The Virus Shows a Need to Reform Banking

This crisis is showing the true business model of banks. They are naturally pursuing profits, and there is nothing wrong with that, but when they do it at our expense and at our risk then the government should act to change this.

Banks resist changes that are unfavourable to the present status quo and they make three claims:

  1. Banks are claiming to be doing “god’s work”, as the former head of Goldman Sachs once claimed. Looking at the way they dress and act seems to confirm such beliefs.
  2. Their second major claim is that they are key players in keeping the economy rolling by financing commerce and industry.
  3. Finally banks are lending less because they claim that regulations are forcing them to allocate too much capital and too many resources to this activity making it too costly.

On all three points there is room to disagree.

Banks are operating to make a profit for shareholders and senior management – that is hardly “god’s work” unless they can describe what they are doing is something more than what any other company on the face of this Earth is doing – and for that claim they have certainly not yet presented any such evidence. Today, doctors, nurses, waste collectors, cleaners and bus drivers are really doing “god’s work” when exposing themselves to the Virus in their daily work.

The second claim that banks keep the wheels of business oiled and running smoothly is also something that can be questioned.

Here are the facts:

    1. Banks lend less than a third of their balance sheets to companies. The vast majority of this lending goes to big companies, of which a large share is for financing mergers and acquisitions and not new investments.
    2. Only a tiny portion – around 2% to 3% goes to smaller companies.
    3. The biggest volume of their lending is for housing loans, of which the largest volume is for older homes and not new developments.
    4. A large amount of banks’ balance sheets are involved in “position taking” and in “liquidity management” – nice words for speculation in the markets.

The banks have tried and succeeded in maintaining the myth that they are financing the real economy. That may have been true some decades ago, but it is no longer the case. There are several reasons for this sorry state of affairs and the banks must take the blame for this themselves. Banks have been poorly managed during the last 40 decades when the financial markets became global. Every ten years or so almost every bank has been caught in bad activities like any of the following:

    1. Lending to Russia and a few other Eastern European countries created huge losses because of  by political instability and poor financial management.
    2. Lending currencies to domestic clients whose currency was devalued against their local currency.
    3. Lending to the US mortgage market – the great wild west of the cowboy banker where nobody ever seems to learn what financial discipline means.
    4. Lending to real estate developers who are natural suspects of poor management, and some of whom get to become president…
    5. Lending to governments in Greece, Italy and Spain – governments who also practice poor financial management that leads to huge costs for taxpayers.
    6. Lending long term with short term deposits and other short term funding like Dexia of France, a failed bank that was formerly sponsored by the French government.
    7. Investing in the global financial markets in various financial products without proper management controls – Deutsche Bank, Citi Bank, etc… just look at their share prices over the last decade.
    8. Almost every big bank participated or was impacted by the financial crisis of 2008 because they were all connected together in the financial markets through deposits, loans, bonds, swaps, and countless derivatives.

The banks, like the British government in their Brexit discussions with the EU, want to have their cake and eat it. This they successfully ensure through their very powerful lobby networks that include many former Prime Ministers and other former political leaders. None of the Nordic countries are an exception to this worrying state of affairs – former politicians are found in almost every bank!

The proof of the pudding is in the eating and it is quite clear that the Finland’s Economy Minister is right to be frustrated with the banks’ performance during this Virus crisis. The banks have received enormous amount of funding from the Central Bank at below market rates to support their lending to the real economy. The Finnish government in response to the crisis has also agreed that Finnvera may guarantee many billions of new bank loans for companies with cash flow problems caused by the crisis. The result has been a farce with little support from the banks. Perhaps this was not such a bad result because more loans to weakened clients increases their risk of greater difficulties down the road. When restaurants and shops are closed down by government decree then these companies are entitled to some taxpayer support. Mass bankruptcies are expensive and clumsy solutions for society – minimal government grants for healthy companies are a better solution to tide them over.

The banks have also claimed to be helping their clients by permitting some borrowers to postpone maturing loan repayments for a year on condition that they continue to pay interest on their loans. This is nothing more than a great business for banks because customers get little relief and banks get to keep high interest payments on all such loans… it is a great business for banks but small relief for individual clients.

There are many reasons for this above mentioned policy failure, which although well intentioned, was designed rather too quickly with companies clamouring for cash when they a suddenly faced with reduced revenues because of lockdown. However, many companies have complained that the banks have not granted the loans even though the guarantee has been confirmed by Finnvera. The banks have even required more collateral or demanded really high margins, thus increasing the pain suffered by the companies.

So now we come to the final point about regulation – and this explains why the banks have not responded more actively to the Finnish government’s request for more flexible financing of companies during the virus crisis.

As said above the banks have argued that regulation has decreased their appetite for lending to the real economy, but this claim is easily countered. The banks have brought this situation on themselves and the result is that it is perfectly valid to pose the question “Do we really need banks in their present form”?

In the paragraphs above there is a long list of banking mismanagement that has been going on for decades that has resulted in huge losses for taxpayers to carry. In order to stop these losses governments have agreed on these regulations, which banks have continued to try to find ways to get round. This has resulted in more complex regulations, and yes, it is true that lending to the real economy has become more expensive for banks and that is defeating the reason why we have banks in the first place!

Hence the title of this article… but the question to be faced is that do we really need banks in their present form to finance economic activity? The answer to that question is actually rather easy to solve by creating a simplified banking code that sets out several different but totally separated types of banks – and why call them banks?

They could be called simply companies like any other company with clearly defined permitted activities and well defined and transparent regulations – for example:

  • Companies for lending to other companies and nothing else – like power and energy utilities.
  • Companies for housing mortgages and home renovations – also like power and energy utilities.
  • Companies for payments – like power transmission utilities.
  • Companies for trading of currencies, bonds, equities and derivatives.

We already have separate companies for pensions, insurance, credit cards, investment funds, financial advisors as well as a growing ecosystem of FinTech companies adding new and innovative services. In addition to the broad networks of existing private companies, we also have thriving public financial institutions that are working in specific national and international financial markets.

What would be the problem to take on the banking sector head on with a major simplification in what they can do and what they cannot do?

Naturally the banking lobby is seriously opposed to such changes because it would create a marked increase in competition and pass more risks onto banks and their shareholders. Why should banks be able to keep their profits and pass their risks to taxpayers. The above would remove this possibility and lead to a big reduction in regulation, better transparency and a huge reduction in risks for taxpayers. Financial costs would also probably be reduced for consumers.

The Virus has exposed the great weaknesses of the present banking system. When looking at Exit Strategies why not focus on cost efficiencies that can revolutionise and really stimulate our economies?

Increasing taxes and cutting basic services sound like the same old austerity programs that got us here in the first place.

Graphic: Run on the Seamen’s Savings’ Bank during the Panic of 1857.
On October 13, 1857, after the Ohio Life & Trust Co. declared bankruptcy, panic struck the New York Stock Exchange and hundreds of other banks and individual investors were ruined. This wood engraving, , shows a crowd gesturing and shoving. A ragpicker picks up now-worthless stock certificates, and a pickpocket operates unnoticed.

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