From the early 1990s until the early 2000s running a bank seemed easy. This was the golden era of banking. Interest rates were trending down, allowing credit to grow faster than GDP. And, for much of the period, yield curves were steep. Economies around the world grew, unemployment was low and, as a result, so were credit losses.
In that environment, it was hard not to make money in banking. Much of the profit came from borrowing short and lending long, the growth and liquidity of the credit markets, and sticky, high margin retail deposits. In the golden era it didn’t seem to matter who ran a bank, as long as they had strong deal making skills and the discipline to avoid overpaying for acquisitions. Exceptional management of growth and costs might lift return on equity from mid-teens to low-20s, but mid-teens was good in any case.
In the early 2000s, the long run of interest rate declines ended, and banking became a mature business, making it harder to grow and maintain returns. Bankers rose to the challenge: they increased the velocity of the credit business through innovative securitization, increased leverage, were aggressive acquirers and introduced new high-margin products for retail and institutional customers. But many bankers did not rise to the challenge of saying no to bad or marginal loans, pricing adequately for risk, maintaining reasonable leverage, and making the hard decision to reduce capacity in the financial system when macro factors required it. The illusion that managing a bank is easy was dispelled.
And then there was 2007…
