'Yesterday’s logic' − speech by Nathanaël Benjamin

Given at UK Finance
Published on 03 July 2023
In the last 12 month a number of risks have crystallised, which are symptoms of the transition to a new macro-economic environment. In that context the supervisory priorities for international banks that the PRA set out in January 2023 remain as live as ever. Nathanaël Benjamin says that banks must be proactive in anticipating these risks. 


Thank you all for being here today. It is a pleasure to see you all – and I must confess it has been somewhat of a relief that Q2 has been just about quiet enough for me to make it here! So first let me apologise for postponing the March event at which I intended to speak, and thank UK Finance for arranging for this event to take place instead. I had to attend to a few matters directly relevant to what I was going to talk to you about… suffice it to say that I’ve now got two fewer banks to supervise.

Indeed as I prepared my remarks for today, I naturally started with the speech that I had intended to give in March. It seems like an age ago now, but if you cast your mind back to early this year, you’ll remember that firms and the market more generally were striking a somewhat optimistic tone. The banking sector was transitioning to a higher interest rate environment. Expected energy supply shortages during the winter had not materialised. And in general, financial market commentators were talking about the prospect of a very soft landing.

Things were indeed mostly rather calm. So calm, I was worried that banks may start thinking that the macroeconomic shift I spoke about this time last year had gone off without a hitch – thereby counting their chickens before they had hatched. And so the speech I had intended to give was about the need to avoid the temptation to think that three months of relative calm meant we had turned a corner.


Now that we have seen the failure of banks like Credit Suisse and Silicon Valley Bank, among others, in case people were complacent before they are probably less complacent now.

To me, these failures are arguably manifestations of the broad shift I spoke about in my ‘New Tides’ speech last yearfootnote [1], when I said that we had entered a new era defined by the end of quantitative easing, higher interest rates, increasing digitalisation, and climate change – which would cause the business model of certain banks to be challenged.

So today, I want to build on that previous speech by elaborating on the messages which we set out in our 2023 supervisory priorities letter for international banksfootnote [2]. I will talk first about the risks in case the macroeconomic picture turns out worse than expected – if there was a consensus breakdown – and what that might mean for banks. I will then talk about commodities; and finally about banks’ business models. And an important point of context I would like to make is that just because interest rate risk is what happens to have crystallised earlier this year for some banks, that doesn’t mean we are any less worried about counterparty risk, which features prominently in our priorities letter. Indeed the broad and fundamental shift in the economic environment can manifest itself in a range of ways for internationally-active banks focussed on investment banking, trading or wholesale business. And by starting to list some of the other potential symptoms of that shift, I hope that I can trigger conversations between you and your colleagues, at board level and below, about how the list continues, how best to anticipate and manage those risks, and how to spot what may be lurking just beyond the horizon.

Global economic outlook: A consensus breakdown

The first aspect of our supervisory priorities I would like to highlight concerns the global economic outlook; the relatively benign consensusfootnote [3] that there still is in relation to that outlook; and whether there could be a breakdown in that consensus, particularly in the US.

As a supervisor of international banks, I am keenly aware that what happens in the US can have a far-ranging impact further afield – and I’m sure you are too. And since many international firms use the UK as their global risk management hub, I tend to worry about the impact that events in the US could have on firms’ trading businesses and counterparty risk in particular.

So far, the US economy has proved resilient. Inflation is falling, though it remains elevatedfootnote [4]. The labour market remains robustfootnote [5], with unemployment of 3.7%footnote [6]; and output and GDP growth remain positive. And though equity indices ended the year in a steep bear market, as at time of writing the S&P 500 was up by over 10% since the year began.

But my job is to be watchful of the risks to this consensus. One risk, which the International Monetary Fund notes as a ‘plausible alternative scenario,’ is that credit conditions tighten significantlyfootnote [7]. But idiosyncratic events, be they natural or cyber – are never far away. And of course, while the US debt ceiling has been resolved for now, there remains plenty of scope for political uncertainty, from elections or otherwise.

The precise impact that a consensus breakdown could have on banks would depend on what causes it. And the US economy is so large, that the impact of any adverse macro-economic outturn could be felt across all asset classes and products in some way. But let me focus now on a handful of business lines and risks, which would be particularly vulnerable to such breakdown, and particularly relevant to the supervisory priorities we outlined in our January letter.

Private Equity and Private Credit Markets

The first of those is private equity and private credit.

Here I would say: be very careful. The impact of consensus breakdown on credit markets could be significant. We are mindful that as interest rates have risen and traditional leveraged financing markets have stuttered, a clear trend toward illiquid private equity financing and private credit has emerged. Some firms are growing rapidly in this space, and with that has come a significant increase in complexity, as firms not only lend to portfolio companies, but also to fund investors, underlying funds, asset managers, and everyone in between. Overall, we see a risk that firms underestimate their aggregate direct and indirect exposures to underlying counterparties and connected collateral – not a good place to be should credit conditions begin to deteriorate, or should those counterparties be feeling the squeeze of the tighter monetary environment through tighter access to liquidity. So we intend to closely monitor private asset financing, and it is important that firms think about those hidden risks they could face, including as they assess and set limits for large counterparty exposures. And of course international banks already have to watch more traditional exposures arising from more direct lending such as commercial real estate – which is relevant in the context of the US nexus.

