Hazard Risk Resilience Magazine Volume 1 Issue 2 - Page 6

INTRO | HIGHLIGHTS | FEATURES | PHOTO STORIES | FOCUS | INTERVIEWS | PERSPECTIVES | BIOS Too big to fail: The Bank of England and financial crisis Social networking key to behavioural change In new historical research on banking and financial regulation from the Tipping Points project, Professor Ranald Michie finds that banks need to evolve continually to meet challenges and that this can require them to grow in size and extend their activities into new types of financial products and services. Prior to the recent financial crisis, banks were found to have taken risks because of the belief that failure was impossible. There was widespread belief that financial innovation had reduced these risks to a low level, and that the Bank of England could always be relied on to support a bank that found itself in difficulties. Belief that the Bank of England’s support would always be forthcoming created a moral hazard in that bankers could behave recklessly, secure in the knowledge that the bank they worked for would be saved from bankruptcy. The fact that no major British bank had failed for over 100 years also made bankers over-confident about their ability to manage their business in such a way as to escape the consequences of the risks they were taking. This allowed them to generate large profits and bonuses, but simultaneously endangered the financial system. Their actions tended to ignore certain factors: the changed nature of British banking as the degree of competition intensified from the late 1980s; the inability of the Bank of England to adequately monitor what they were doing; and the vast increase in the transactions taking place in the inter-bank money markets located in London. Professor Michie recommends that the Bank of England should take on the responsibility as lender of last resort to the London money market as a whole, rather than to individual banks. This way the financial system could be saved if necessary without encouraging moral hazard from bankers as the government would only guarantee bank deposits in savings accounts wholly invested into the National Debt, which is already secured by government. A new book by renowned economist and author Paul Ormerod, a researcher on the Tipping Points project, looks at how social networking can help change human behaviours in order to address global risks, such as those caused by climate change. Key Finding: When the financial crisis of 2007-08 occurred banks relied on the support of national central banks, which was insufficient in resolving the crisis. What is required in the future is for the Bank of England to be able to carefully monitor bank behaviour and have mechanisms in place to cope with both illiquidity and insolvency. Also, closer international cooperation between banks is essential if a future global crisis is to be avoided. ‘Too Big to Fail: UK Financial Services Reform in History and Policy’. Economic Affairs, 32, 3. doi: 10.1111/j.1468-0270.2012.02168.x Paul highlighted the policy implications in an article in Nature. During the 2012 London Olympics there was high risk of car traffic and public transport disrupting the events due to congestion in the centre. Public transport commuters were bombarded with messages urging people where possible to avoid driving or taking buses and trains, a strategy which was reinforced by employers who allowed their employees to work from home or have flexible hours. The strategy worked because it created network effects where people in social groups imitate or copy one another’s behaviour. Positive Linking: How Networks Can Revolutionise The World looks at how social networking can lead to behavioural change that is effective at addressing risk. According to Dr Ormerod, obesity, a widely known social health risk, is driven by the network effect of ‘peer acceptance’, where if most of your friends are obese, it is more acceptable to gain weight. In order to help reduce the risk of obesity, gaining weight should be seen as less acceptable in social groups. Network theory is important for understanding the complexity of economic, social and environmental problems where behavioural change is essential to resolving them directly. Key Finding: In policymaking, incentives should not be given only with individuals in mind, but should account for social networking as an underlying factor of behavioural change. ‘Social networks can spread the Olympic effect’. Nature, 489, 337. doi:10.1038/489337a Positive Linking: How Netw