Banks should serve the real economy - RSA

Blog: Banks should serve the real economy - how?

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  • Economics and Finance

The BankingFutures project has launched its report on how to rebuild a healthy banking sector following 18 months of consultation between senior bankers, regulators, investors and civil society groups. Speaking alongside Lord Blackwell, Chairman of Lloyds Banking Group, Andrew Bailey, Deputy Governer of the Bank of England, Karina McTeague of the Financial Conduct Authority and James Leigh-Pemberton of UK Financial Investments, I was invited to give a response on behalf of civil society and this is what I said.

The essence of BankingFutures’ recommendation is that we need clear, and hopefully consensual, answers to two questions.

-       What do we mean by serving the real economy?

-       And how can we ensure it happens?

I’d like to consider three areas: universal service, credit growth and allocation, and the intermediation of capital and risk.

Universal service

There seems to be a general view that there is a utility element to domestic banking. As with water and electricity, in a modern economy we believe that all citizens should be fully connected to the credit and payments systems. But it is not in the interests of for-profit businesses to serve unprofitable customers.

I think we can break this challenge down into three components:

  • branches,
  • transactions, and
  • fair credit.

Of these, the rapidly reducing need for physical branches is going to lead to massive closures over the next few years. For each bank this is rational behaviour, but for the economy as a whole this is bad news and for branchless communities it is a severe blow.

Whether to serve the needs of cash handling small businesses, the elderly or digitally excluded there is still in aggregate a requirement for branches and will be for many years. This is a classic co-ordination failure. Can we reduce the branch network while ensuring all communities are served? In my experience working with the Campaign for Community Banking services on this issue, there has been little appetite from the BBA or UK banks to engage on this question. I hope that bringing the spirit of BankingFutures to this issue will lead to more fruitful discussions.

On transactional services, and access to responsible and affordable credit, we have another collective action problem. To maximise the country’s economic potential, everyone must have access to transactional banking and credit on fair terms. But the UK does not compare favourably on this score with estimates varying from 1.5 to 3 million adults unbanked.

In the US, the Community Reinvestment Act effectively attaches the universal service obligation to the banking licence and lets banks find ways to satisfy it. In the rest of Europe, local stakeholder banks (cooperatives and public banks) can and do choose to serve unprofitable customers by effectively cross-subsidising from their more affluent customer base.

In contrast, in the UK we seem to have invented a system where the poor effectively subsidise middle-class customers through penal account and credit card charges for some and free-in-credit current accounts for others.

I believe these are challenges that banks can find creative solutions to, if they can act collectively with regulators and other stakeholders to do so.

Credit growth and allocation for the real economy

The second set of challenges – around credit growth and allocation – I feel less optimistic about. I hope that everyone in this audience is happy with the statement that banks create money. Bank deposits are digital IOUs from banks, but unlike any other kinds of IOU in the economy, bank deposits function as money. It is considered primarily a private matter how many deposits banks create and who they lend them to.

But bank deposits are underwritten by the state. Their acceptability depends on the state. They are arguably therefore a public good. Certainly, how much money is created in total, and to which economic sectors it is lent, are matters of the highest public interest. So here is the problem – there is no guarantee that if you add up all the individual lending decisions of banks that you will arrive at the optimal level of credit growth and allocation for the economy.

In fact, theoretical and empirical evidence suggests the opposite. We see too much credit creation during booms, and too little during recessions. Too much credit flowing to real estate and financial asset speculation, and too little to SMEs and infrastructure investment.

Individual banks cannot solve this problem. More competition cannot solve this problem. Rigid free-market ideology cannot solve this problem.

Here we need innovative thinking in how to manage inherently unstable credit systems combined with strong political leadership. Credit guidance arrived through the back door after the crisis, with Funding for Lending, Sectoral Capital Requirements and QE. It is time to debate more transparently how we actively manage credit growth and allocation to serve the real economy.

Socially useful capital markets

Finally, and very briefly, on capital market and risk intermediation, my plea would be that banks expand their sense of duty beyond looking at financial returns of products and deals. When I first joined Barclays as a corporate broker in the 1990s I felt pride in the idea that we were helping UK companies raise capital to finance the creation of real wealth. Let’s see banks competing hard with each other to demonstrate to the public, backed up with hard evidence, the positive economic, social and environmental impact of the activities that they finance.

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  • Tony, very positive approach, with which I agree. However, can we find another way to divert credit from real estate and other financial assets? Why not make real estate less attractive to investors by diverting the rent arising from their locational advantages to public revenue by means of a land value tax? If at the same time, taxes on employment were reduced, people would be keener to work for their living, rather than rely on the unearned income from holding financial assets...

    • Andrew, I think that land value tax is a very interesting idea and one I would like the RSA to take a look at.

  • There are the 40 or so small, ethical not-for-profit finance providers who are members of the Responsible Finance Association (formerly the Community Development Finance Association). We have the advantage of a local presence in the communities we serve and we fund the "unprofitable" clients who banks struggle with. We are massively undercapitalised and could do a great deal more if we had more funds to do it. This is a real alternative for small businesses, digitally excluded and other financially excluded members of our communities - and represents I believe a welcome diversity in the financial sector. It's just too small at the moment - although we are focussed on growing it!

