Arthur Doohan: We all had a pleasantly salacious time some days ago watching various white-collar villains being hauled before the courts and given "good talking to's" by our esteemed judiciary. In the vernacular I believe this is referred to as the 'perp walk', where the fourth estate gets to harmlessly indulge our ancient tendencies to 'hue and cry' and 'witchhunt'.
All of which amounts to slamming the stable door on a horse whose cantering about the farmyard is still damaging this economy. Bad bankers and banking has caused huge current problems for everyone in the state. The same problems are afflicting most of the developed economies concurrently and concertedly.
Banking has seldom been an asset to the state or the economy in Ireland. It has had just as poor a history of labour disputes as other sectors and it has been sufficiently unfriendly to enterprise and innovation that the state has had to set up its own banks and to establish the global model for government agencies to stimulate investment, both foreign and domestic. And all this while the banks demanded the same privileges that obtained elsewhere such as depositor guarantees and light touch regulation.
So, if we are to avoid more of the same from our banks and to help us get out of this morass, I would ask you to consider a " 'purp' walk" for banking, that is, let us take out for a stroll the notion of the 'purpose' of banking. Specifically, what are banks for, what have they actually been doing, what are they doing now and what should they be doing in the future.
What we have
We, currently, have what are called 'universal banks', that is, they do 'everything' with respect to money and quite a few other things beside. Our banks borrow money, lend money, move money, convert money, 'invest' money and advise on all of the foregoing. For all of these services they charge fees as well as potentially profiting from 'exposures' or risk taking we inadvertently allow them to enter into with our money. About the only thing they don't do is print the damn stuff, despite what some 'theorists' will tell you.
This concentration of business models into a single conglomerate is a historic accident rather than a strategic decision. It is an accident waiting to happen which it does, repeatedly, as the history of banking shows. Further, it is an 'accident' that disregards the prudential structures that exist in all other financial markets.
Nowhere else are the risk takers allowed operate the risk transfer mechanism. In plain English, in every other financial market in the entire planet either there is an 'Exchange' which is an independent entity that carries no risk or risk transfer is done multilaterally from each to each other. Only in banking are the handful of big players, who carry the most risk, allowed to operate the 'clearing system'.
Out of this strategic oversight grows the risk that allows politicians to frighten us with threats of ATM shut downs and failures to pay wages and the like. The recent systemic problems at RBS/NatWest/Ulster have shown us that the 'clearing banks' are prone to failings in this.
There is, also, an embedded conflict of interest in the fact that banks are allowed to charge 'advice fees' for selling products that they will make profits on. Is there any legislation or regulation that forces bank officials to advise clients of their competitors products or services? If there is, I assume, it is 'enforced' to the usual standard of the Irish fiduciary authorities, says he pulling his lower eyelid to the floor….
A further issue is that its 'risk management tools' (derivatives principally) and risk transfer methodology (securitisation mainly) have proven to be ineffective and actually dangerous in many cases.
Added to all of this is a star system of employment leading overpayment for what amounts rewarding people for lucky gambling outcomes and encouraging doubling up of both good and bad bets.
Lastly, our banks insist on being given a Government guarantee for their 'raw material' (our deposits) so that they don't have to take responsibility for their profligacy. This exposes us to their 'moral hazard' and gives them a free embedded option, known, on Wall St., as the "trader's put" (the trader can 'put' you into trouble but walk away untouched himself). It has been amusing to watch them turn the notion of 'moral hazard' on its head in refusing to allow borrowers some relief from the bankers mistakes while they refuse to deal with their own moral bankruptcy; amusing in a very frustrating way, that is.
So, clearly, banking is a mess but our Government is in thrall to it even if the people no longer are. Clearly, also, it has been a mess for a very long time.
It is structurally unsound, overly complicated, morally deficient, professionally conflicted, technically overreaching and given to self-indulgent excess. In parenting terms, it's a spoilt child with a cocaine habit driving the family car.….with the family on board.
What we need
Anybody can lend money to anyone else and they can charge interest for it? So, why do we lend our money to bankers rather than directly to businesses or housebuyers? On the continent people do that, they buy bonds of (lend money to) businesses and housing associations they know. Yes, they have banks as well but 1) "not so much" and 2) "not so big".
In the 'Anglo-Saxon' world of business practice that we Irish have adopted by default (a word we must judiciously use), we do have a share buying culture but not a bond buying one. We use our banks as risk diversification mechanisms for our prudential investment strategy. That is, we let the bank manager invest our money in a pool of loans and we take a reduced return in exchange for a heretofore presumed safe one.
We need to preserve this function in banking and that is the only thing we need to keep.
