Monday, March 4, 2013

Are banking values bankrupt?

It has of late become significantly less glamorous to admit that you work in the banking sector. The banking crisis of 2008 and ensuing world financial crisis have been accompanied by a series of scandals and shocks involving major banks. Think HSBC and drug cartel money, Barclays and Libor, Wegelin and tax evasion. The latter, Switzerland's oldest bank, has announced it plans to close after pleading guilty to helping American citizens avoid taxes on assets worth US$ 1.2bn.

As more banks remain under investigation and banking regulation stays high on the agenda, major banks from the OECD world are revisiting governance standards whilst cutting costs and laying off personnel. JP Morgan Chase & Co, the biggest US bank, recently announced plans to cut up to 19,000 jobs in its mortgage and community banking units. Late 2012, Swiss bank UBS announced plans to cut up to 10,000 jobs, many of them investment bank traders based in London. From New York Bloomberg estimates that over 300,000 job cuts have been announced by financial institutions since 2011.

In leading economies such as the US, the banking sector has certainly seen the good times in decades past, times when the contribution of the financial sector to GDP grew significantly. By 2007, banking salaries were 1,7 times higher than non-banking professional salaries in the US (Financial Times 31.10.12). Today, the EU is taking steps to cap bankers bonuses at twice their salary. The European Parliament has agreed to a mandatory 1:1 ratio on salary relative to variable pay, which can rise to 2:1 with explicit shareholder approval. Swiss regulators are taking the same route. More reason for bankers to be unhappy. By end of 2012 the City & Guilds Career Happiness survey of 2,200 workers in the UK found that of all sectors bankers ranked lowest on its happiness index.

Nobody doubts the fact that the financial and specifically banking sector remains a key, interconnected industry in our society. Question is if its function is just that of being an intermediary, an unconcerned processor of financial flows. In how far can banking as systemically critical in our societies fulfill its role in a manner that fundamentally adds sustainable value?

In my work with banks in developing markets, the challenges of unserved communities, formalizing the informal sector and financial literacy are evidently enormous.  Working in emerging economies, it is striking how the mere fact of having a bank account can be a developmental milestone for entrepreneurs. This assumes that the banks involved are taking their roles as financial educators and responsible service providers seriously, banks that are providing services increasingly via the Internet and mobile phone technology.

In developed markets such as Europe, bank assets (including loans) are the equivalent of 160% (Germany) to 556% (UK) of GDP. As a central mechanism in the economy, banking remains fundamentally about the provision of loans and deposits. Banks have always been recognised for their role in "creating money", turning short-term deposits into long-term loans, transforming debts with short maturities (deposits) into credits with long maturities (loans). It is the so-called money multiplier effect of turning your deposits into loans for others, again enabling them to initiate economic activity that generates profit, new deposits and so the impact snowballs. In this sense loans also create deposits, and banks and the banking system are clearly more than just conductors that transfer real resources more or less efficiently. But could they also be semiconductors that amplify signals and the conversion of value?

In this role as intermediary between borrowers and lenders, banks traditionally make most of their money - e.g. charging more for loans than they pay for deposits. It is here that basic principles of transparency, accountability and customer responsibility ask whether a bank is creating sustainable value. Mortgage crisis, predatory lending, irresponsible microfinance and the like have raised renewed questioning from the public about whether banks can be trusted to offer clients clear and fair advice. When banks in emerging markets enjoy high interest revenue thanks to dramatic growth in unsecured (short-term) lending, this raises concerns about whether customers (e.g. increasingly indebted households) have been enabled to make responsible decisions.

Inevitably, at economically difficult times banks suffer with the rest of the economy. This comes with lower demand and rising prospects for non-performing loans with long overdue payments. Particularly vulnerable or risky are households and smaller enterprises (who are much more dependent on debt capital than large enterprises). And at times of financial crisis, fear of the systemic consequences of capital flight (bank runs) and a destructive domino effect in the economy looms large.

Can leading banks rise amidst crisis and prove themselves as key actors in a value creating chain as opposed to value drain? How can banks be turned into semiconductors for sustainable value? Some bank managers are preoccupied by (i) the mainstream, the serious questions of core banking systems that the Basel Committee on Banking Supervision is addressing. Other managers are grappling with (ii) the "less serious" or "public relations" demands of a growing environmental, social and governance (ESG) agenda, an agenda that most in the financial industry still regard as somewhat peripheral. More on this in the next (Part II) of a three part series on banking for sustainability.

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