    • Thanks Karen, I am a supporter of the CDFI movement and will be speaking at the Responsible Finance conference this year in Manchester. Keep up the great work!

  • The banks are closing branches to make themselves more efficient, but people want local branches. Is there a way to meet both goals?

    I believe there is with some lateral thinking.

    Banks should get together so each branch can serve many baking organisations.

    For example, one outlet could serve HSBC, Nat West, Lloyds, Barclays etc.

    The number of premises will reduce, saving the banks money, but the access to local branches stays the same for customers.

    This is where I believe intelligent government can make a big impact, to give win-win solutions.

  • Thanks for these provocative thoughts!

    May I suggest three additional approachesto building a healthy banking sector that are worth considering?

    First, credit unions. When I lived in theUK, credit unions were tiny, almost non-existent entities, hobbled and unableto grow due to very poor enabling legislation.

    When I moved to Canada, I discovered creditunions that were massively successful. Vancity Savings, based in Vancouver, isa member-owned financial cooperative. It has 509,000 members, 58 branches, and$18.6 billion in assets (£9.3 billion). Founded in 1946, it consistently wins awardsfor being among the best corporate citizen, and the most socially responsiblecorporation, etc. 100% of its profits goes back to its members, is given to thecommunity through a variety of funding mechanisms, and is re-invested inVancity. Britain could have a similar success if the legislation was changed toempower credit unions, instead of hobbling them.

    Second, public banking. The Bank of NorthDakota, established in 1919, is owned by the State of North Dakota. It has $4billion under management, and it is the depository for all state taxes andfees. It lends consistently to community banks, student loans, farmers andother key sectors of the North Dakota economy. When a private bank createsmoney, the interest benefits the bank and its shareholders. When a credit unioncreates money, the interest benefits its members. When a public bank createsmoney, the interest benefits the state as a whole. In 2014, the Wall StreetJournal reported that, “it is more profitable than Goldman Sachs … has abetter credit rating than J.P. MorganChase & Co. and hasn’t seen profit growth drop since 2003.”’s-only-state-owned-bank-became-envy-wall-street

    Thirdly, the national creation of creditthrough a public-owned federal bank. The Bank of Canada is a public bank ownedby the state. Until 1974, the government used it to finance majorinfrastructure investments such as the Trans-Canada Highway and the St.Lawrence Seaway, creating and issuing credit at zero or very low interest loans.In 1974, the government was persuaded by the Bank of International Settlements(a private body) to obtain all of its debt financing through the privatesector, instead of creating it directly, and since then Canada’s public debthas gone through the roof. There is now a legal move afoot at the Supreme Courtto require Canada’s return to the pre-1974 situation, which would (among otherthings) enable Canada to finance its transition to a 100% renewable energyeconomy with zero-interest or very low-interest loans. Britain could so thesame, if there was the political will to overcome the private banking interestsof the City.

    I explore these and many similar changes inmy new book Journey to the Future: ABetter World is Possible.

    Best wishes,

    Guy Dauncey, Vancouver Island, Canada

    • Thanks Guy, these are all excellent proposals that I have also advocated. We are pleased to be hosting a public lecture by Ellen Brown of the Public Banking Institute on Wednesday 17 February at 1pm - I hope you can watch online.  You are quite right about how UK credit unions are very much the poor relatives of the international movement, but the movement is at least gradually growing and modernising. There is little sign of it moving into SME lending though,  I believe that come the next financial crisis, public credit creation will have to be back on the agenda - you may have seen that both Martin Wolf of the Financial Times and Adair Turner, former head of the UK Financial Services Authority, have advocated it.

      • Thanks! Ellen Brown has been my source for public banking inspiration. I'll watch her talk (but later - 1pm UK is 5am my time). Does RSA have a good connection with the New Economics Foundation? I'm not sold on the Positive Money solution, and I think the private banks should still create money - but there needs to be much more transparency about it, showing links to inflation, and to the nature of the money they create, ie for what purposes. 

        • I was previously the Head of Economics and Finance at NEF, and am co-author of the economics textbook 'Where Does Money Come From? A guide to the UK monetary and banking system' 

          My position is to advocate a range of banking reforms, including greater transparency and control over private credit creation as you suggest, to structural reform to increase the proportion of banks whose have a dual social and financial mission (as with Canadian credit unions), complementary currencies and also public credit creation.

          • :) Thanks! I have been engaged in new economics for a long time, but for the last 25 years fully immersed in climate solutions. (I used to live in the UK until 1990). My new book Journey to the Future: A Better World Is Possible is a blockbuster ecotopian novel, set in the year 2032, and it delves deep into the future economy and finance, as well as a host of other things. My regular work is at Thanks for the work you do!

  • Well done, a very fine speech too.This must have taken some nerve to deliver in front of the banks and regulators,but someone has to make a stand and tell then straight.I wish I had been there to see the reaction.Being from a banking background it is good to see that you are confronting the problems and not advocating the status quo as many do,we need more like you to make these points.Keep up the good work.

    I support the Postivemoney organisation and we are spreading a very similar message.

    • Thank you Vince. Positive Money are doing great work in spreading understanding and debate about the need for deeper, more systemic reform of the financial system.

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