Repo Matched Books

Second, I would like to talk about repo matched books. Many firms operate extremely large securities financing businesses, where they sit between borrowers and lenders of US dollars, usually using sovereign debt as collateral. Counterparties on either side can be other banks, insurers, asset managers, and hedge funds – the full range of bank and non-bank financial institutions (“NBFIs”). Though there is little maturity transformation, the size of these books makes them important for the effective functioning of the sovereign debt market and the wholesale financial system more generally.

One is accustomed to thinking of these transactions as low risk. After all, there is little maturity transformation, and the underlying collateral is high quality. This may be so. But as we saw with gilts last year, we are now in an environment where even sovereign debt markets can see extreme bouts of volatility, with jumps in haircuts, sharp deleveraging, higher funding costs for banks and their clients – and of course, enormous flows of cash and collateral.

So firms need to be prepared for volatility that was once historically unimaginable. And firms need to be financially and operationally resilient enough to handle the large collateral flows that are occasioned with increased regularity. That means ensuring that adequate financial resources (that is, cash and capital) and operational resources (such as well-staffed and efficient back- and middle-offices) are in place to manage these volumes and this risk when they arise. And firms need to understand how their counterparties use and are exposed to ostensibly ‘safe’ assets and transactions, so that the dynamics that might emerge in the market can be anticipated and prepared for.

Structured Equity Derivatives and Autocallables

Finally, let me touch on another area vulnerable to a breakdown in consensus: structured equity derivatives and autocallablesfootnote [8] – as these are products that may begin to look attractive to investors if equity indices trend strongly higher from their 2022 lows, and if global rates, as anticipated by market pricing, reach their peak. These are notoriously challenging large and complex global books, many of which are booked and managed in the UK, and history is littered with firms that have happily picked up pennies in front of this steamroller. Recent trends – a consolidated market for the supply of these products, and rotation of books from diversified single name underliers into more crowded index-referenced products, warrant firms’ close attention.

Of course, the precise impact that a consensus breakdown could have will depend on what causes it. And the US economy is so large that a breakdown in the consensus could affect almost every asset class and product in some way, including for example commercial real estate, which has been increasingly in the spotlight. So it is particularly important that banks evaluate their business models against those potential vulnerabilities.


The second aspect of our supervisory priorities that I would like to elaborate on is commodities. We wrote that last year’s developments in commodity markets provided an illustrative example of the types of risk that could crystallise for some firms with commodities exposures. And we couched this point in terms of climate change, and the energy transition in particular – a key feature of the new era we are entering.

That is because the energy transition may well drive significantly higher demand for the batteries, solar panels, turbines, and other machines necessary to produce clean energy – and these machines use industrial commodities, including precious and rare earth metals, in significant amounts. So the green transition could see commodities markets change drastically.

To give you a sense of the scale of the demand shift we may ultimately see, let me cite one fact that I find almost unbelievable. Between 2009 and 2011, China used more concrete in three years than the USA used in the entire 20th Centuryfootnote [9]. So if, or when, that ‘concrete moment’ comes for commodities, then the scale of the change we can expect to see is enormous, with those markets increasing vastly in importance – an importance that will be amplified by geopolitical, economic and financial considerations. This is the primary piece of context that I have in the back of my mind, whenever I think about commodities, notably metals, as well as energy markets.

But more specifically, I mentioned commodities and climate change together because there is a complex interplay between the two that I would like to bring out, and which I think warrants careful consideration even for firms that do not have a commodities franchise or direct commodities exposures.

Let me try to articulate this point by talking about water, as last year’s drought was spectacularly illustrative of this interplay. I’m sure many of you are aware that there is a link between water and food prices. But how many of you knew that nuclear energy could also be affected, as was the case in France. As it turns out, nuclear reactors cannot discharge coolant into already warm rivers. And this can limit electricity output during a heatwave, just when it is most needed by households and industry alike. And how many of you knew that that same drought would see the Rhine just inches away from becoming unnavigable,footnote [10] curtailing industrial output across the entire course of that river?

Outcomes such as these demonstrate that the risks we’re facing here are going to be particularly hard to understand and manage ex ante. Because with supply chains that are now more complex and tightly coupled than ever before, risks from climate change will make their way to banks and their balance sheets in fiendishly unpredictable ways. This could be through the corporates that they lend to, the securities that they hold, the assets that they take as collateral, and more besides – through a complex web of connections that climate change is exposing, slowly but surely.

