Wednesday, 10 March 2010


In my last post, I set out five questions for the future of the global financial services market. They were:

1. What we want of our future global financial services market;
2. How it should be capitalised;
3. How it should be regulated;
4. How it should be paid for;
5. What happens when an institution fails.

In this post, I will tackle the first.

I once used to think that no one looks after banks if they go down. In the past, this was the case (witness Barings, BCCI). However, I was remarkably wrong when the latest crisis happened as I (along with many others) had failed to spot that the global financial and economic systems at large had become so closely intertwined that allowing a major player to fail now would be like amputating a leg without anaesthetic or proper surgical instruments. If the victim survived the shock and loss of blood, they would have to adjust to a very different way of doing things.

In the same way, the loss of several major players on the world financial stage has resulted in a massive shock to the system and, after rushing the victim to the ER, we’re now in "intensive care mode".

We need to decide what we want of a global financial system both now and going forward. It's not enough to legislate for sins of the past (did Sarbanes-Oxley really achieve anything, except to drive companies to list on the London Stock Exchange rather than on the NYSE?). We need to think of the future and of the unthinkable. Knee-jerk reaction of the type we've seen in many cases will only do more harm than good.

So where do we start?

Back to basics: whatever you may think, banks are a vital part of any economy in that they: provide a safe haven (in theory) for savings; promote transformation of excess capital (savings) into products that add value to the economy (loans to businesses); provide an efficient mechanism for moving wealth from one party to another (payments); support global trade with an international network of either their own branches or of correspondents. They require specially trained staff who adhere to a set of rules which prevent them doing things that other organisations might consider “normal business”.

In other words, they're an integral part of the global and national economies. Think of them as the plumbing or wiring in a building. You might notice if this failed for a short time, but if the whole lot failed permanently, you would be faced with re-wiring and/or replumbing the whole building. So it is with banks. They're capable of causing a major disaster and so need the same safety precautions that plumbing and wiring do. We want our lights to work when they're meant to and the same for our taps. We don't expect the house to be burnt down when we turn on the lights, or flooded by faulty pipework.

We require our plumbers and electricians to be trained and certified competent. We don't expect them to be millionaires (and don't pay them enough to be so), but we do expect them to do the job properly with good quality materials and need inspectors to make sure this happens before the building is declared fit for purpose.

We want our infrastructure to work properly, and this includes basic financial services: savings, payments, loans, investments. The rest is icing on the cake.

With the loss of confidence, banks are lending neither to each other nor to the economy, and yet an economy needs finance to grow.

Banks need to remember the responsibility that goes with their position in what is a strategic industry. Much has been made of the distinction between the "low risk" and the "high risk" activities that the large players undertake, and that it is the "high risk" activities that risk bringing them down (but equally, allowed them to make the stellar profits that we saw in the past). Was this the case with Northern Rock? The risks that banks undertake need to be clearly understood, controlled, funded and ring-fenced. I'm not saying that banks shouldn't undertake riskier activities as this is what often leads to innovation, growth and prosperity. However, it seems clear that where this prosperity is confined to a select few, we should question its real value to society.


Banks are a strategic industry and risks need to be managed in this light. We need to adjust our expectations of what we expect them to do, the profits we expect them to earn and how much we expect them to lend.

We want them to innovate, but not at the potential cost of loss of confidence. We need to respect the fact that because credit is cheap, they shouldn't use it to undertake riskier lending.

We want a global financial system that supports economic growth by lending to activities that contribute to this without undue risk.

We want managers who have been bankers all their lives, not brought in from fast-moving consumer goods companies to develop sales. If that means not lending to people who can't pay back, or making less in profits then so be it.

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