Getting from here to there
Domestically, we have been witnesses to Lenihan's and Noonan's 'Frankenstein-ian' misadventures in attempting to create a viable banking system by assembling bits of dead institutions into facsimiles of living ones. Even the nomenclature of 'pillar banks' has been unfortunate in that instead of being strong and supportive they are seen as immobile, hard and old-fashioned.
Contrary to the assertions of those 'on the take' from the system, neither the Guarantee, the recapitalisations, NAMA or any other of the fudged reforms has created any institution capable of advancing new credit; as the closures, redundancies and shrinking debt levels attest.
Internationally, we have only seen the Vicker's Commission in the UK consider any changes to the structure and nature of banking. The concept of 'ringfencing' has a pleasant and well-meaning 'ring' to it but it has not been shown to be either 'organic' or concretely implementable. Further, the seven year implementation timetable seems unnecessarily long for such minor reforms and seems designed to allow for a sustained lobbying process to water down the provisions which has already got under way and already has the support of the Chancellor. Fortunately, the latest wave of scandals seems likely to consign Vickers to the dustbin of inadequacy and irrelevancy.
So, having dispensed with the current situation without reference to the classic Kerryman's 'directions' joke, we have to ask what road do we take to get to a stable safe banking system.
There was nothing wrong with 'Glass-Steagall' apart from bankers not liking it which in itself seems a sufficient reason for bringing it back. The implied principle of having separate and single 'business lines' for operations with fiduciary duties would seem a sensible one and should be extended to the fullest degree. It would make real the concept of 'ringfencing'.
This would imply the creation of a utility clearing mechanism divested from the banks. If it was good enough for the gas and electricity networks here and abroad I don't see why it doesn't apply to the banks.
It would also imply the divestiture of the banks credit card businesses. Again, there is no reason why not to and there is no good reason why we should be tolerating financial 'conglomerates'. People already hold multiple cards from multiple operators, some of which are not bank affiliates and the banks already pool credit data into separate agencies to determine credit ratings. A further advantage to separating these 'business lines' is that the credit card system is in itself a form of clearing system and if completely independent of the banks would give a strength in depth through redundancy to the economy's need for payment clearing mechanisms.
Lastly, the banks should not be allowed to dispense advice for which they charge fees which puts them into conflicts of interest. This is the same objection in principle as saying that 'audit' and 'consultancy' should not be provided to businesses by the same firms.
For those who wish to cavil about the expense implied in these reforms, I can only point to the expense we are all being put to by not having these reforms and ask which you would rather go through again.
This leaves us with the problem of morally hazardous bankers. The operational difficulty is that we 'guarantee' the deposits but the problems come from the loans. How can one guarantee the loans? You can't in practice. What you can do in practice is constrain the guaranteed banks from lending offshore.
A particular problem with the Irish banking crisis was that German and British fundmanagers seeking higher yields lent money into Irish banks who lent it to their pet developers to overpay for German shopping malls and British hotels. It has not been explained why it is the moral duty of the Irish taxpayer to compensate these 'professionals' for their greedy mistakes. I understand why the Irish must pay for the hotels and shopping malls built in Ireland but I do not see why we are liable for those bought elsewhere.
I am not suggesting that banks should not be free to lend overseas…only that they should do it via distinct legal entities and that these should not be guaranteed by the State. If the bankers complain that the won't be able to do business overseas that is their problem not that of the State or its taxpayers.
In order to square the circle of competition and robustness and redundancy, I would want to see the 'mutual' sector restored to a position of health and strength. This could be done in many ways but perhaps the simplest would be to merge the EBS and PTSB and perhaps IL&P to give a fourth 'player' in the credit advance/banking sector.
As a final flourish to wrap up everything in a neat bow tie of robust redundancy, the PostBank should be reconstituted so as to provide a third clearing mechanism.
These reforms would leave us with a GDP appropriate banking industry robust to shocks with enhanced transparency and competition.
If the bankers say that they will be 'hamstrung', I say that they have 'hamstrung' the whole economy and that they should get used to suffering like the rest of us.
The Irish economy and the Irish people need working banks much more than it needs Irish owned banks and we need banks that won't get too big for our boots.
There is a quiet discussion being held right now in the Dept of Finance about the future shape of banking in Ireland. In that 'discussion' the civil servants are responding 'how high?' when the banks talk, in exactly the same way they did when the banks rewrote our bankruptcy legislation. We need to tell our politicians to get involved in that discussion and if they won't then we should get involved in it directly.
Those reforms in bullet form are;
- Create a utility clearing function to separate credit risk from payment transmission.
- Create single business line banks by divesting credit card businesses
- Forbid advice fees
- Remove the 'deposit guarantee' from funds lent overseas
- Reconstitute a fourth major lender from the old 'mutual' entities
- Reconstitute the PostBank
This is an edited version of a post which originally appeared on Arthur Doohan's blog