It’s Time to Cut Public Support for Banks

Banks are busy paying out dividends and buying their own shares back from the market even when the regulators are asking them to limit these activities as the inevitable Corona-related credit losses begin to appear. Many banks are ignoring this request, saying that their investors expect to receive dividends, and that such requests are an interference by government in the markets.

Furthermore, banks claim that they have adequate reserves to match any future losses. This claim must be questioned. Do banks really have adequate reserves? Not so, say the bank regulators who are not convinced and that is the reason that banks stop paying dividends and making share buybacks.

If banks do say that they have adequate reserves, then it is relevant to ask if public support for banks should be stopped. If the banks regulators are “interfering in the free markets, then is not public support the same type of interference and thus unnecessary?

An analysis of banks’ financial statements reveals banks only use 25% to 30% of their balance sheets for corporate and commercial real estate lending in the Nordic countries, less elsewhere in western countries. Banks make these loans to companies and real estate projects as business decisions for which they are solely responsible. They do this on their own volition – it’s a business that no third party forces them to do, and it is precisely this business where the largest credit losses accrue. Banks, their shareholders, their creditors and their third-party insurers should take full responsibility for their own losses. These risks and costs are should never be for taxpayers to cover.

Another 30% to 40% of their balance sheets is for rather low-risk housing loans, and the remaining 30% is basically for trading and speculating in currencies, interest rates and derivatives and other financial assets.

What public support do banks receive?

Banks enjoy many levels of public protection, which is not available to non-banking companies in the private sector – here is the list of public support for banks:

Taxpayers are depositing money with them and at the same time we are guaranteeing that these same deposits will be repaid on time and in full up to a set amount which is by no means small.

Taxpayers are also guaranteeing the creditworthiness of the biggest banks that are “too big to fail”. We not only guarantee our own national champions, but since we are in the EuroZone, we also guarantee the other big banks in the EuroZone. The banks and politicians will claim that this is limited by “Rescue Funds”, to which the banks are contributing. However, but these funds are a small fraction of what is needed to cover the outstanding risks and their probabilities of bank failures.

Taxpayers are also the “owners” of the central bank here in Finland and of the European Central Bank (ECP). These two are buying huge amounts bank bonds, short term bank debt instruments, as well as providing big loans to these banks. This is a huge risk concentration for taxpayers.

Banks are controlling our payment ecosystems – we cannot function without them. Even the smaller banks are too important to fail because of this crucial activity.

A number of big banks are also involved in speculative activities like hedge funds, high speed trading, and higher risk real estate finance. Many people think that financing offices and shopping centers is relatively safe – now a pandemic caused by a single tiny virus is ripping the lid off that assumption.

Taxpayers are also paying for regulators here in Finland, and for the people at the European Central Bank. After the financial crisis of 2008, and the recent bankruptcy of WireCard and Greensill, we cannot be sure that they have the resources or the competence to perform their duties. As reported earlier in FinnishNews, there was plenty of media reporting on the frauds well before the regulators stepped in.

Universal banks should be split up

Given the above, one can ask the question what would happen if banks carried the full risks without these benefits from the public sector. Alternatively, one could ask what would happen to the share prices of banks if they did not pay dividends or use current profits to buy back their own shares and used these reserves to cover the risks of current and possible future credit losses and other risky activities.

The outcome would be that bank share prices would fall to a level that reflected the expected fall in dividends and share buybacks. Share prices would fall until the markets are convinced that there sufficient reserves were created to cover current and future losses. That would also be the point in time that dividends and share buyback could start. It is unlikely that banks would reduce lending because this activity is a major source of predictable long-term revenues. Margins may increase but competition would keep them at reasonable levels.

Is here any evidence on how the markets would price bank shares under such a regime? Several huge banks have extremely low share prices when comparing to historical levels – Deutsche Bank, Citibank, Commerzbank, UBS, Credit Suisse, Wells Fargo, Unicredit, Barclays Bank, Lloyds Bank, Raiffeisen International Bank, Royal Bank of Scotland and many other including some of our Nordic banks all have such low share prices. Is this price level an expectation of future cuts in public support for banks? It appears so…

Banks are meant to be financial experts, but their dreadful long-term share price developments point to a poisonous history of mismanagement that also belies wonder why top bankers have been paying themselves such huge bonuses, another source of concern to regulators and taxpayers since the financial crisis.,

We are now amid a truly massive global pandemic crisis, governments, (read taxpayers), have been forced to support ordinary companies and the unemployed with cash and loans. Public debt has soared to new heights never seen before. Now is probably a good time to make sweeping changes to the open-handed public support for banks, given the present financial strains ultimately borne by taxpayers.

Do we need large universal banks for house mortgages, or should they be transferred to smaller specialized narrow housing finance companies, without heavy and costly banking regulation? They could take deposits and provide ordinary retail banking services to private clients and small companies and nothing else. Public support could be justified here because they are smaller and have a less risky lending profile.

Do we need banks to trade and speculate in financial products while receiving massive public support? No, of course not, but we give such public support now, and there is no logic in that!

Lending to medium-sized and large businesses should be another separate banking business run by wholesale banks who chose to be in that line of business. Such banks should be excluded from all public support, while being regulated to prevent risk concentrations. Their shareholders and creditors should be on the hook for their losses, not taxpayers.

Arguments about the need for size and economies of scale in banking have largely dissipated because computer systems can now be run on cloud systems. There  are now many low-cost applications available for the most commonly used banking products used by small and large customers. Banks have not really been at the leading edge of innovation for retail clients, even less for corporate clients. This means that small banks and small niche financial companies can be quite cost efficient, a fact that we can see in Finland today where several smaller retail banks function profitably – Ålandbanken and S-pankki are two such banks. As seen from the share prices of big incumbent banks, they have become white elephants ambling around the globe without a board and management that can keep them lean and fit for purpose.


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