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Systemic Risks from COVID-era Financial Innovation: In Talks with Melanie Richards

By Unicast Entertainment

For the 19th episode of Unicast’s running series of virtual interviews with industry leaders from across the professional spectrum, they held a conversation with Melanie Richards – former Deputy Chair and Partner at KPMG UK, referred to as the ‘Most Senior Women at KPMG UK’ by the Financial Times. Though their conversation this episode, they discussed a wide variety of issues ranging from the raging debate on equalities of outcome versus equalities of opportunity, the misnomer of work-life balance and the moral hazards of the auditing and accounting industries. Yet, what was most pertinent in our understanding of the world today, was their discussion on the stability of capital markets and the COVID-era risks of financial innovation.

The premise of the question was simple: can financial innovation become too much? The COVID crisis has given rise to creative solutions for financing, where firms are leveraging unique facets of their business to source funds for further expansion (or, merely, to survive the onslaught of the crisis). An example cited was a ‘subprime M&A deal’ in the UK, which was funded by Euro- and Sterling-denominated debt at 6-7% collateralised by realty equity – a deal which clearly facilitates deep interconnections between an assortment of markets. So, can such financial innovation – once made mainstream – cause greater systemic risk? Post the GFC, where many financial entities were exposed to these risks of financial innovation in a poorly regulated environment, is this a concern even banks are actively surveiling?

One of the first things Melanie Richards points to, however, is that the GFC was a crisis caused by the fact that banks ended up holding a lot of the risk that circulated in the economy, as a result of which it became necessary for central intervention to bail the said banks out. Today, Melanie argues that “risk sharing has become more diversified” and so the presence of potentially toxic elements on financial balance sheets is much sparser. The other element that Melanie discusses is leverage ‘in totality’ across the economy, which she states is nowhere near where it was during the GFC. This ensures that financial institutions are not as fragile as they were previously, which is why financial innovation is not as concerning. Instead, Melanie argues that risk has concentrated itself into equity markets “where it should be.”

While Melanie, therefore, seems fairly optimistic about the resilience of markets and its ability to accommodate for financial innovation, the one concern she does seem to hold is with regard to the general behaviour of financial institutions. Here, she cites how institutions often act upon things they do not entirely understand and that becomes a grave source of concern when billions of dollars are invested with assumptions that simply do not hold in all contexts.

Thus, while she remains content with the fact that the risk seems to exist in the domains in which it should, she argues that many institutions are not fully cognisant of all of the risks that come with their activities which is a perennial source of worry.

To watch the full interview with advice on professional growth and key industry insights, check out: https://www.youtube.com/watch?v=_RitGNBtjnM

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