For many people the banks caused the financial crisis of 2008 from which we have still not recovered. The balance sheets of some banks have grown larger than the economies which host them and so they are deemed to be too big to fail. The normal rules of capitalism therefore do not apply in that the beauty of capitalism is its model of creative destruction. Businesses fail and are replaced by more innovative businesses that are more fleet of foot and more responsive to customer needs. But banks grow to enormous proportions without being especially fleet of foot or indeed responsive to customer needs and when they have large retail arms they are bailed out by governments when they are otherwise bankrupt. As I write this the latest crisis is in Spain where for too long the banks have not recognised the riskier mortgages on their books but have simply rolled them over. This crisis has got to the point where the Spanish government is seeking to break European rules by getting bailout funds paid directly from the European Central Bank to the Spanish zombie banks. Clearly Germany and others will not agree that as it is illegal and so the crisis gets ever deeper.
Last week I attended a Criticaleye seminar in the City on the subject of the banks with speakers from Lloyds TSB, Santander, the Agricultural Bank of China and IBM banking practice. Mike Hobday, Banking Practice Leader for Global Business Services. IBM stated that the banks are not doing enough for UK economic growth. They need to differentiate their products and services more. They should also share services to reduce costs, (which I am sure is where IBM comes in.) He cited the innovation of eBay which arranges payment through PayPal, effectively a supplier of online banking services to 100 million customers. This is a Person to Person (P2P) transaction, but there is little such innovation in Business to Business (B2B). Mike reminded us that the great days of mercantile expansion were financed by Dutch and then British banks that were prepared to take risks so that long voyages could be undertaken.
Mark Stokes, Managing Director of Large Corporates, Lloyds TSB said that confidence, skills and growth capital all have to be in place to stimulate economic growth. There were new sources of growth capital but without the distribution to lend them. But that surely supports Mike Hobday’s point that innovation is required.
Steve Pateman, Head of UK Banking at Santander, gave some examples of innovative marketing. His bank had recently escorted 12 female entrepreneurs on a trade mission to Boston, Mass. All won contracts out there and they created a new network in the process. It was not a prerequisite that they banked with Santander but Steve was hopeful that they would bring their custom in time. No doubt this is very laudable but unless it was done on a massive scale it would make little difference.
Brian Stevenson is now a Non-Executive Director of Agricultural Bank of China and also an adviser to some private equity firms, but he used to be Chairman and before that CEO of the Global Transactions Services Division of Royal Bank of Scotland. His was the clearest exposition of the challenges facing banks in their relationship with business. He described the challenges of the global economy with most of the growth coming in the developing economies while there is little foreseeable growth in the developed economies for the next several years. The internal challenges include privacy, security and crime. The banks can offer risk management services on counterparty risk, liquidity risk, country risk and many others. They can offer information and advisory services provided they only offer advice on their own areas of expertise. He observed the early stages of innovation in B2B internet banking.
But the banks are under enormous regulatory and political pressure. He described the conflict between the need to rebuild capital now stipulated by politicians and then reinforced by regulators and the need to increase lending to business. He did not try to answer the question as to how this conflict would be resolved, and as it was a question I had submitted in advance of the seminar I spoke to Brian about it afterwards. He told me that it was unlikely to be resolved. When he was at RBS he would have a monthly meeting with the Treasury in which he had to demonstrate that he was managing affairs properly in the bank. Then his office would be invaded by politicians of all colours who, faced with an employer in their constituency who was about to go to the wall, demanded that RBS, 83% owned by the taxpayer, should keep it afloat. He had to explain to these innocents that he would be in dereliction of his fiscal duties if he loaned to businesses that were not going concerns.
George Osborne had attempted to resolve the dilemma by giving the steer that the banks should deleverage their overseas assets and repatriate the capital for lending to UK plc. I asked Brian if the numbers stacked up and he said it was marginal for most banks. Indeed many of the best opportunities for banks to make good returns on their equity were in emerging markets overseas.
In discussion the question was asked if the banks should be broken up, but I think there is evidence of innovation but coming from other sources. I have already given the example of PayPal probably at the forefront of disintermediation. Then there is Handelsbanken from Sweden. Its innovation is not to be innovative but to practise banking the old-fashioned way. It devolves all lending authority to the local manager. It does not make him prepare a budget which leads to targets and speculative lending but leaves him to decide what is right for his locality. This has worked very well for it in Sweden and it came through the Swedish banking crisis of 1990 unscathed. In fact it was the only Swedish bank that did not have to discuss applying for a state guarantee. It’s expanding into the UK, a much bigger market, by looking for the right local manager first. Once it has found him it asks him to open a branch in his home town and let him do the rest.
Another brand new bank is Metro launched by Antony Thomson who told me recently how he is building up a bank from scratch, taking retail deposits, not borrowing from the wholesale market and lending only against firm collateral. His bank is already the most capitalised in the world in terms of ratios.
Meanwhile in Spain seven terrible regional banks were all put into one big group called Bankia. The toxic assets were supposedly put in another vehicle to ring fence them. Now, lo and behold, Bankia needs another bailout of around 19 billion euros. My son works for an American bank in Madrid that is well capitalised and making good returns on a range of business lending. However, he tells me, and he is completely bilingual, that there is no word in Spanish for accountability.
But then how much better are we? The banking crisis has been caused by poor management of risk by the banks. But they are regulated because of this threat. The regulators have been deficient in every way. According to the current issue of Private Eye[i] “Freedom of information requests have elicited the unsurprising fact that no FSA official has been the subject of either disciplinary or performance management proceedings relating to their duties in regulating RBS, HBOS, Northern Rock, Bradford & Bingley, or Alliance & Leicester – all FSA-regulated banks that required a rescue in 2007-8.”
Incredibly it goes on to say “Against that, between August 2008 and December 2011, 461 staff were the targets of disciplinary proceedings for ‘failure to adhere to the FSA clear desk policy’ thereby creating a ‘risk of loss of internal information.’ ”
So a number of people were sacked for having an untidy desk, but noone was sacked for failing to prevent the collapse of major banks and helping to save the taxpayer £65 billion on saving RBS and HBOS alone.
A compliance officer at the seminar asked sadly why bankers had not learnt anything in thirty years. I wanted to tell her that they had learnt nothing in three hundred years. It seems that every generation is doomed to make the same mistakes as its predecessors. But in banking we all pay. The thing they are afraid of now is if Apple, Google or Facebook decide to convert their networks into banks. Because they will just cream off the profitable P2P transactions but seek to offset the risks to the traditional banks. Then the banks will have to have even more capital lying idle and it will become a sluggish business with very poor returns.
Copyright David C Pearson 2012 All rights reserved
[i]In the City Private Eye 1 June – 14 June, 2012