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Transcript
Knowledge Management in Finance
JOHAN WINBLADH
Vysoka Skola Manazmentu, City University, Bratislava, Slovakia
Abstract. Knowledge Management in Finance make financial markets safer and decrease the
risk of crises. Financial crises is not caused by the lack of tacit knowledge of its causes. Some
types of financial crises, such as banking crises can be avoided or at least made less severe by
implementing a knowledge management framework systemising and implementing more
knowledge into the decision making. Private banks and banking managers may not be interested
and it is possible that the regulator can benefit from implementing knowledge management into
their regulatory affairs.
Keywords: Knowledge Management, Ba, SECI, Financial Crises, Banking Crises
1 Introduction
Finance and Knowledge Management are two very diverse and different fields. However in Finance the key
to success is decision making. Making the right decisions lowers the risk of default or financial crises for that
matter. Developing the right knowledge, storing the knowledge, retrieving and sharing the knowledge can
increase the accuracy in financial decision making. Can financial crises be avoided or at least become less
painful with better decision making? And can better decision making capabilities be based on Knowledge
Management?
2 The knowledge Management Framework used in this paper
What is ba? In short it means shared place in Japanese. The concept of ba was originally proposed by The
Japanese philosopher Kitaro Nishida was the first person to propose the idea of ba but the idea was concretised
by H Shimizu [6]. From these early concepts Professor Ikujiro Nonaka develops the SECI model [5]. The SECI
model is useful for knowledge creation. Socialisation, Externalisation, Combination and Internalization.
The ba framework is the shared space where knowledge is created. Or as Nonaka states that “ba” is a shared
space for developing relationships. The space can be does not have to be physical. Examples of physical spaces
are offices, conferences, and meetings face to face. Virtual spaces are electronic spaces such as communication
over the Internet. Ba is the space for improving knowledge among groups of people as well as individual
knowledge.
The four Ba’s are analogous to the four phases of the SECI model. There are four types of ‘ba’ that
correspond to the four stages of the SECI model. The four different ba’s are adapted to the mode of conversion
of knowledge and since each ba is different and adapted for knowledge conversion and/or knowledge transfer
they all support the knowledge spiral.
2.1
The Concept of Ba - the Ba cycle
Originating Ba - The originating ba is the shop floor - The financial analysts, traders, decision makers in
banks, central bankers, government and private individuals i.e. everyone making financial decisions.
• Dialoguing Ba - Tacit Knowledge of all financial decision makers.
• Systemising Ba - Formalising the outcome, doing the research publish the research and findings.
• Exercising Ba - Implementation, using the information. That is the hard part where politics and personal
preferences as well as psychology plays a huge role. In the end we will have to trust that legislators and
central banks will use the knowledge developed and by implementing the knowledge they will influence
the rest of the system.
o Individual
o Institutional
o Country level
•
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o
World level
2.2 Looking at financial debacles and issues
A financial crisis is a scenario with rapid fall in prices on an investment vehicle, a group of investment
vehicles or the market as a whole from its peak. Market may or may not be continuous during the decline phases.
2.3 Types of crisis
2.3.1 Banking panics
A sudden rush of withdrawals is referred to as a run at a bank or bank run. Banks operate under a system
called fractional reserve banking which mean that they lend most of their deposits keeping only a fraction in
reserve. If the run leave the bank without cash it can bankrupt and depositors who did not run at the bank lost
their money. Therefore most modern societies have deposit insurance both to protect depositors as well as
protecting the banking system from runs. However depositor insurance may lead to moral hazard. When bank
runs are common we can talk about a widespread banking panic. The most recent major runs are the run against
Northern Rock in 2007 in the UK, and the run against Bank of United States in 1931.
In situations when banks are reluctant to create loans because worrying about insufficient funds is called a
credit crunch. An example of a credit crunch is the savings and loan crisis in the late 1980s, which is one major
cited factor of the recession of 1990-1991.
Knowledge to develop - which banks do not fail and why - regulate the banking market after the best
practises of such banks. The other possibility is that there are no such banks and that banking is inherently risky
and since banks are beneficial for the society the society will have to continue to bail out failed banks. Then
knowledge about how to minimize the cost of bailout needs to be developed and implemented instead. Making
the banks smaller, less interconnected to avoid contagion. The danger here is shadow banking.
