a product’s true value. You need to thoroughly understand the competition and effectively communicate the unique advantages of your product.

3. Pricing.

One of the most basic decisions you have to make is how much you’re going to charge for your product or service. Giving your stuff away is the way to go on the web, but remember that you still need to figure out how you are eventually going to make money—you can’t make it up on volume. Start by understanding how much customers value what they’re gaining from you. Then you need to estimate your total costs, analyze the competitive landscape, and map out your long-term strategy. For your company to survive, your product’s price must be greater than its overall cost.

4. Selling.

Persuading customers to buy a product that they need is one of the most important skills an entrepreneur must learn (read It’s All About Selling for Survival). You’re going to be selling at every juncture. So you have to understand what it takes to close a deal and put together the necessary sales process. And this process has to be perfectly conceived. Be sure you test your selling strategy as you would your product.

5. Delivery/distribution.

This is easy on the Internet. But for big-ticket items, you usually require a direct sales force; for mid-range products, distributors or value-added resellers; and, for low-priced items, retail outlets or the Internet. It’s different in every industry and for every type of product, but you have to get this right. Your products need to be designed and packaged for the channel through which they will be distributed to customers.

6. Supporting Customers.

In addition to teaching customers how to use your product, you need to ensure that you can deal with defects and returns, answer product questions, and listen to and incorporate valuable suggestions for improvement. You may need to provide consulting services to help customers integrate and implement your products. If your product is a critical component of a business, you may also need to provide 24/7 onsite or web support.

7. Achieving customer satisfaction.

The ultimate success or failure of a business depends on how much it helps customers achieve their objectives. Happy customers will become your best sales people and buy more from you. Unhappy customers will become your biggest liability.

All the pieces have to come together like a jigsaw puzzle in your business model. The good news is that you don’t have to start from scratch when formulating it. You can give yourself a head start by learning from competitors and other markets. It is not only the successes that provide valuable lessons; it is also the failures.

You can innovate as much in your business model as you do in your products. Be prepared to evolve your innovation strategy as you gain experience and as your market changes. Like your products, it will probably take several versions to get your business model right; you get better with practice.

How important is diversity within an organization

How important is diversity within an organization*

By the implementation of latest technologies, the world has turned into the global village. Such modernization in communication has allowed several organizations to spread their businesses in different parts of the world. It is in fact very positive step according to the different aspects of life.

When multinational organizations start its operations in new places, it gives broader chances of employment to experts and skilled people of that particular area. Such activities take place on city, state, province or country level.

On one hand, an organization is extending its business, and on the hand the organization must build a diverse environment. Human resource department shouldn’t be bias in relation to age, gender, race, ethnicity, physical abilities or qualities, and nationality.

The only apparatus of judgment should be educational background, work experience and expertise. Differences may prevail on an interpersonal level due to inequality in personalities, work styles, communication styles, and organizational skills. However, organizational decisions should be taken by ignoring all these unethical things.

HR management officials should make such effort to apply diversity; effectively and meaningfully in the workplace. It is not sufficient to simply acknowledge differences among people. Knowing the similarities among a diverse workforce is important in building high performing work team.

A significant way to approach similarities in organizations is to determine the goals and objectives to be met, and to form a team of individuals whose similarities will create synergy and whose differences will complement each other.

The end result of such diversity is a working environment that is inclusive. It is important for the HR officials to seek and recognize the individual talents and contributions that every employee brings to the workplace. In doing so, the differences and similarities will encourage accomplishment of the organization’s goals through a workforce that is prolific, creative, and effective.

Sometimes, organizations find very diverse consumer markets in terms of attitudes and preferences. In the workplace, these contradictory perspectives can contribute to the creativity that is needed for an organization to succeed. Thoughts developed in a diverse environment are very important because unique approaches and perspectives can lead to creative solutions for business issues.

Multinational organizations and groups deal with diversity in terms of cultural differences and are challenged to develop cultural competencies. Organizations must look for a mutual understanding among its diverse employees to achieve effective business results.

