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BirdsEye View

the frequency of black swans

 At a recent Forum, Mark Turner wrote the following list:

O Early ‘80s inflation

O ‘86 stock market crash

O S&L crisis late ‘80s

O 2000 tech bubble

O 9/11

O 2008 financial crisis

O Pandemic

O Inflation and Fed’s rate hikes

O Regional bank crisis (SVB, Signature etc.)

O Office CRE/Big city hollow out

O Ukraine war

O Climate change

And, at a recent Bank Director Magazine issue, two old friends opined on board risk governance responsibilities.

Gene Ludwig, the former Comptroller of the Currency and inventors of CDars, among many other things, said:

There’s too much time spent, not just in board meetings but in risk discussions generally, on the center of the bell curve—the normal distribution—and less on the tails.

Mike O’Neill, the CEO who turned Bank of Hawaii around and then served at Citibank’s chair, said:

Put through your model some scenarios that you think are absurd, that you think will never happen and see what the consequences are if those scenarios occur more frequently than one would like. Because the never-will-occur scenarios occur more frequently than one would like. 

Three wise bankers are all pointing out to us one important fact: Black Swans occur with far greater regularity than we expected. It almost seems as if, every 5-10 years at the most, some calamity visits us with profound impact on our operation, and sometimes our very existence.

Preparedness has been a top priority for our industry for decades. We have Disaster Recovery and Business Continuity procedures, call trees, PR firms on hand to assist us when a disaster befalls. Interestingly, many of those could not be activated when the Pandemic hit. Those who had hundreds of laptops on hand were better prepared than those who didn’t. Some were already implementing DocuSign while others didn’t. But overall, none of us envisioned our banks operating fully remotely, let alone making millions of loans that way.

The advice provided above by people much wiser than I am is sound. Use it not just at the board level, but also in your own management-level risk committee and DRBC activities. What unthinkables can we conjure up that have a very low likelihood of occurrence coupled with a catastrophic impact? Think Loss-given-default and probability-of-default. What will never happen, but if it did will yield both terrible consequences and wonderful opportunities? 

The Pandemic is the most recent such event, and indeed it has brought us both. We should start thinking about the next Black Swan, and get ready for it.