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.
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:
- 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.