Faktor Zeit in der interkulturellen Werbung-2

Faktor Zeit in der interkulturellen Werbung (2)

Zeit der Werbung*

Werbung wird nur dann wirksam, wenn sie gesehen wird. Sieht der Zuschauer mehr Stunden pro Tag fern, dann bleibt auch für die Fernsehwerbung mehr Zeit, gesendet zu werden. Wo liegen die Spitzenreiter in der TV-Nutzung und wo wird relativ weniger ferngesehen?

Land	1994	1995	1996	1997	1998	Ranking 1998
USA	243	241	239	238	238	2
Frankreich	189	193	192	193	197	7
Deutschland	178	186	195	196	201	5
Spanien	219	219	221	218	218	3
Großbritannien	228	227	229	228	241	1
Tschechien	179	197	200	192	198	6
Russland	180	219	224	206	215	4

Quelle: IP (1999): Television 90, European Key Facts, S.21 (Über Argentinien, Brasilien, Indonesien und Israel wären keine Vergleichszahlen erhältlich).

Die Statistik zeigt die angloamerikanischen Länder Großbritannien und die USA an vordersten ’Front’. Vergleicht man deren Werte mit Deutschland, Tschechien oder Frankreich, so ergeben sich Abweichungen um mehr als 20%. Das heißt, für die TV-Werbung in den USA oder Großbritannien bleibt rechnerisch ein Fünftel mehr Zeit, Spots über den Äther zu schicken.

Sucht man nach Gründen für diese Unterschiede, so spielen hier u.a. die Akzeptanzwerte des jeweiligen Mediums eine Rolle. So geben beispielsweise 69% der Amerikaner das Fernsehen als wichtigste Quelle für Nachrichten an.** Mit 53% sehen mehr als die Hälfte aller US-Bürger es gleichzeitig als glaubwürdigste aller Nachrichtenquellen an. Dieser Wert wird umso aussagefähiger, wenn man ihn mit dem der zweitwichtigsten Informationsquelle – den Tageszeitungen - vergleicht. So halten weniger als halb so viele Amerikaner, nämlich ledigleich 23%, dieses Medium für das verlässichere. Dieser Nimbus der objektiven und zuverlässigen Informationslieferung, den das Fernsehen in den Vereinigten Staaten besitzt, wird durch die Nachrichtensprecher, die sogenannten anchormen – personifiziert.

In Spanien dagegen ist der Akzeptanzwert des Fernsehens nach der Francodiktatur erheblich geringer. Hier könnte u.a. die ideale Übertragbarkeit von Fußballspielen, dem Nationalsport Nr. 1 auf der iberischen Halbinsel, zu relativ hohen Verweildauern vor dem Fernseher führen. Darüber hinaus sind die TV-Geräte präsent. Der Spanier sieht nicht nur zuhause fern, sondern hat auch in jeder Bar die Möglichkeit fernzusehen.

In Deutschland und Frankreich können die geringeren Werte durch die Wichtigkeit der Druckmedien, insbesondere der Tageszeitungen erklärt werden, die nach wie vor eine starke Konkurrenz zu den audiovisuellen Medien darstellen.

In Ländern wie Brasilien oder Indonesien ist das TV-Gerät die einzige landesübergreifende und für alle Schichten bezahlbare konsumierte Informations- und Vergnügungsquelle. Hier dürften die Werte denen der USA und Großbritannien relativ nahe kommen und lediglich durch längere Arbeitszeiten, schlechtere Erreichbarkeit oder einfach nur Nichtverfügbarkeit von TV-Geräten etwas reduziert sein.

Es bleibt also festzuhalten, dass in den untersuchten Ländern eine einheitliche Fernsehkonsum-Gewohnheit keineswegs feststellbar ist. Ganz davon abgesehen, geben die Zahlen nur Durchschnittswerte wieder und gehen nicht auf schichten- und altersbedingte Unterschiede ein. Ebenfalls dürfte die Zusammensetzung der Sendungen in bezug auf die Platzierung von Werbezeit, interessante Gesichspunkte ergeben.

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