2.3.2 A bubble in any asset (stock, commodity or real estate)
A bubble is when an asset is priced above the Net Present Value (NPV) of its future cash flow i.e. interest or
dividend discounted at its present cost taking all information into respect. When a bubble burst asset prices
plummets. In reality it is very hard to know if an asset price is above its fundamental value. Other times a bubble
is fairly obvious but continuous on the assumption that other investors will continue to buy the asset [3].
Leverage reinforces both positive and negative effects. Leverage means to borrow on margin to purchase
more of an asset. Often leverage is considered to be a main reason for crisis and the severity of a crisis. Investors
buying on margin will be forced to sell to cover their obligations meaning that asset price declines may go
further than without leverage. Moreover if the market collapses rapidly the investor might not be able to meet
their obligations and default on their debt. Buying on margin was commonplace before the 1929 crash.
A few famous bubbles include: the Dutch tulip mania of 1637, the Wall Street Crash of 1929, the Japanese
property bubble of the 1980s the dot-com debacle of 2000-2001. Other bubble worth mentioning are railway
bubbles of late 1800s, the real estate bubble of 1992-1993 etc.
Asset bubbles are difficult since it makes economic sense to buy in a bubble and sell later. However
knowledge about bubbles are developed but largely ignored. In this area it is matter of implementation. The main
issue is that the will is missing.
2.3.3 Currency crisis, balance of payment crisis and sovereign defaults
Currency crisis and sovereign defaults only have one thing in common, they refer to international financial
crisis.
Currency crisis can occur when a country maintains a fixed exchange rate and that fixed exchange rate is
considered to be above its fair value. It is called the “one way speculative game”. That is if the currency is
overvalued sell it forward and the speculator cannot lose since an overvalued currency will not be revaluated. If
the country is forced to let its currency float or fix the exchange rate peg at another lower level, then we have a
currency crisis. During the ERM crisis of 1992-1993 several European countries failed and were forced to
devaluate or completely withdraw from ERM. The second recent and famous currency crisis is the Asian crisis
of 1997-1998.
Balance Of Payment crisis (BOP-crisis) occurs when more money is flowing out of the country than in
meaning that foreign exchange reserves will fall rapidly. Borrowing foreign currency often covers the fall in
foreign exchange reserved. BOP-crises are often connected with currency crisis and asset bubbles.
If a country defaults on its payments we have a sovereign debt crisis. Very few countries fail completely on
their debt since a sovereign debt default will disqualify the country from international financial markets for a
long time. Some Latin American countries defaulted on their debt in the 1980s and Russia defaulted in 1998.
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The PIIGS sovereign debt crises also belongs in this category. The last crises is well covered in mainstream
medi and there is no reason covering it here. Again the knowledge is available but largely ignored and with that
attitude Knowledge Management will not make a difference. An other explanation is that the area is mainly
political and for many politicians the next election is the only important factor.
2.3.4 Recession
When economic growth stops or the economic activity slows down for more than a few quarters we can talk
about a recession. If the negative or zero growth is for a longer time period it is called a recession. If there is
growth but the growth is slow we call it stagnation. A recession is not necessarily a crises, however they both
impact the living standard. Also an area hard to deal with using a knowledge management framework.
3 Crisis recessions and contagion
Recessions are often connected to financial crisis and turbulence in financial markets. One question that
arises is what is leading factor? Is the panic triggering the crisis or is the crisis just a symptom of the recession?
One can argue that financial crisis lead the way for recession, however that is a little bit to simple. Milton
Friedman and Anna Schwartz among others argued that initial economic decline lead to the crises and that
Federal Reserve prolonged the crisis by not creating enough liquidity for the banking system [1].
The Great Depression of the 1930s was preceded by a stock market crash. Banks went bust and there was
very little liquidity in the system, which prolonged the crisis. Some claim that the US subprime crisis and other
real estate crisis around the globe are leading to recessions in 2008.
Economists are trying to solve the puzzle about what is causing crisis and how to avoid panics as well as
prescribe a remedy if a crisis already occurred. However there is little consensus and as to date there is no
panacea in how to deal with crisis.
Contagion is when financial crisis spread from institution to institution, from bank to bank, from country to
country. It is basically the systemic risk in the system [2].
A good example of contagion was the spread of the Thai crisis of 1997 to other South East Asian countries
like; Malaysia, Indonesia, and South Korea. The question is however if the crisis spread or if countries’ in the
same region have similar problems that would have lead to crisis in any case.
The Wall Street crash of 1987 had little impact outside the financial sector; other crises are believed to lead
to recession of the whole economy. In general if the crisis lead to a flight to quality and a flight to liquidity the
amount of risk capital is lowered and less investments lead to less economic activity. There are some welldeveloped theory around this issue; “Kiotake-Moore model” and the “Third Generation Models of Currency
Crisis” [3] [4].