All banks, commodities house or otherwise, need to be up to the task of identifying those connections pro-actively, and anticipating when and where these risks could emerge, because ultimately when they crystallise for the broader economy, they crystallise for banks too.

And for those firms that do have a commodities franchise, and whose business model includes providing commodity hedges to corporate clients, I would also add the following: that with hedges, comes margin; and with margin, comes volatility and cash-flow needs that corporate clients are not always set up to manage. And so this is a risk that firms must handle carefully, ensuring that while they’d want to avoid hedging costs becoming prohibitive, the cost should always reflect the risk that actually remains with them. And banks must maintain that risk management, even in the face of market and commercial pressure to do otherwise. It is really important that through their interactions with the commodities sector, notably insofar as pricing and margining are concerned, banks do not de facto allow those commodities counterparties (who might be feeling the tighter liquidity conditions) to kid themselves that activities such as hedging are cheaper than they truly are economically. And it is even more important that those conversations happen early and gradually enough so that banks can provide liquidity to the sector in an orderly and predictable way, without having to turn those taps off abruptly – which can be very destabilising.

Business models

To close I would like to speak about what the new macro environment might mean for the business model of international banks. While not explicitly mentioned in our priorities letter, as we have observed this year, confidence in the viability and credibility of a bank’s business model is crucial for its clients and for the market – because once that credibility is lost, there is only so much that healthy capital and liquidity ratios can do to save you.

In a world of rising rates, clearly retail and commercial banks will tend to benefit from higher interest margins.

However, investment banks and wholesale firms are more exposed to market volatility and broad macro-economic shocks, and do not benefit so directly from higher interest rates. For these firms, it feels that scale is becoming ever more important. Ever-larger players that have ever-stronger balance sheets will be able to withstand or even benefit from volatility and come out stronger on the other side. And at the same time, digitalisation will make it all the more difficult for smaller firms to achieve that scale, as technological developments make existing customers less ‘sticky’ and allow niche specialists and non-bank intermediaries to ‘salami slice’ the banking system, and move individual business lines away from their traditional home and into the non-bank sector.

This kind of pressure will tend to result – as it always does – in challenged business models for banks. And there will be a temptation – as there always is – for firms to move into opportunities that are not in their DNA. Of course, economic dynamism, growth and competitiveness demand that banks innovate alongside the wider economy. Productive finance – banks’ ability to provide liquidity, take risk, invent new products, and establish business lines – is very important for productivity overall.

But we know that such moves can also be a big risk management challenge, and a classic harbinger of risk management failures, when they are not sufficiently thought through or executed carefully. And no business line is without execution risk, be it prime brokerage, or consumer lending, or indeed – and in particular – crypto. So firms need to ensure that their business as it currently exists is operationally resilient before growing or changing significantly, before venturing into new products or markets. And firms should plan for such growth with open eyes and a healthy dose of scepticism about the latest fad, lest they join the annals of firms that have over-extended themselves in the pursuit of growth.


So let me conclude.

When I reflect on my time in role so far, and think about the events of the past 18 months – the immediate aftermath of Russia’s invasion of Ukraine; nickel; the LDI episode, Silicon Valley Bank, and then Credit Suisse – I find it hard to disagree with the conclusion that Chat GPT came to when I described this speech to it, which is that “the greatest danger in times of turbulence is not the turbulence – it is to act with yesterday’s logic” – an apt quote by Peter Drucker.

The risks that I outlined today are just a few that could arise as a result of having transitioned to a less benign macro environment. Yesterday’s approaches to commodities, or matched books, or new products, simply won’t do. So with these examples in mind, boards and executives need to continue the list and make their own assessment of how their firm could be affected by the tectonic shift that we are experiencing. Ultimately, I think that firms with a strong clarity of purpose, sufficient regard for the lessons of the past, a healthy dose of humility, and a keen eye to the future will tend to fare the best – but only time will tell.

I would like to thank Andrew Linn, Simon Stockwell, and Brad Hudd for their assistance in preparing these remarks.

  1. New Tides’ Speech by Nathanaël Benjamin, 20 July 2022.

  2. Dear CEO letter ‘International banks active in the UK: 2023 priorities’

  3. Compare the IMF’s world economic outlooks for October 2022, compared with more recent outlooks published in January and April 2023

  4. Federal Reserve FOMC Statement May 2023

  5. ibid

  6. US Bureau of Labour Statistics May 2023 employment situation (accessed on 12/06/2023)

  7. IMF World Economic Outlook April 2023, p.8

  8. An autocallable is a popular structured product that pays a high coupon if the underlying – typically equity indexes or single stocks – passes an upside barrier, at which point it automatically matures and the investor’s principal is returned.

  9. Smil, Vaclav (2013) ‘Making the Modern World: Materials and Dematerialization’.

  10. The Rhine is inches from being too shallow for shipments; Bloomberg News, July 2022.

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