Actuarial insights into the global banking catastrophe

Abstract

Purpose

The purpose of this paper is to investigate the underlying causes of the series of banking disasters that unfolded from July 2007 onwards and to suggest what action should be taken to avoid a repetition.

Design/methodology/approach

The practices and culture that have evolved in banking over recent decades are compared and contrasted with general principles of actuarial science and with Adam Smith's blueprint for a well‐functioning market economy as set out in his Wealth of Nations. Recent instances of financial turmoil such as the Northern Rock debacle and the global “credit crunch” are then viewed from a longer term perspective.

Findings

The serious weaknesses identified by comparisons with actuarial science and the wisdom of Adam Smith, amplified by perverse methodologies of finance theory and “fair value” accounting and unchecked by the lax regulatory framework, take not only the global banking industry, but also the entire global economy to the point where the self‐stabilising properties of Western capitalism are destroyed. To avoid a repetition, banking practices and culture must be completely rebuilt along actuarial and “Adam Smith” lines, the destabilising methodologies of finance theory and “fair value” accounting must be abandoned, and the new and more prudent approach must be rigorously enforced by a strong regulatory regime.

Originality/value

By adopting a longer term actuarial perspective, the paper identifies deeper problems and suggests more fundamental solutions than have generally been the case in the continuing debate as to the best way forward in rebuilding a robust financial system.

Citation

Clarkson, R.S. (2009), "Actuarial insights into the global banking catastrophe", Journal of Financial Regulation and Compliance, Vol. 17 No. 4, pp. 381-397. https://doi.org/10.1108/13581980911004361