“There’s no such thing as a black swan!” A belief that was set in stone – until actual black swans were discovered in Australia. Another favourite conviction, that certain very large companies were simply “too big to fail” – i.e. would never be allowed to go bankrupt – was overturned when Lehman Brothers did precisely that in 2008. The lesson to be learned from such sudden demolition of established truths? You should be able to think the unthinkable. And in the banking and business world, this is only possible through financial analysis.
The advent of the coronavirus pandemic in February 2020, with its raft of utterly unforeseen consequences, has taught us yet another lesson: We cannot rule out potential developments simply because they are extremely unlikely or hard to imagine. Since then, I have dropped the phrase “I can’t imagine that” from my vocabulary.
Of course it is absolutely clear that every single bank department should perform an in-depth analysis of impending transactions. All analysts deploy their expertise and specialist skills to arrive at valid results, using the full range of standard analytical methodologies such as balance-sheet analysis, financial mathematics and similar tools. Before making an investment, the investment fund manager always takes a very careful look at the investment target’s key performance indicators and business data, as well as consulting technical analyses to assess the impact on the portfolio as a whole. The same is true of the securities analyst, who will subject the same data to detailed examination without necessarily referring to management decisions at all. Finally, credit analysts use a similar set of mathematical tools to delve into a corporate borrower’s business figures, causing balance sheets to disappear in a puff of formulae as they compare and assess the raw data. But the scope of due-diligence audits of this kind extends far beyond mere figures. The analysis – performed with a bank’s usual care and attention – should also include any risks associated with an investment opportunity, as well as the latter’s strengths and weaknesses.
In some areas, however, it is also essential to “think outside the box” by factoring in events that rarely occur and – as a rule – are also highly unlikely. Just because you cannot imagine something does not mean that it will not happen at some point. COVID-19 and the coronavirus have taught us this salient lesson. In the future, we will have to adjust our existing templates for assessing securities investments or loans. The only question is: How should we best factor in such an incident – how likely is it to occur? And if it does, what will be its scope and impact? While we may not be able to quantify such future developments down to the last decimal point, we should seek to anticipate and track them as closely as possible. Because – as current circumstances are showing us – the more improbable an event is, the more dramatic and far-reaching are its consequences. This is especially true when we reflect on the drastic events that have shaken the global economy to its foundations over the last two decades, such as 9/11, the 2008 financial crisis, the Fukushima nuclear meltdown – and now the coronavirus. One can only congratulate those who anticipated these events, or at least took appropriate precautions.
Meticulous assessments and the principle of commercial prudence should characterise all analyses in a bank’s various business units, including the investment fund management, securities and credit departments.
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