Tuesday, 25 May 2010

How Should We Pay For Financial Services?

This is the fourth question that I attempt to answer in my series on the global financial services market.

There is a psychological resistance to paying for banking services. Unlike consumer goods, or other professional bills such as lawyers, doctors, dentists and accountants, banking services don't provide any tangible benefit. Indeed, it seems to be adding insult to injury to have to pay someone to keep your hard-earned cash safe. What people don’t realise is that there's a cost to the global financial system, which I see as coming in three forms:

1. The cost of providing professional banking products and services;
2. The cost of regulation;
3. The cost of safety of deposits.

The cost that noone has really mentioned (but that we have all seen) is the cost of the irresponsible pursuit of revenues without taking all stakeholders into account.

As the world becomes more sophisticated and demanding, bank customers are becoming the same. Banks need to pay for systems, people and products to meet these demands, and that has to come from somewhere. Up until the late 70s, these costs were met mainly through the difference between the interest earned on loans and that paid on deposits (with a bit of fee-earning thrown in). With the advent of interest-bearing current accounts, this all changed, and banks had to look to other means, a lot of which have been the cause of debate and referrals to the Competition Commission in the UK.

The second cost is the cost of increasing regulation. The world’s regulators cover their costs by charging fees to those whom they regulate. Naturally, there’s pressure on them to keep these costs as low as possible, and as the bulk of said costs will be salaries, it follows that if these are kept low, the quality of regulator may not necessarily be of the grade required. Could the UK FSA, the Federal Reserve and Iceland’s regulator have anticipated the crises about to engulf them in 2007 if they had had a better quality of staff? Did they see this coming, but lack the "clout" to do something? Perhaps. Equally, the banks need to pay people to make sure that they meet all the regulatory requirements – not cheap!

The final cost (more relevant since the global financial crisis) is that of ensuring deposits. Essentially, banks pay a levy to insure individual deposits up to a maximum value (GBP50,000 per individual in the UK).

Given all the above, it follows that someone has to pay. If I buy a new car, the price that I pay will include (in basic terms) the cost of parts, labour and a profit margin. I have a choice of whether I buy a cheap car or an expensive one, and have to accept that a cheaper one may not be as powerful, comfortable, reliable, well-equipped, etc as a more expensive one. So it is with banking services. The problem is, we seem to have paid a lot for dubious behaviour which was not checked or controlled and look at the results!

If I want safe, reliable and professional banking services, I expect to pay for them. This could be in the form of monthly or annual charges, wider margins between borrowing and lending rates, differentiated products with attendant fees, etc. However, I expect my bankers to act with due care – something that not all have done in the past – and to be penalised if they don’t.

If we want a “Rolls Royce” global financial services industry, we have to pay for it. Part of this cost might be “subsidised” by, for example, regulators levying higher fines on those that they regulate if rules are broken, thus defraying their costs. Equally, part of this may have to be met by governments in future (worth it, if the trade-off is less burden on tax payers bailing out trouble-stricken banks in future?). However, the costs of these fines and/or government subsidies would in the end be passed back to the customer/taxpayer.

Otherwise, we should think seriously about not earning interest on current accounts, or about paying a monthly fee for our banking. We think nothing of paying a monthly subscription for mobile phones, satellite TV, or broadband internet, so why not banking if it means a better, safer service?

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