Why did seasoned bankers not notice cracks in the European banking systems well before it happened? This is a question posed by Sunjay Lutchman, Head of Economic Stress Testing at ABSA. Lutchman, a speaker at this week’s marcus evans Optimising Best Research Practices conference in Johannesburg.
He believes the pan-European bank stress tests carried out this year did not give a genuine snapshot of the EU financial system.
“Stress Testing is definitely beneficial from both a banking and macroeconomic perspective, but rightfully agreed the accuracy of the models need to be validated. The recent pan-European bank stress tests have shown that models can provide a very poor forecast of reality!
“Stress testing has failed dismally when it came to informing banks of the optimal capital carrying levels. This was indeed the case in Europe and many stress testing models proved to be hopelessly incorrect. Indeed, a virulent market contagion threatened to spread throughout the Eurozone, as pressure mounted on the bond markets of Greece, Portugal, Spain, and Ireland. The Bank for International Settlements (BIS) estimated in September 2009 that the banks of France, Germany, and the UK, alone, have more than US$1.2 trillion in exposure to the debt of those four countries. European leaders scrambled to respond to the crisis and secure the Euro as workers in Greece took to the streets to protest austerity measures.”
In simple terms, large macroeconomic models simply failed – they failed to recognise that the boom will at some point in time come to an end, he adds.
Stress testing must be seen as one of many tools or techniques available to any bank, in order drive business and inform capital carrying levels, says Lutchman. “It helps insert a single piece in a puzzle and in doing so informs an overall coherent picture, but it must not be seen as the Holy Grail for lending activities of banks. For example, senior management wisdom and experience despite being softer cues are also invaluable sources of information.”
To develop and sustain economies, bank lending to small businesses has to resume and Lutchman says small businesses need to fight for their share of the pie.
“In my opinion, small businesses need to demonstrate their staying power, even in the most difficult of economic times. They need to create a far greater positive perception in the eyes of the banker. One way to attract more capital is to ensure prudent management practices and not over gear in terms of equity. Strong balance sheets are a definite win and quite a lure for bankers willing to extend loans. Another way is to keep their business operations contained at first, and allow for the natural growth in their businesses. One of the saddest legacies of small business is when they implode from too much business too soon in their life-cycle. Philosophically, it takes almost 18 months before a child is able to walk/run independently. Why do business entrepreneurs not adapt the same line of reasoning in their own small businesses?”
The marcus evans Optimising Best Research Practices conference will take place on 5 and 6 August, 2010 in Johannesburg.
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