The profitability problem

The Co-Operative bank has pulled out of its proposed purchase of Lloyds branches, citing the bad economy and tougher regulatory requirements for banks. Various people have suggested that this said more about the Co-Op itself than anything else: "bad economy and tough regulation" easily translates into "business is weak and we are short of capital". Indeed they are. In February this year, the Co-Op shamefacedly admitted to a £1bn black hole in their capital. But Robert Peston points out that the Verde branches would actually be better capitalised than the Co-Op's own, and the deal would therefore have improved their overall capitalisation. So what is going on?

The regulatory environment for banks is indeed tough and becoming tougher. The Prudential Regulatory Authority is determined to clamp down on risky activities and force banks to protect themselves and the financial system from failure through increased capital buffers and liquidity reserves. And the Financial Conduct Authority is imposing tighter supervision of larger banks, and serious restriction on products and funding strategies that it considers to be not in customers' best interests - which include many of retail banks' more profitable activities. Nowhere does the need to make profits feature in the terms of reference of either regulator. They don't seem remotely interested in ensuring that commercial banks can be profitable.

Yet both should be. An unprofitable bank is a risky bank. And an unprofitable bank is unlikely to give good value to customers.

Firstly, the risks. These centre around the ability of banks to absorb losses. Banks are at risk of insolvency if the value of their assets falls - for example through a spate of bankruptcies among borrowers. They are also at risk of running out of money if depositors decide to remove their funds, although this can be mitigated by an effective central bank acting as lender of last resort provided that the banks in question have sufficient acceptable collateral. The risk of running out of money is therefore mitigated by banks holding high-quality liquid assets such as government bonds. And the risk of insolvency is mitigated by capital.

Contrary to popular opinion, capital is not "cash". Nor is it deposits, or any other sort of debt. It is shareholders' funds - what in other companies would be called "equity". Just to remind you (I know I've written about this before), banks can raise capital in three ways:
  • directly from shareholders by means of new shares (rights issues). Shareholders are unlikely to want to buy more shares in banks that are already offering a poor return on their existing shareholdings.
  • by retaining earnings (profits) instead of dishing them out to shareholders as dividends, employees as increased wages and/or customers as reduced prices. This of course requires them to be making profits.
  • by reducing the overall size of their asset base, either by reducing the risk profile of the assets or by selling them. Put bluntly, this means limiting lending to better risks, selling off parts of their business, and reducing the amount of lending they do.
If a bank is not profitable, it cannot give any sort of decent return to its shareholders, it cannot build up capital, and it is unable to undertake the sort of risk lending - particularly to businesses - that really benefits the economy. It is highly risk averse and reluctant to lend except against very good collateral and/or at high rates. And if it is chronically short of capital and regulators are unyielding, it will slowly break itself up, or it may seek a buyer. Its focus is on self-protection and damage limitation rather than on developing a vibrant and well-diversified lending portfolio. In short, it is a zombie.

Having a banking system made up of the living dead is an incredibly unhealthy state of affairs for the economy. I am personally of the opinion that a large part of the UK's stagnation is caused by the fact that two of its five big banks are badly damaged (RBS and LBG), one more is undergoing major restructuring (Barclays), and a fourth (HSBC) has suffered serious reputational damage due to criminal activities in one of its overseas operations. RBS and LBG are currently making losses, and Barclays is generating a return on equity that is well below its cost of capital. This is not sustainable. These banks simply are not in a fit condition to support the economy.

Nor can they give good value to customers. I've worked for a bank that wasn't making any money. In 1989, Midland Bank declared a full-year loss following writedowns of its holdings of Latin American debt and a ridiculous mistake on money market positions. The following year it managed to scrape together £11m, a dismal return for the UK's fourth largest bank. Midland was desperate to make money: it had very little capital and a huge portfolio of dodgy loans. So it took stupid risks - hence the position error. And it cut costs. Particularly staff costs. It embarked on a programme of redundancies and restructuring across its entire business. No-one knew where the axe would fall next. It became a demoralising place to work, not only for staff but for the managers whose job it was to make redundancies and if possible encourage people to leave before being made redundant - after all redundancy is a cost....

Staff who are worried about their jobs don't generally give good service to customers. And it is unreasonable to expect them to do so. Their first priority is their families. It's not that they become any less competent, but they become preoccupied with their own concerns and see little point in going out of their way for customers when they do not know how much longer they will be around to serve them anyway. I don't know what it's like to work for Barclays at the moment, but I imagine the situation must be pretty grim: the bank is making job cuts across the board and restructuring large parts of the business. There was recently a serious shakeout of senior management, and in my experience that is nearly always followed by weeding-out of the people perceived as being "followers" of the senior managers who have lost their jobs. Barclays is busy re-educating all its staff in its new "core values", which include a commitment to customer service - but how effective will this be when staff are worried about their own futures? The job market in financial services is very difficult at the moment.

Yet the FCA makes no mention at all of the critical need for banks to take care of their staff. They seem to think that good customer service can come through intrusive (and expensive) supervision coupled with strict limits on the types of business banks can do. No it can't. Banks are people businesses. If the staff aren't happy, neither will the customers be.

