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How to spot a financial institution in stress

We had a really interesting discussion at the Financial Services Club this week with Charles Thomson, former Chief Executive for the Equitable Life.

The Equitable Life is a financial institution that failed at the end of the last decade and it was notable that many of the reasons why I failed are similar to those of today with the Royal Bank of Scotland, HBOS and Northern Rock.


  • Management were arrogant and aggressive in creating a growth strategy
  • Sales was the singular focus, and the company had the best salesforce of all the life companies of Britain
  • Products were sold that sounded too good to be true, and they were
  • Customers were sucked into these products and, years later, it turned out the company did not have the capital adequacy to pay on their promises
  • The numbers people – in this case, actuaries – had miscalculated market movements badly and had only accounted for boom markets rather than bust ones
  • The regulators were afraid to challenge the firm and the firm was viewed as the most successful in its sector, based upon its results and cost-income ratio

All in all, the story was one of highly geared finance run amok, with no-one to challenge the logic.

In fact, what struck me about this story, along with those of our banks, is that it is very easy to make a financial firm look good if you run it like a Ponzi scheme.

A Ponzi scheme borrows from one to give to the other.

The other sees a good return on their money, and so they give more money which you then give back to the one.

Like a Ping-Pong game, a Ponzi scheme just shifts money around the system so everyone thinks they’re getting a great deal when, in reality, it’s just one small pot of gold that’s leveraged t to the hilt through magical sleight of hand.

That’s what Equitable, Northern Rock and others did.

They weren’t being run as a Ponzi scheme, obviously, but they were shifting money from wholesale markets to retail through securitised lending or shifting money from customers into funds they thought would always increase on top of the bonuses, but that were ultimately unsustainable.

And that’s where a regulator should really focus.

If you find a financial institution that’s leading the pack, growing fast, showing leadership in cost-income, gaining market share, offering products that are far more competitive than anyone else in the industry and demonstrating a clear swagger of confidence that no-one dares to challenge …

… challenge it, as somewhere lurking under that shiny veneer may be stinking mess of assumptions that prove to be totally wrong.

In other words, the time to test whether a financial institution is in stress is when it is having its greatest success.


About Chris M Skinner

Chris M Skinner
Chris Skinner is best known as an independent commentator on the financial markets through his blog, the Finanser.com, as author of the bestselling book Digital Bank, and Chair of the European networking forum the Financial Services Club. He has been voted one of the most influential people in banking by The Financial Brand (as well as one of the best blogs), a FinTech Titan (Next Bank), one of the Fintech Leaders you need to follow (City AM, Deluxe and Jax Finance), as well as one of the Top 40 most influential people in financial technology by the Wall Street Journal’s Financial News. To learn more click here...

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  • It’s an interesting thought experiment, but conclusions are perhaps too bright & shiny. Likely, a culture of the regulator to spot the tall poppy and lop him down to size would have adverse consequences, as it would tend to decrease entrepreneurship, innovation, diversification and competition 😉
    The other difficulty with such an approach is that you are asking of the regulator something you can’t do yourself, that is determine which of these ‘deviations’ are good and bad a priori. As von Mises said of regulators, if they were as good at understanding the market as the players, they’d be out there playing. So regulation must by fate of knowledge asymmetry adopt a strategy that works even with poorer knowledge than the industry might have.
    Bankruptcy is the answer. Question to ask is really, why didn’t the tall poppies crash under their own weight? Who was holding them up?

  • Bruce Lloyd

    I much appreciated the stimulating presentation and the useful blog comments? But what about the role of the auditors? Surely it is their job to pick up fraud and other illegal activities (miss-selling?) as well as having to sign off the accounts as a viable ‘going concern’? The regulators are sitting on a much more public and political double edge sword; if they miss something they can become liable for the losses, and if they create a lot of public dust and then find nothing, they could possibly find themselves being sued too? There are no perfect answers, and even if there were, they would be totally uneconomic. Certainly there is scope for a major study into whether and how regulators add value? Surely it shouldn’t be the job of the taxpayer ending up bailing out failings in the private sector in these areas. It would be much better if we could rely on the auditors, although we need to recognize that there are no perfect answers here either. I would also add that it is worth mentioning the hypocrisy of much of the financial media, who say nothing at the time, and then blame everyone else in retrospect?

  • > But what about the role of the auditors?
    > Surely it is their job to pick up fraud
    > and other illegal activities (miss-selling?)
    > as well as having to sign off the accounts
    > as a viable ‘going concern’?
    short answer is this: what auditor spotted the bankruptcy in GFC-1? Pick any year after 2007? Even by accident, as we watched firm after firm crash & burn, why didn’t the auditors pick one of them up?
    Longer answer from me only is written on my blog’s 7 part audit cycle: http://financialcryptography.com/mt/archives/001126.html