It continued with the publication of the findings of the Parliamentary Committee for Banking Standards. This was quickly followed up by the Chancellor’s Mansion House speech where he announced the government would privatise Lloyds soon and hold off moving Royal Bank of Scotland back into the private sector for some time. Thursday morning saw the Bank of England’s Prudential Regulation Authority uncovering a £27.1bn blackhole in the UK bank’s balance sheet.
Clear
Despite the hail of announcements, two things have become increasingly clear. The first is that the sector really is serious about cleaning up its act, and it is willing to at least consider some very challenging measures to do so. The second is that UK banks will become far more concerned with financial safety and soundness. This means the careful management of risk will become increasingly central to their activities.
This increasing risk consciousness will have some significant implications for the sector. It will mean that banks will be run less like “loose federations of money-making franchisees” (as Manchester University’s Professor Karel Williams described them), and more like high-reliability organisations concerned with carefully monitoring risk. If this is the direction of travel, it could mean that large banks begin to look more like safety-conscious organisations like power generators, airlines or resource-exploration companies. Part of this is likely to be a culture that emphasises the broader purpose of banking, more robust whistleblowing policies, more long-term remuneration structures, more rigorous governance processes, and better regulation.
These reforms may prove to be a double-edged sword. They will make the banking sector safer and more responsible. But they are also likely to decrease variety in the sector. We have already seen the first steps towards this with the ‘bail-in’ of the Co-op. What has long been a mutual with members has suddenly become a company with shareholders.
Although the chief executive has played down the impacts of this change, it is likely to have some longer term effect on how the organisation is run. Maintaining the mutual ethos may be tricky when you have shareholders demanding a return.
The PRA’s analysis of the capital shortfalls in UK banks represents another significant challenge to the Co-op business model. One of the surprise findings was a shortfall of £400m on Nationwide’s balance sheet.
The mutual will be required to come up with a plan to raise this amount by the end of this month. Raising additional capital is relatively easy for private banks, which can go to capital markets. However, finding capital quickly is more difficult for mutuals owned by members. This is why the Co-op bailed-in bond holders, making them shareholders.
If Nationwide were to follow the Co-op, it would result in a further decline in banking diversity. This would mean banks would all have increasingly similar business models. This one-size-fits-all approach may help to assure the regulators, but it may have significant unintended consequences. It could reduce consumer choice, as the public could no longer choose between mutually-owned or shareholder-held high-street banks. It may also mean that poorer customers who were traditionally covered by mutuals might find themselves abandoned by increasingly risk-averse banks. Decreased diversity would also increase systemic business model risk. This means if all banks adopt the same business model and this business model fails, the whole sector will fail. Most healthy banking sectors have a rich mixture of large banks and small banks, global banks and national banks, as well as private and co-operative banks. The requirement of the PRA may reduce this variety.
Reduced diversity in mainstream banks will probably open up new opportunities for other providers. It will certainly provide a new market for so-called ‘shadow banks’, such as pay-day lenders. Although these lenders might reach out to the poor, they charge usurious rates. The growth of shadow banks could see many disadvantaged people who are seen as a bank credit risk finding that access to credit at a reasonable rate will dry up.
Another surprising development might be the spread of micro-financing initiatives in the UK. Companies in the US are already experimenting with importing micro-financing from developing countries such as India to poor communities in North America. There is a hope that micro-financing will give these poor communities, which are considered a bad investment, access to small amounts of capital at reasonable rates. There are many positive stories about the impact of these initiatives – but recent evidence suggests that micro-financing schemes have frequently failed. Recipients have often taken on multiple loans and find themselves unable to pay them back. In Bangladesh, micro-finance loans are not taken out to buy productive assets (like a cow or to set up a business). Instead, they are used to fund dowries or even pay back other loans. The spread of micro-finance in the UK may also bring some of these problems as well.
Resurgence
Another potential outcome could be resurgence of grass-roots mutuals targeting the unbanked. These will likely be local organisations that operate in a more democratic way. It is likely that the various global protest movements like Occupy will act as laboratories for these new ways of doing banking. Some models that we have already seen appearing out of these movements include the alternative currency, Bitcoin, peer-to-peer lending, and slow money.
The Parliamentary Committee for Banking Standards did recognise the problems around the growth of these non-standards lenders. It recommends that the shadow banking sector is brought back into the purview of the regulators and is held to the account of the same high standards of the mainstream banks. This would seem a sensible way to level the playing field. It is also an excellent proposal to reduce the kinds of risky practices that are brewing in the margins. But such a proposal might have the result of creating a monoculture of business models in the finance sector.
Andre Spicer is professor of organisational behaviour of Cass Business School
- This week has brought a lot for the UK banking sector.
- The increasing risk consciousness will have some significant implications for the sector.
- A potential outcome could be resurgence of more grass-roots mutuals targeting the unbanked.
