There is a particular kind of risk in financial services that rarely announces itself with drama. It does not arrive as a crisis event, a market crash or a regulator standing at the door.
It emerges quietly, gradually and often rationally, through a succession of individually defensible decisions which, over time, erode the standards that in the end hold so many financial services markets together.
The global financial crisis was not created in a single moment of recklessness. It was built through compromise, through drift and through the slow normalisation of reduced scrutiny in the pursuit of growth and liquidity. Back then, the mortgage market sat at the centre of that process.
In the years preceding 2007 and 2008, underwriting standards softened incrementally.
Competitive pressure, capital deployment and the demand for origination combined to create an environment where due diligence increasingly came to be viewed as a source of friction rather than protection and one of the clearest illustrations of that was the gradual reduction in securitisation audit scope.
Earlier in the decade it was not unusual for loan file reviews to examine around a quarter of a portfolio. By the point the crisis began to unfold, that figure had, in some cases, reduced to nearer 5%.
MARKET RISK
That is often how market risk accumulates. Lenders questioned the operational burden and expense associated with comprehensive review processes.
Funders, meanwhile, faced their own pressures around capital deployment and return generation. That environment encouraged compromise and lowered any appetite to insist on maintaining the original parameters of review.
The difficulty, of course, is that due diligence is not a variable cost in the way many people would like it to be.
It is not an optional layer which can be flexed indefinitely without consequence. Proper scoping exists because it defines what a funder actually knows before committing capital.
It determines the extent to which loan quality, underwriting consistency, operational controls and origination standards have genuinely been tested rather than simply assumed. When that visibility is reduced, risk does not disappear. It simply becomes less measurable.
IMPROVED GOVERNANCE
Today, things are different. The regulatory environment is materially stronger, governance has improved and many lenders and funders operate with far greater discipline than existed previously. However, it would be equally dangerous to assume the underlying behaviours which contributed to past failures have vanished entirely.
Recent lender failures internationally have served as an uncomfortable reminder that discrepancies can still emerge between the picture presented to funders and the underlying reality sitting within loan books. That has inevitably triggered renewed scrutiny across funding and private credit markets, including here in the UK which, in my opinion, is healthy.
“Problems only become obvious in retrospect once the cumulative impact can no longer be ignored.”
The lesson from history is not that crisis is inevitable. It is that market deterioration is often almost invisible while it is happening because every individual compromise appears commercially rational at the time.
Problems only become obvious in retrospect once the cumulative impact can no longer be ignored.
For lenders, this means engaging constructively with the review process rather than treating scope as simply another negotiating lever.
For funders, it means recognising that the pressure to deploy capital cannot come at the expense of understanding the risk being assumed.
Being a party to the scoping process or engaging directly is the only way to ensure all your risks have been adequately covered.
The market has spent the best part of two decades rebuilding confidence through stronger discipline and greater transparency.
Preserving that confidence requires the same discipline to hold firm even when commercial pressures make compromise appear easier.
