Let’s be honest, the financial sector needs to learn to get the basics right
After the collapse of both Credit Suisse and Silicon Valley Bank, the financial sector needs to learn the basics before an over-emphasis on ESG, writes Matthew Lesh
Rumblings in the financial sector – from the collapse of Silicon Valley Bank to Credit Suisse’s merger with UBS – are sending shivers down many spines. The Bank of England assured our banking sector is “safe and sound” – but it may just fall on deaf ears.
The era of ultra-low interest rates and cheap money created malinvestment and vulnerabilities that are now being exposed – from the LDI crisis last September to crypto scams and asset bubbles. We are walking through a field of financial and economic landmines, unsure of what crisis will explode next.
This was not meant to happen. The post-2008 regulatory system was supposed to limit excessive risk-taking, provide necessary stress testing and end the “too-big-to-fail” mentality. Instead, regulators have been forced to offer liquidity to markets and bail out depositors. In the process, they are creating what economists call a moral hazard: encouraging riskier behaviour in future in the knowledge that the taxpayers will provide a backstop.
These are devilishly complex issues. If you don’t deliver a bailout, there’s a risk of financial market contagion and economic calamity. If you do, you may just be delaying the inevitable reckoning and creating problems in the future. Nobody should envy those facing this trade-off.
Nevertheless, the financial sector, from the banks to the regulators, has been distracted in recent years. The relentless focus on environmental, social and governance (ESG) goals did not save Silicon Valley Bank from collapse; nor did it ensure proper stress tests for pension funds using LDIs.
In fact, critics highlighted how SVB had dozens of people working in ESG and dedicated $16bn to the cause – while not having a chief risk manager for most of last year. Meanwhile, Credit Suisse was meant to host an Asian investment conference ironically named “Embracing reality” this week. Reality comes at you hard and fast sometimes.
Banks are not embracing ESG in a vacuum: they are facing heavy regulatory pressure to do so. Just last month the Financial Conduct Authority published a discussion paper on “Finance for positive sustainable change”. This is an extraordinarily radical document from a supposedly apolitical body. It not only floats the idea of embedding sustainability in business objectives but also “positive sustainable change” like diversity and inclusion. It also discusses linking executive pay to these objectives.
These proposals would fundamentally reshape the nature of our socioeconomic system. They would legally entrench partisan political concepts while making managers less accountable to shareholders and customers.
It could also have significant unintended consequences: it is easy to assess whether a company is delivering a profit, but how do you accurately measure environmental or social impact? It’s almost impossible without clear and universally-accepted metrics. The current lack of such metrics could allow managers to shirk from their responsibilities and encourage poor management or riskier behaviour.
Recent events demonstrate the need for regulators to focus on financial stability, low inflation and economic growth. It is of course ridiculous to claim that ESG is responsible for recent financial shenanigans. But it is difficult to deliver financing for climate projects, or provide loans to underserved communities, when your bank fails. The finance sector must get the basics right – only then it can devote its energy and resources to what comes after.