CAN banks reform, and if so how? Or are they condemned to being socially useless? The past week brought important contributions to a debate that continues to concern the business community and the wider economy.
Few questions are more important: no banking recovery, no economic recovery.
And they have particular resonance in Scotland. A few years ago Scotland took pride in a banking system whose probity was acknowledged worldwide. Now, with a much-shrunken RBS still 81 per cent owned by the state and Bank of Scotland now embedded in the stricken Lloyds Banking Group, there is all too little public discussion as to the recovery process – whether we opt for independence or not.
Last week Andrew Haldane, executive director for financial stability at the Bank of England, delivered a speech entitled “Occupy Economics, Socially Useful Banking”. Even the title put the wind up some of his colleagues at the Bank and beyond.
Here in Edinburgh, Lady Susan Rice, managing director of Lloyds Banking Group Scotland, among other venerable positions, was the keynote speaker for the Professionalism in Banking event at the University of Edinburgh Business School, where I was on the panel. This concentrated on a behavioural approach to change within the banking system.
And last week I had the pleasure of lunching with Mary Campbell, a leading corporate financier exceptionally well informed on the state of the business banking market. “Scary Mary” might be an apt description of her briefing to me. Her fear is that the banks are so saturated with toxic loans and the process of deleveraging likely to be running many years ahead that only the most radical solutions can deliver the economy out of its state of rigor mortis.
Haldane’s analysis was no less sweeping. The question he set up was: can banks rediscover their social usefulness? What do we want our banking system to do? And how do we create the system?
He invoked the Occupy movement – and sailed into immediate controversy by asserting “Occupy has been successful in its efforts to popularise the problems of the global financial system for one very simple reason: they are right.”
Occupy, he argued, touched a moral nerve in pointing to growing inequities in the allocation of wealth and incomes globally. At the heart of the global financial crisis were – and are – problems of deep and rising inequality.
Haldane focused on the way in which the boom in asset prices heightened inequality. “The asset rich, in particular the owner-occupying rich, become a lot richer. Meanwhile, the asset-less and indebted fell further behind”.
What followed was an era of ultra-cheap credit to lift the asset-less into the rising group of asset-rich. This was done by a massive rise in credit. And with this came expanding bank balance sheets and ever more sophisticated financial products.
People and money were drawn into high risk, high return investment banking. Salaries here exploded. Inequalities became ever more brazen. The economy overall suffered as human and financial resources were drained from elsewhere in the economy. As for the banks, “the humble, regional loan officer was pensioned-off, replaced by a centralised credit risk model which neither answered back nor required a pension. Branches were closed in an effort to contain costs. Banking became a transactional business, underpinned by a sales-driven, commission-focused culture.”
Hence the charge of socially useless banking. It is a compelling analysis Haldane sets out with clarity and conviction. How on earth do we start to put this right? While not wishing to skimp on the detailed complexities of Basle 111 and bank regulation, I will go straight to five important reform strands he sets out – the “five Cs”: culture, capital, compensation, credit and competition.
He supports a separation, or at least ring-fencing, of retail and investment banking activities; higher levels of capital reserves to provide greater levels of financial protection; changes to banking compensation with such schemes as deferral until retirement for some bonuses; more effective central bank intervention to moderate credit and asset price behaviour; and the promotion of competition – more entrants into the banking industry. Haldane complains that there has been no new banks set up in the UK for a century, though this I felt was harsh: banking licences were shelled out to building societies and many more institutions came to undertake banking activities.
Rice’s critique was more moderate in scope, but broadly similar. Her concern centred on the need for behavioural change in banking, stressing that it cannot be left to regulation or structural change alone to rebuild our stricken banks. To restore trust in banking she laid emphasis on four “Cs” of her own – controls, competition, capital and compensation. We need, she argued, to reclaim the language of reputation and trust. It was not enough to change institutional structures: we need to change the behaviour of people within these institutions. Banks have lost sight of the qualities of trust, integrity and probity which underpinned professionalism in banking.
In truth, there was not much with which to disagree in this well-presented analysis. The questions that crowded in were first, how such change was to be effected, and second whether it would be enough, not only to restore the public’s trust in banking but also to withstand the next eruption of animal spirits which will surely come. Bankers, as I argued, are as much prone to the behavioural compulsions of the business cycle as the rest of us.
A tall order? Arguably not as tall as the challenge Campbell sees ahead. It will be many years before we witness anything like “normality” in corporate banking. A McKinsey Global Institute report earlier this year found deleveraging in Spain and the UK is proceeding far slower than in the US. Indeed, the ratio of UK debt to GDP has continued to rise and UK households have increased debt in absolute terms.
In the examples of Sweden and Finland in the 1990s, debt was reduced significantly in the early years, there was a second phase growth rebound, but government debt was only reduced gradually over many years.
It is the length of the recovery process that should particularly concern us. Many companies are barely equipped to handle a downturn lasting three years. When it lasts four years and more, the temptation for company owners to throw in the towel and sell out becomes compelling.
This has led Campbell to contemplate radical approaches. Why not monetise the bad loans and give a massive one-off boost to household incomes to pay down debt, or, for those with no debt, to spend the lump sum to give an immediate demand boost? It is, however, just the sort of “Helicopter Ben” solution from which Sir Mervyn King recoils.
I cannot report any definitive answers to questions raised. But I took heart from a passage in the Haldane speech. There are 400,000 employed in banking. “The vast majority, perhaps even 99 per cent, were not driven by individual greed and were not professionally negligent … It is unfair, as well as inaccurate, to heap the blame on them.”
That I certainly agree with. And it is with this 99 per cent that recovery and revival in banking ultimately lies.