The Financial Crisis and Managerial Behavioral Biases

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In terms of confirmation bias, it is quite obvious that banks are responsible for the large holdings of subprime – linked securities, one of the origins of the financial crisis. In particular, traders at a bank when serving subprime securities, they may not aware of the risk they build up and may harm the institution and financial system because of some biases mentioned above such as overconfidence, availability bias, or herding. However, even if they know, they still manipulate their belief and search for information that reconfirm their behavior, maybe by telling themselves that those securities are not really risky at all. This behavior is known as confirmation bias.

During the time of the global financial crisis in 2007 – 2009, amongst a large number of banks suffered, the failure of HBOS was considered one the largest and most spectacular. What behavioral factors led to this collapse of the bank which used to be well – respected? The downfall of HBOS occurred from the failure of the Board in identifying and managing risk as they suffered from behavioral biases, including overconfidence, illusion of control and groupthink. First, overconfidence in HBOS’s board members expressed from the beginning (McConnell, P. 2014)., through their first annual report in 2001: “In Corporate Banking the growth rate of over 30% - continued this year – give good grounds for confidence in the team’ s ability to grow quality assets, …” This overconfidence and optimism made them being blind to potential problems and took excessive risks, which was turn out to be really dangerous when credits became stressed. In addition, HBOS’s managers kept an illusion of control as they believed they had a supervisor understanding of the UK lending market. When the financial crisis started in 2007, maintaining this illusion, instead of re – evaluate or restrict the risk like other lenders, HBOS kept increasing market share. Finally, the role of groupthink in this failure is also worth considered. The so – called HBOS whistleblower named Paul Moore claimed that he had warned the Board to reconsider the strategy for sale growth to avoid risks. This warning was not even recorded properly due to the influence of groupthink, the tendency to follow the same, mostly optimist, belief. And as a result, this disastrous strategy is what cause the collapse of HBOS.

In conclusion, it is an indisputable fact that managerial behavior biases in financial institution is one of the most important factors cause the financial crisis. In my opinion, understanding behavioral biases helps us to make decisions wisely and avoid preventable risk. On a broader view, it is a good idea for government, or behavioral finance researchers in particular, to present financial innovations or reform the financial system which can mute the effect of irrational thinking and prevent its adverse influence on the economy as it has done recently. It must be a really difficult challenge, however, it is worth trying for.

REFERENCE

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McConnell, P. (2014). Reckless endangerment: The failure of HBOS. Journal of Risk Management in Financial Institutions, 7(2), 202-215.

Packin, N. G. (2013). It's (Not) All About the Money: Using Behavioral Economics to Improve Regulation of Risk Management in Financial Institutions. University of Pennsylvania Journal of Business Law, 2(15).

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McConnell, P. (2014). Reckless endangerment: The failure of HBOS. Journal of Risk Management in Financial Institutions, 7(2), 202-215.

Sinclair, T. J. (2012). Institutional failure and the global financial crisis.http://wrap. warwick. ac. uk.

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Gulnur Muradoglu, Y. (2010). The banking and financial crisis in the UK: what is real and what is behavioural?. Qualitative Research in Financial Markets,2(1), 6-15.

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