Why Your Banker Plays It Safe

The risk in banking doesn't come from culture but from structure.

No risky business here.

Photograph: Hulton Archive
This post originally appeared in Money Stuff.

Here is a fun behavioral economics experiment. Ernst Fehr and Michel Marechal of the University of Zurich and Alain Cohn of the University of Michigan got "128 employees of a large, international bank," gave them some money, and asked them to make a bet with it:

They were given US $200 of which they could invest any amount in a risky asset which (i) paid back 2.5 times the investment with 50% probability or (ii) nothing with 50% probability. Participants knew these probabilities and were allowed to keep all the money they did not invest. We use the dollar amount invested in the risky asset as a proxy for participants’ willingness to take financial risks.

If you bet it all, you like risk; if you kept it all, you don't. The trick is that before having them bet, the experimenters asked them some questions. Some of them were just asked random innocuous questions ("such as what is their favorite leisure activity"), while others were asked "seven questions about their professional background and experience" in order "to increase the saliency of participants' professional identity." And:

We find that bank employees in the professional identity condition took significantly less risk. They invested about 20% less in the risky asset relative to the control group. Thus, the results do not confirm the widespread belief that the professional norms in the financial industry promote risk taking. 

That is: If you get some bankers, and remind them that they are bankers, they will take less risk than they will if you don't remind them that they are bankers. Thinking banky thoughts -- about banking, and their bank, and their banking careers -- makes them more conservative than they would otherwise be. The experimenters tried this again with "nonbanking employees recruited from the alumni network of an executive education program" and found no similar effect: "If anything, the professional identity condition tends to increase risk-taking among non-banking employees," and the non-bankers took more risk to begin with. But they did successfully replicate the effect with a sample of "142 employees from many different smaller and larger banks," who also took less risk after thinking banky thoughts. 

One way to think about this might be that the risk in banking doesn't come from culture but from structure. The salient fact about banks, as banks, is that they fund themselves with a lot of very short-term debt; that's what being a bank means. If you have $5 of equity and borrow $95 overnight to buy $100 of assets, and those assets go down to $98, then those lenders might not want to roll over their loans, and you'll have to sell the assets to pay off the lenders, and you'll sell them in a fire sale at $94 and eat through your equity and impose losses on the lenders and be a "systemic bank failure." And everyone will talk about how risky your business was, and they'll be right, but on the other hand your subjective experience was that you bought some safe-looking assets that only lost 6 percent of their value even when you sold them in a fire sale, which is like a typical morning for bitcoin. And in fact this description does kind of fit the financial crisis, where a lot of banks blew themselves up on AAA-rated securities. Other businesses -- unicorn startups, neighborhood restaurants, whatever -- tend to take more business risk, but they don't fund themselves with tons of short-term debt, so those risks aren't as scary to the broader economy.

But obviously the control experiment that you'd really want to see is: bankers, but 10 years ago. Is there something about the culture and professional identity of banks as banks that makes their employees particularly risk-averse? Or is it something about their culture as banks in 2017, after a long decade of crisis and scandal and regulation? Is banking culture cyclical, and are we just at a risk-averse time right now?

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