4 A few recent crises since 1980
1982; Currency and Banking Crises Mexico and later Latin America
1982; banking crises in United States
1985; Debt crises Chile
1989-1991; United States, Savings & Loans and Latin American debt crisis
1992; Currency Crises in United Kingdom, Finland and Sweden
1995; Mexican Peso crises, spreading to Argentine and Brazil
1997-1998; Asian Financial Crisis
1998; Russian Sovereign Debt crises
2000; United States, Europe, Asia etc. “DotCom” Crises
2000-2001; United States, recession, later accelerated by the 9/11 terrorist attacks
2006-2008; United States (mainly, so far) The Subprime Crisis
2008-Ongoing; European Debt Crises (PIIGS)
There are many more examples for example the ERM crisis of 1992, the 1994-1995 the Mexican peso crisis,
hitting Argentine and Brazil after confidence of developing nations currencies was questioned. The 1997-1998
East Asian crisis started with a run on the Thai bath but spreading to Malaysian ringgit, Indonesian rupee and
Korean won. In Russia the ruble was devaluated in August 1998. The Brazilian real fixed rate was abandoned
January 1999. The list is far from complete or exhausted. In this paper the Asian crisis and the Subprime crisis
will be used in illustrating turbulence and crises in the financial markets.
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5 Universal Reasons for Financial Turbulence and Crisis
5.1 Money Multiplier and fractional reserve banking
5.1.1 Fiat Money
Fiat currency has no intrinsic value and cannot be converted to gold or another currency at a guaranteed rate.
However it has to be accepted as a legal means of payment by government decree. One main feature for its
acceptance is the governments demand for it as the only legal mean of paying taxes. Fiat money is debt money
created through a chain of debt. Since the value of fiat money depends on its acceptance and credibility it is an
obvious candidate for a currency crisis.
5.1.2 Money as debt
Money as debt is based on the usage of fractional reserve banking. Due to financial innovation the money
multiplier easily becomes very large. Meaning that M3 is increased which can lead to inflation and a flight from
currency.
5.2.Positive Feedback
Financial and real estate markets are prone to positive feedback. This may be due to emotional and cognitive
factors, which is a part of behavioural finance and not within the scope of this paper. When housing or stock
markets go up it creates a belief that the prices will continue up and creates and incentive to buy more and more
leading up to a bubble. More scientifically speaking positive feedback can create autocorrelation in prices and
increase volatility and if many market participants are affected by positive feedback in their investments
decisions prices will of course be more volatile and go up and down respectively more compared to its
fundamental values. Financial (developed stock) markets are full of examples of people buying in bull markets
and selling in bear markets. In less mature markets the evidence of positive feedback is stronger on the
downside. However volatility is more striking in market declines.
5.3. Commodity inflation (oil)
The oil shocks of 1973-1971 and 1979-1980 are good examples of the world economy being highly
dependent on one commodity for its growth of productivity. When the oil price went up rapidly the recession hit
both Europe and the US.
5.4. Contagion
Is the phenomenon of transmission of economic shocks spreading between countries? Meaning that if one
country is thrown off equilibrium it can change the equilibrium for other countries for example exporting or
importing similar goods.
6 Common causes of crisis
6.1 Internal factors
Problems with trade, and weaker export growth possibilities, caused perhaps by rapid appreciation of local
currency as in the Southeast Asian crisis in 1996-97)
Dramatic drop in local asset prices, including real estate and a negative impact on the overall economy (lost
confidence, loss in consumer spending, drop in investments etc.)
Political unrest, due to unpopularity of reforms or the opposite, stopped reforms due to political unrest,
scaring investors off.
Bad loans to that extent of shaking the confidence and the whole economy including the financial systems
and debt markets
Central bank reserves extended to forward commitments (basically the bank will be easily low on funds if
their currency is speculated against further)
6.2 External factors (foreign factors)
As in the Asian crisis confidence could be lost due to imbalance in neighbouring countries with similar
economic structure. It can be the case of contagion which means that a currency crisis occur in two or more
countries simultaneous. One more example of this can be the ERM crisis in Europe 1992. It can be explained by
a crisis in one economy will alter the equilibrium for neighbouring countries the difference between contagion
(investor sentiment) and real connection between countries economy must be made. Real economic linkages
would be referred to as spillover effect showed how contagion alone could make an economy more vulnerable to
a currency crisis.
