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Dominic Barton, Roberto Newell, and Gregory Wilson have worked for private and public sector clients in countries around the world, including the United States, Canada, Thailand, Korea, Singapore, Indonesia, Jamaica, Mexico, Ecuador, and Colombia.
As the authors write in Dangerous Markets, this work has been highly absorbing: "We learned by doing – in at least twelve countries, many with similar problems, all different. We have been tear-gassed and forced in some cases to travel with armed guards. We have worked through bank holidays, been swept up in street demonstrations and riots, and forced at times to evacuate our client's work site. At still other times, we were the target of labor agitation and abuse due to our role in bank or company restructuring. Every day of a crisis has been a new adventure for us, some more exciting than others."
In this interview, the authors discuss their book and offer collective responses to some key questions.
 | | Why did you decide to write this book? Answer |
| | | | What are some of the main reasons for financial crises in companies, economic sectors, and countries? Answer |
| | | | Why do you believe financial crises are likely to be more frequent, more severe, and longer lasting in the future? Answer |
| | | | Why do you think it is so important for financial crises to be managed proactively? Is it really possible to do so? Answer |
| | | | What are some of the warning signs of an impending financial crisis? Answer |
| | | | What is the relationship between microeconomic and macroeconomic factors in creating financial crises? Answer |
| | | | How can managers prepare for a financial storm before it hits? Answer |
| | | | What are the things that must be done in the first 100 days of a crisis? Answer |
| | | | How can companies and countries capture strategic opportunities after the storm has passed? Answer |
| | | | What are some of the key elements in driving successful bank turnarounds? Answer |
| | | | What system safeguards can be implemented to prevent or reduce the impact of financial crises in the future? Answer |
| | | | You call for the private sector to take the lead in developing a new market-driven financial architecture to lessen the likelihood of future crises and to lay the ground for sustainable growth. What would this architecture look like? Answer |
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| | | Why did you decide to write this book? | | When the Asian financial crisis hit, McKinsey & Company saw an increase in the demand for our consulting services in the private and public sector, helping both companies and countries manage through the complex problems associated with financial crises.
Frankly, we wrote the book to help us do a better job of helping our clients, by forcing ourselves to codify not only what we already knew from our other collective experiences but also what we were learning first hand, on a daily basis by serving clients in difficult situations in diverse markets. Many of our clients encouraged us to write this book. Our firm also invested in gaining a deeper understanding of the causes of financial crises because we thought it was important to help our future clients. Finally, having seen the social and economic destruction that financial crises cause, we felt an obligation to share the lessons that we have learned with a broader audience as our contribution to minimizing the huge financial costs imposed on societies. | | | | | | What are some of the main reasons for financial crises in companies, economic sectors, and countries? | | Financial crises are caused by a variety of underlying structural problems in an economy that are triggered by either an external event such as a currency attack and devaluation (e.g., Thailand and the Asian crisis of 1997) or an internal event such as depositor flight and a fundamental lack of customer confidence in the financial system (e.g., Argentina, Uruguay, and Turkey in 2002).
Our research shows that the underlying causes of financial crises are distinct but related. Like earthquakes, forces build up over time (e.g., nonperforming loans), and if they are not managed properly, then there will be a massive correction at some point in the future. Value destruction in the real economy – the inability of individual companies or entire industrial sectors to earn their cost of capital – is a leading structural problem that often is difficult to see during normal times and therefore is often overlooked. Eventually, companies that can't earn their cost of capital won't be able to pay their debts to banks and other creditors.
Weak financial sectors – banking systems that lend funds without the proper credit risk management skills in place (basic asset-liability mismatches) or try to grow too quickly or lend under government pressure to favored industries – are another factor. Poor financial system oversight is another. Too often, weak national financial systems try to integrate into the global capital markets too quickly to access lower cost capital before all the necessary systems and safeguards are in place. | | | | | | Why do you believe financial crises are likely to be more frequent, more severe, and longer lasting in the future? | | There were double the number of financial crises in the 1990s compared to the 1980s, according to a World Bank study. As we continue to work in various countries around the world, we continue to find deeply embedded structural problems in both the real economy and the financial sectors. More countries are trying to link into the global capital markets without being fully prepared. There are more connection points and consequently a higher risk of contagion effects spreading from one country to another. There also are faster information flows and more liquid capital markets that can shift funds rapidly from one investment to another. In the book, for example, we give an overview of mounting, unmanaged issues we find in countries like China, Japan, and India.
While it is extremely difficult to predict the precise timing and next location of a crisis, we know that some day these structural problems – whose costs mount daily – must ultimately be recognized and managed once a real crisis strikes. We also know that crises do spread rapidly – the contagion effect – as we've seen most recently from Argentina to Uruguay and potentially other parts of South America, as similar structural weaknesses are exposed and a loss of confidence spreads beyond national borders. | | | | | | Why do you think it is so important for financial crises to be managed proactively? Is it really possible to do so? | | Financial crises can be managed proactively in ways that minimize the ultimate costs and maximize the speed and completeness of recovery. For companies, proactive crisis management can mean the difference between surviving and prospering or failure.
