Technology Risks In Commercial Banking: KfW Bank Case Study

The speed at which commercial banking is being automated is astounding. The automation process is about two decades old. However, over time, many difficult processes have been automated. However, commercial banks have realized that automation can be a double-edged sword and can sometimes lead to spectacular blunders which can impact the reputation of the bank.

Germany’s KfW bank learned this lesson the hard way. The bank ended up losing a lot of money for its over-dependence on technology.

At one point in time, KfW bank was nicknamed “Germany’s Dumbest Bank” by the German media. KfW bank has been involved with two separate incidents where they have lost a lot of money due to technological glitches.

In this article, we will have a closer look at the two infamous incidents which have decimated the reputation of KfW bank as being a prudent banker.

The 2008 Lehman Crisis: The 2008 Lehman Brothers crisis was an economic catastrophe of epic proportions. Lehman Brothers bank was inching towards bankruptcy for a few days before it finally went bust in a spectacular fashion.

As Lehman Bank was nearing its bankruptcy, more and more creditors stopped making payments to Lehman Brothers. However, this was not the case with KfW bank.

KfW bank had a swap agreement with Lehman Brothers. This meant that at a given date, the banks were going to exchange their cashflows. KfW bank depended upon its technological database to make automated payments to its counterparties. This database had a list of counterparties that were nearing bankruptcy. However, due to a certain error, this list did not refresh for a certain number of days. As a result, when the KfW bank system processed the payment, Lehman Brothers did not show up as a risky counterparty.

Hence, the bank’s payment system did not block the payment but instead went ahead and paid close to $400 million dollars to Lehman Brothers minutes before the bank went bankrupt! This was absurd given the fact that Lehman Brothers was almost certain to go bust and hence KfW could not really expect it to hold up its end of the swap and make the contractual payment.

Since KfW is a government-owned bank, there was a huge uproar about the technical glitch which resulted in a loss to the bank’s shareholders. The incident was heavily politicized and there were allegations of corruption as well.

KfW bank tried to get back its money from Lehman Brothers. However, it was only able to recover a small portion of the losses. This incident highlighted the risks posed by a high degree of automation and straight-through processing.

The 2022 Crisis: The KfW bank had learned a bitter lesson in 2008. It was assumed that after the full-blown scandal and public outrage, KfW banks would ensure that proper systems are put into place and there are risk management procedures that help the company deal with any adverse situations. However, this was not the case.

Fourteen years later, in 2022, the KfW bank faced financial losses thanks to another technical error. This time, the loss caused by the error grew by more than tenfold. This time, KfW bank’s erroneous systems ended up transferring more than $5.4 billion to four different counterparties and once again exposed the vulnerability of technology-driven banking systems.

Some changes were made to the banking software at KfW bank. These changes were implemented in February 2022. Due to incorrect configuration, the system started behaving in an erroneous manner.

The bank’s systems started transferring money repeatedly for payments that had already been made. By the time, the error could be detected, billions of dollars had already gone out of the bank’s coffers! Once again, KfW bank has started demanding the money bank from the counterparties which received it.

The amount of money that KfW bank will be able to recoup from its counterparties is yet to be seen. However, KfW has stated that they were able to contain the losses since they were able to detect the issue in a timely manner.

The second technological lapse from KfW bank has shown that every commercial bank is prone to expensive technical losses even if such a bank had already witnessed a loss in the past.

The fact of the matter is that technology is a great enabler in the banking sector. When it comes to retail banking, the losses from technological glitches are small. Hence, banks can easily absorb them if such an event occurs.

However, when it comes to commercial banking, a technical glitch can lead to a black swan event which has the capability of causing extensive financial losses to commercial banks. Such losses can take years to recoup from or they could also lead to the bankruptcy of a given bank.