Opinion | What C-Suite executives should learn from global financial crisis

Prabal Basu Roy

Every generation has a defining moment and in terms of catastrophic events, hopefully, ours is behind us: the crash of Lehman Brothers and the financial crisis of 2008. Despite all the theoretical knowledge, such events provide a rare perspective for those in the thick of things, and a learning experience no Ivy League institution can provide.

I was in the vortex of the crisis. From the vantage point of being both closely associated with companies and as a fund manager, my learnings were unique and insightful. Surprisingly, most takeaways were to do with the basic principles of finance. Ironically, it was actually the education imparted by storied MBA programs which led to most of the mistakes committed in that period.

CFOs and CEOs would do well to learn from the mistakes of that period.

1. Do not follow the herd. When the whole world is bullish, it is time to apply the brakes, no matter how unpopular it might be. In the run-up to the crisis, Indian companies went on a huge foreign currency borrowing program to fund unbridled expansion for which they are paying the price even today. JP Associates, Jindal Steel and Power, and GVK are only some examples. The most notable example was Tata Steel’s hyped-up acquisition of Corus Plc at the top of the steel cycle. It should have been obvious that the steel cycle will decline following the tapering off of China’s Olympics-led infrastructure binge. Given the expertise within the Tata group on steel,  warnings by many were ignored, and Ratan Tata’s veto carried the day. It’s a chilling message for CEOs: Heed to professional advice in times of all round, irrational optimism.

2. We live in a progressively inter-connected world. Do not heed the advice of self-styled pundits who propagate the idea that India has decoupled from the global forces. This oft-repeated maxim had devastating consequences for retail investors often in the clutches of financial “experts” and market makers doing daily rounds of popular TV channels

3. No two financial crises are similar in terms of their dynamics. Strictly ignore attempts by the ignorant to superimpose past statistics and force fit logic to substantiate their biased worldview. No one can actually time a crash, though an objective reading of the fundamental signals provide enough time to exit. Raghuram Rajan was highly accurate, albeit a few years ahead,  as was eccentric hedge fund manager Michael Burry of Scion Capital. They had few takers for their ideas at that time.

4. Never take on financial risk which you can’t explain to your non- finance colleagues. Never take on financial risk till the counterparty is clearly identified and assessed. Ignore the ilk of glib-talking, pin-stripe suited bankers who peddle derivative products for that extra yield in your treasury operations. In 2006, I withstood pressure from our majority investor to invest our substantial treasury portfolio into one of their exotic derivative products. These later came to be known as  Collateralized Debt Obligations (CDOs), derivatives created by packaging sub-prime mortgages.

5. Despite business pressures (most CEOs underestimate balance sheet complexities and are almost completely fixated on profit & loss and earnings per share drivers), CFOs, in particular, should remain focused on creating adequate fortification for the solvency of their respective corporations and keep an eye on the entire financial system level liquidity. The dangers of excessive leverage and, more importantly, the need for transparently evaluating risks in a tight control environment, must remain on the permanent radar of the CFO and the chief risk officer (CRO) as it is unlikely to be implemented otherwise. They must also constantly scan the environment and have the capability to pick up early warning indicators – and then stand on their own despite the inevitable pressure to ignore these on the altar of inevitable business expediencies – and ready the organisation to manage the coming whirlwind.

Northern Rock in the UK sought emergency funding from the Bank of England one full year before the Lehman episode (as short-term funding was beginning to dry up) and subsequently collapsed in August 2007. If only decision makers had used this signal, or the Chapter 11 bankruptcy filing of the high flying New Century Financial Corporation in the US in April 2007, matters would have been very different in the autumn of 2008.

The structure of the global economy is fundamentally very different now. Significant technological changes have driven this, especially in financial services, through mobile networks and digitization, with the rise of fintech, e-commerce, and cryptocurrencies. Unfortunately, the early signs of a synchronised economic growth and high liquidity are fraught with dangers of increasing debt levels (up by $70 trillion or 50 percent more than the 2008 crisis levels), rising interest rates and volatile currencies. Nationalistic politics threaten the post-war liberal global order, and thus international coordination.  Trade wars are now on the verge of becoming a reality which would disrupt global supply chains and markets. Asset bubbles are evident all across the world due to the ultra-low interest rate environment and low volatility over the last decade. Policy makers too have diminished fiscal and monetary space to ward off another crisis and, paradoxically, policies to mitigate the 2008 crisis may be paving the way for a new one given the political resistance to implement core changes in inefficient economies in this “borrowed decade”.

Hence, despite a much stronger banking system and a revamped core financial stability framework, corporations and market players have to constantly monitor these dangers and fragilities in the financial system, and use the learnings from the post-Lehman decade to ward off challenges which are brewing up in the global environment.

(The author is a Sloan Fellow from the London Business School, private equity investor, and corporate advisor. He has also rich corporate experience as a former director and group chief financial officer in various companies. Views are personal.)