For example, our research shows that countries such as Sweden and Korea, which did a comparatively good job of financial sector restructuring as soon as their respective crises hit, had a much more rapid return of GDP growth, direct investment, and credit recovery than other countries like Indonesia and Ecuador, which fundamentally failed to manage their crises actively in the early days. Enough time has elapsed that we can see it in the countries' macroeconomic data.
We also cite numerous examples in Dangerous Markets of companies that have actively managed their ways through crises to enhance their competitive position and shareholder value dramatically increases. The case of Housing & Commercial Bank in Korea, now merged with Kookmin Bank, is one of those many outstanding success stories we have seen in numerous countries. So, managing crises does matter for both companies and countries. | | | | | | What are some of the warning signs of an impending financial crisis? | | We look at a number of warning signs that are derived from the structural imbalances we have seen primarily across the real economy, the financial sector, and macro-economic policy.
For example, in the real economy we look to see if individual companies and entire sectors are earning their cost of capital and if their interest coverage ratios are sufficient. In the financial sector, we look at a myriad of key indicators, some leading indicators such as too rapid loan growth (e.g., higher than 20 percent annually) and some admittedly lagged indicators such as return on assets and nonperforming loans, for which we usually add our own adjustments to get to numbers that we feel are more grounded in reality than local accounting practices may demand. While we may not be able to "predict" crises as a result, we are able to reach a well informed view, based on a systematic and comprehensive diagnostic, of how vulnerable a company or a country might be to future financial crisis given some reasonable assumptions and benchmarks we have observed in our client work. | | | | | | What is the relationship between microeconomic and macroeconomic factors in creating financial crises? | | Both macroeconomic and microeconomic factors are important, and it is difficult to separate one from the other. There are clear linkages that must be understood by executives and investors. From our perspective, most observers emphasize the macroeconomic factors like fiscal deficits and exchange rates and while these are important, we believe that microeconomic factors can play an even bigger role in the depth and duration of financial crises.
Korea's problems in 1997 were not macroeconomic in nature at all: monetary growth was moderate and the country was running a fiscal surplus. Yet, we found subsequently that most sectors in the real economy had been consistently destroying shareholder value year after year, and financial institutions – merchant banks and commercial banks – were weak in multiple dimensions, especially risk management.
In Argentina, by contrast, the crisis came primarily from the macroeconomy: Years of deficit spending, fours years of recession, and a monetary policy that was governed by a one-to-one link of the peso to the dollar eventually took its toll on the financial sector when the government defaulted in its debt and de-linked its currency, resulting in a significant devaluation and a complete failure of customer confidence in the banking system. Rapid depositor withdrawals led to a devastating set of government restrictions on bank deposits (the so-called "corralito") and a series of forced bank holidays (i.e., a mandatory closure for all banks). These actions were the direct result of poor macroeconomic policies that were ultimately transmitted to the microeconomy of the banking system, affecting ordinary citizens in tragic ways. | | | | | | How can managers prepare for a financial storm before it hits? | | | First, managers can start now to conduct a systematic diagnostic of the structural weaknesses and warning signs that we outline in the book, for all of the countries in which they operate. Second, they can start to aggressively manage their company's cash position as the first of five key actions. In crisis after crisis, we are reminded that cash is king and can make the difference between winning and losing. Third, they need to organize internally to manage the crisis and find the talent, internally or externally, to guide them through difficult times that can last for years. | | | | | | What are the things that must be done in the first 100 days of a crisis? | | The first 100 days are typically the most critical ones in a crisis. The tactics that management teams use during this period can help to decide if the company has "earned" the right to be a competitor in the post-crisis environment. Inspired leadership and relentless execution are universal pre-requisites.
Specifically, management needs to get five things right during the initial crisis period. First, cash has to be managed aggressively on both side of the balance sheet. Second, operational risks (e.g., potential supply chain interruptions) need to be managed actively. Third, scenario planning must be implemented and conducted systematically to allow a flexible response to rapidly changing conditions and uncertainty. Fourth, unproductive, non-core assets must be identified and either divested or restructured swiftly. Finally, managers must work hard to constantly maintain the confidence of all of their various stakeholders (e.g., investors, customers, employees, regulators). While these steps may seem obvious, too few companies implement and then manage them successfully during a crisis. | | | | | | How can companies and countries capture strategic opportunities after the storm has passed? | | Financial crises create both real threats and new opportunities, and require a mind-shift to rise above the day-to-day challenges and begin to think strategically about the long term. We cover 30 companies in the book that have done extremely well by actively managing through a variety of financial crises.