37
The most obvious change of equilibrium is “cost and competitiveness”. If a neighbouring country devaluates
its currency, then their export tend to become cheaper which in turn affects countries around with same and
similar export products.
International investors may shun a region after making losses in one country. If large investment portfolios
are being rebalanced at the same time it will lead to an increased outflow of money. More reasons for
withdrawing hot money may be to cover losses in other countries or to repatriate profits while there still is a
profit (flight to safety, flight to liquidity and cash-in effects). One strong source of contagion is interbank
lending, also referred to as a credit crunch, where available liquid funds diminishes rapidly sometimes to such an
extent that it is not possible to obtain credit for sound and good investments.
Other out of region investors such a mutual funds, pension funds, insurance funds etc. May look at a region
and their different economies as one. Investors see only “South East Asia” not Thailand, not Malaysia, not
Singapore, not Indonesia as individual economies on their own merits. “If there is a hurricane in Thailand then at
least it must be storm in Malaysia”. This phenomenon is called the “wake up call” effect. This also possibly
shows that investors from far away may have a lack of understanding of fundamentally different macroeconomic
positions of individual countries. This might not only be common for the developing world but also for the
developed world. An American investor sees Europe a one entity and a European investor see’s North America
as one.
The important lesson from above is that many different reasons, real and imaginary can lead a confidence
crisis and rapid capital withdrawals.
7 Implementing Knowledge Management
One area where it seems like Knowledge Management can be very helpful is in the banking arena. Using the
SECI model or the Ba model:
•
•
•
•
Originating Ba - The originating Ba is the shop floor - the shop floor for the bank got two aspects bad
borrowers and bad collateral. In this the Socialising stage, the effort of identifying sources of tacit
knowledge. A good source may be banks not having difficulties for a long time.
Dialoguing Ba - Tacit Knowledge of all financial decision makers. This is the Externalisation oart of
SECI. Bankers have a tacit knowledge about who not to give a loan, now that must be concretised. It is
the same thing with bad collateral, due to bubbles etc. If for example real estate prices go up more than
growth of te economy or is out of range using for example the Heerengracht index, then The financial
analysts, traders, decision makers in banks, central bankers, government and private individuals i.e.
everyone making financial decisions. The knowledge should be explicit by now.
Systemising Ba - Formalising the outcome, doing the research publish the research and findings of how
to run safer banking and minimising risks of default. This is the combination stage where all knowledge
should be combined into a useful system.
Exercising Ba - Implementation, using the information. That is the hard part where politics and personal
preferences as well as psychology plays a huge role. In the end we will have to trust that legislators and
central banks will use the knowledge developed and by implementing the knowledge they will influence
the rest of the system. If knowledge management fails to improve banking and lowering the risk of
banking crises then it probably will fail here in the internalisation stage and the reasons can be that
profitability in good years deteriorate as the robustness and chance of survival in crises increases.
Bankers and politicians have reasons for preferring short term profitability instead of long term
survivability. Reasons are bonuses and elections.
8 Conclusions
In conclusions banks willing to use knowledge management and systemising knowledge and best practises
from the best and safest participants will be able to improve their survivability. However it may not be in the
bank managers interest and must possibly be implemented by the regulatory authority. The result will lower the
governments costs of bailing out failing banks. If the regulations imposed on banks will lower their profitability
interets spreads will go up and the lower risk in the system will be paid for by the banks customers.
38
Literature
1.
Milton Friedman and Anna Schwartz (1971), A Monetary History of the United States, 1867-1960.
Princeton University Press
2.
George G. Kaufman and Kenneth E. Scott (2003), What Is Systemic Risk, and Do Bank Regulators Retard
or Contribute to It?
3.
Gregory Koutmos; Reza Saidi Applied Financial Economics, Volume 11, Issue 3 June 2001, pages 291 –
297
4.
Masson, P. 1998. Contagion: Monsoonal Effects, Spillovers, and Jumps between Multiple Equilibria,
Working Paper No.98/142, IMF.
5.
Ikujiro Nonaka, Noboru Konno, The concept of "Ba’: Building foundation for Knowledge Creation.
California Management Review Vol 40, No.3 Spring 1998.
6.
H. Shimizu, "Ba-Principle: New Logic for the Real-time Emergence of Information," Holonics, 5/1
(1995):67-69
Contact data:
Johan , Winbladh, M.Sc.
Vysoka Skola Manazmentu/City University, Panonska cesta 17, 851 04 Bratislava, Slovakia
[email protected]
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