Sunday 10 Oct 2021 | 20:57 | SYDNEY
Sunday 10 Oct 2021 | 20:57 | SYDNEY

The bankers still don't get it


Stephen Grenville

19 September 2011 09:31

As the world economy struggles to extricate itself from the mire of the 2008 global financial crisis (with GDP in the major advanced economies still below 2007 levels), you might expect that the central player in this disaster, the financial sector, would have undergone transformative reform. You would be disappointed.

The financial sector in the US, UK and Europe failed in its core functions: intermediation to shift resources from savers to the best investment opportunities; price discovery to guide market decisions; and risk management to ensure that, if things went wrong, this would be a slip, not a disaster.

In the Eurozone, the tragic denouement of the French and German banks' mindless lending to Greece is unfolding. Ireland's taxpayers face years of austerity to repair its irresponsible banking system. UK and Swiss taxpayers are similarly lumbered with paying the price for hosting the risk-laden activities of international investment banks.

Swiss bank UBS's announcement last week that it had lost $2 billion to a 'rogue trader' might serve as a reminder that universal banks are as unmanageable as ever. It is, however, just a post-script to UBS's $50 billion of GFC write-downs.

The sector's problems are many: 'too-big-to-fail' is not the only issue. But it is a good place to start, as it pits the irrefutable logic of reform against the vested interests of the industry.

At the analytical level, there is unanimity that routine commercial banking should be separated from the rest of the financial sector's activities (derivatives, proprietary trading, underwriting, funds management and so on). Universal banks might make sense in a world of perfectly efficient markets, diligent managers and all-wise regulators. But now we have experienced just what trouble universal banks can get themselves into, and how taxpayers have to fund the consequences of even the most egregious behaviour, the idea of separating routine commercial banking from the difficult-to-manage remainder is compelling.

In the UK, the Vickers Commission has proposed 'ring-fencing' routine retail banking, offering protective support to the vital credit and payments services needed to keep normal commerce going, while denying this protection to other financial activities. Retail banking accounts for only one-third of UK financial activity. Even this very moderate version of functional separation has provoked loud protests from the financial sector

But the main basis of these complaints just goes to demonstrate that bankers still don't get it. They say ring-fencing will increase their costs. Just so.

At the moment, all their activity receives the subsidy of an implicit government guarantee. Ring-fencing is proposed precisely to shift the cost of the broader risks away from the taxpayer. Investment bank customers and shareholders will have to pay for this risk, not the taxpayer. Perhaps, just perhaps, it might make bankers more careful.

So what of the US, the epicenter of the crisis? More on that in a follow-up post.

Photo by Flickr user wallyg.