First, investors and executives need to appreciate that crises can change basic assumptions in fundamental ways: there are market discontinuities, regime changes, and new degrees of freedom that may have been unthinkable prior to the crisis. Regulations change, often opening up markets to new capital and new skills. New and different competitors subsequently emerge, just as traditionally strong competitors can stumble and fall. Customer attitudes can shift dramatically: foreign providers that once were shunned may find a consumer flight to quality. Companies and their employees that may have been culturally reluctant to accept change in the past are now forced to embrace new ideas and new ways of doing business to survive and save their jobs.
Second, a thorough review of a company's tangible and intangible assets is required. Hard assets on the balance sheet such as investments and loans must be recalculated from a new market perspective; because of the crisis, they invariably are worth less than before. Consequently, companies are forced to think creatively, often for the first time about their intangible assets: their customer brand and loyalty; their internal knowledge and intellectual capital; and the fee-generating "factories" – processing businesses that could be retooled to serve third parties – that may be buried in the company and effectively unmanaged today.
Third, after this review, the crisis itself will force management to redesign the company's basic strategy. Increasingly, this strategic review builds on the analysis of the new degrees of freedom and the company's assets – tangible and intangible – to devise a new portfolio of initiatives and options for the new post-crisis competitive environment. These new initiatives and options will be a function of both the size of the potential opportunity over a near-, medium-, and long-term time horizon as well as a familiarity and capability to manage the risks involved. | | | | | | What are some of the key elements in driving successful bank turnarounds? | | First, a bank turnaround is a bank turnaround, regardless of the country or circumstance. While the individual context and local culture always need to be considered, there are common success factors that we find anywhere we work in the world. In Dangerous Markets, we highlight the success stories of the Mellon Bank turnaround in the United States and the Christiana Bank turnaround in Norway contrasted with the failure of Ecuador's Filanbanco.
There are seven actions required to enhance the chance for success. First, new management must be installed. Second, the credit processes and portfolio strategy must be completely revamped. Third, the treasury function must be tightly managed to preserve cash flow. Fourth, typically, the bank must be downsized before it can grow on a sustained basis in the future. Fifth, a relentless focus on results and performance without excuses must be instilled throughout the company. Sixth, new capital must be added, sooner rather than later. Finally, nonperforming loans (NPLs) must be segregated and managed aggressively, freeing up the rest of the bank to focus on a return to profitability, customer service, and shareholder value. | | | | | | What system safeguards can be implemented to prevent or reduce the impact of financial crises in the future? | | Once a crisis begins to stabilize, there are a number of new systemic safeguards and new standards that need to be put in place to reduce the threat and potential impact of a future crisis. Think of it as a 3-tiered safety net: corporate governance and conduct; market supervision; and government regulation.
First, individual companies can do a great deal on their own, without waiting for new laws or policy directives, to strengthen themselves. Our research shows that companies that enhance their corporate governance, for example, not only are rewarded by investors and the marketplace but also are more clearly differentiated from their competitors. Typically, this means having a more independent board, new management processes such as audit committees, and greater financial transparency. At the market level, building greater capital market capabilities in the form of new debt and equity instruments and exchanges, attracting new investors, and developing rating agencies can help to reduce the pressure on underperforming and strained banking systems that adjust abruptly in a crisis by means of a credit crunch as loans get pulled and lines of credit are extinguished. Finally, governments can do more to become better financial regulators in line with new market realities and increasingly recognized global risk management standards. | | | | | | You call for the private sector to take the lead in developing a new market-driven financial architecture to lessen the likelihood of future crises and to lay the ground for sustainable growth. What would this architecture look like? | | Our view is that the private sector – primarily investors and intermediaries – have an economic self-interest in avoiding crises in the future and ensuring sustainable, uninterrupted growth. Therefore, we think it is incumbent on the leading players to devise a new set of globally recognized and explicit standards and safeguards across multiple dimensions. We know this effort will take time and won't be easy, but we frankly don't see a viable alternative to the private sector stepping up to play a greater role to establish market-oriented, customer-focused rules for competition and market conduct, risk management, and customer protection. Waiting for some of the international institutions to step in and fill the void with their rules is not an attractive option.
We can imagine a group of leading investors and financial CEOs, perhaps at the World Economic Forum in Davos, Switzerland next year, deciding to get together off-line to explore the idea of creating a new self-governing organization (SGO) to set standards and monitor performance of individual companies around the world. Standards would be set for corporate governance, transparency, accounting, bank closures, and so on, and then monitored and benchmarked on a periodic basis. This new SGO could also evolve into knowledge and education center depending in the interest of the major players.
In many cases, these standards would be set at a higher level than many nations require today, but the major players would have an economic self-interest in achieving these higher market standards to be able to compete with a globally recognized seal of approval. Ultimately, national laws would have to change and move closer to these new standards if governments and companies truly want access to the lowest cost of capital for economic growth and development. | | | | |
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