Newly Cautious Bankers Are More Dangerous Than They Seem

An NYSE trader Photograph by Michael Nagle/Bloomberg

There is a reason for HSBC’s falling profits, Chairman Douglas Flint told the Wall Street Journal: The bank has become too risk-averse. ”There is a creeping concern that staff are very clearly focused on the penalties for getting things wrong and building risk aversion into the way they think,” Flint said. “We’re in a business that takes risk and manages risk, and we have to avoid getting to a state where people believe there is a zero risk tolerance.”

Surely this is a good thing, no? The financial crisis was caused by excessive risk-taking. Newly prudent banking sounds like the sort of finance that won’t tank the economy, and few tears will be shed for smaller bank profits if it means no more taxpayer bailouts. Even so, Flint is not wholly wrong: If risk aversion goes too far, it can become its own source of risk.

More risk offers the potential for bigger rewards. In exchange for the possibility of large losses, investors expect larger profits. The reverse is also true. Taking no risk at all means very little profit. Flint claimed risk aversion cut into HSBC profits because the bank does less lending and is more reluctant to expand into new markets. Risk aversion also poses costs in terms of money and time spent dealing with regulators and hiring compliance specialists. He reckons an over-focus on risk has distracted HSBC from its core business and will ultimately mean lower growth.

Extreme risk aversion can also be a problem for households. Since the financial crisis, fewer peopleespecially millennials—want to own stocks. But it’s nearly impossible to accumulate enough money for retirement without stock-like returns; savers risk poverty when they can’t work anymore. More risk aversion might also explain why fewer people are starting new businesses (PDF). Entrepreneurship is a risky endeavor for an individual, but in the aggregate it fosters a fast-growing, job-generating economy.

Anyone who makes a risky decision—to start a business, invest in stocks, build a complex financial model—faces an uncountable number of potential outcomes that can’t be controlled. Risk aversion can quickly become the problem if it means actively avoiding only the narrow set of risks that are easy to see. Too much risk aversion can create a false sense of security and leave you blind to less overt but more dangerous risks.

If banks learned from the financial crisis, they probably will be more careful and less profitable. But it would be a mistake to dismiss Flint’s comments. He suggests that HSBC employees have become too focused on risk as regulators define it. That might be all right—if regulators were able to anticipate all the risks out there. Otherwise, it raises the question: If bankers are overly focused on regulatory risk, what might they be missing?

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