Nor can a bank that is desperate to improve the returns to its shareholders give good value to customers. This is a fundamental conflict of interest: customers want low prices, but shareholders want profits. Reading the Barclays' strategic review announcement from February 2013, it is (to me at any rate) very clear where their focus is:
"Based on the results of its strategic review, Barclays is today making several commitments. Barclays seeks to:
Financial commitments
  • Deliver a return on equity for the Group in excess of the Group cost of equity in 2015, which we have assumed will remain at the current 11.5% level;
  • In 2013, reduce headcount by at least 3,700 across the Group, including 1,800 in the Corporate & Investment Bank and 1,900 in Europe Retail and Business Banking. This is expected to result in a restructuring charge of close to £500m in Q1 2013;
  • Reduce the Group’s total cost base by £1.7bn to £16.8bn in 2015, including interim cost estimates of £18.5bn and £17.5bn in 2013 and 2014 respectively. This excludes ‘one-time’ costs to achieve the strategic plan of £1bn in 2013, £1bn in 2014 and £0.7bn in 2015, delivering a Group cost to income ratio in the mid 50s in 2015;
  • Target Risk Weighted Assets (RWAs) of £440bn by the end of 2015, after mitigating the estimated impact of CRD IV (£81bn) through legacy asset and other RWA reductions (£75bn), enabling RWA investment in selected areas;
  • Report a transitional Common Equity Tier 1 ratio above its target ratio of 10.5% in 2015; and
  • From 2014, accelerate our progressive dividend policy, targeting a payout ratio of 30% over time."
Barclays' adjusted return on equity in the quarterly results just announced was 7.6%. Admittedly this did reflect restructuring costs, but I struggle to see how they will achieve a return on equity in excess of 11.5% within two years while ALSO giving customers good service and value for money. And the cost-cutting targets are extremely challenging. The FCA should be looking at the viability of these financial targets in relation to the new regulatory focus on customer value.

Which brings me neatly back to the Co-Op. You see, the Co-Op is a mutual. It is owned by its customers. Here is the Co-Op's statement explaining the reasons for withdrawing from the Lloyds deal (my emphasis):
"The Co-operative Group announces that it has withdrawn from the process currently being run by Lloyds Banking Group for the disposal of branch assets (“Verde”) after The Co-operative Group and The Co-operative Bank plc Boards decided that it was not in the best interests of the Group’s members to proceed further at this time. This decision reflects the impact of the current economic environment, the worsened outlook for economic growth and the increasing regulatory requirements on the financial services sector in general."
Taking on the Verde business would have made the Co-Op Bank the fifth largest retail bank in the UK. It would have been subject to tighter regulation, higher capital and liquidity requirements and more intrusive supervision - all of it in a difficult economic environment. This was not in the best interests of its customers.

And therein lies the problem. The tougher regulatory environment for banks is supposed to reduce the risks to taxpayers and improve value for customers. But in a stagnating economy where profitable lending opportunities are hard to come by, banks are already struggling to make money. Tougher regulation increases their costs and circumscribes their earning opportunities. As Noble Cause put it on twitter:
Such severe limitation perversely may mean that risks to taxpayers actually increase and value for customers declines. The approach to regulation needs to be rethought. Banks must be able to to take reasonable risks in order to make money. An unprofitable banking sector is in no-one's interests.


Related links:

Co-Op Bank's £1bn black hole - This Is Money
Will the Co-Op pull out of banking? - Robert Peston, BBC
Cyprus and the financing of banks - Coppola Comment
Approach to banking supervision - Prudential Regulation Authority
FCA Risk Outlook 2013 - Financial Conduct Authority
Barclays Announces Senior Management Changes - Barclays
Strategic Review Announcement February 2013 - Barclays


Comments

  1. The banks would have loads of capital free if they were required to run down their loans to the financial sector - which add nothing to society.

    Banks can always get capital at a price. The problem is that as usual they are holding the boring retail side hostage

    Investment banking should be fully equity funded and maturity matched, and frankly society shouldn't have to care if that goes bust any more than it does if Frank's chip shop goes under.

    The only thing banks are there for is to run the transaction system and make capital development loans to businesses and consumers. If they can't do that properly, then there is a strong argument to reinstate the National Girobank that can and let the existing dinosaurs go to the wall.

    This debacle also shows the weakness of the co-operative and mutual models - which of course struggle to raise risk equity for acquisitions. A company could have looked at a rights issue and equity dilution.

    But that's probably for the best. Mutuals and co-ops are best left to grow organically.

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    1. I'm afraid this simply isn't true, Neil. The fact is that for years now retail banks have relied on added-value products such as insurance - often mis-sold - to beef up their return on equity. It is those products and practices that the FCA intends to clamp down on, but the extent of the restrictions it plans to impose in my view risks throwing the baby out with the bathwater. Retail banks make no money at all from payments, and at the moment profitable lending is a scarce commodity. To say "banks can always get capital at a price" is simple nonsense. If they cannot offer adequate returns to shareholders, they will not be able to raise capital - it is as simple as that. You blame investment banking for this, when the real issue is the very low margins in retail banking.

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    2. It is always true. Banks can get capital at a price. If that price is too much to make lending profitable then they will run down their lending until the RoC gets back to what it needs to be to pay that capital.

      If the margins are too low in retail banking then the banks are trying to lend too much for the current cost of capital and must shrink. And that shrinkage should be focussed by regulation on lending to financial organisations for what is essentially gambling. If they still can't get back to a sensible ratio then the bank must be allowed to go bust.

      And ultimately if the banks can't lend, then the government must spend or the economy will start to contract

      The real issue is relying exclusively on the mythical allocation powers of private banking for monetary injection.

      Banks are already heavily subsidised by the state via the lender of last resort function and the deposit insurance system. They need to shape up and do the job required of them, or be replaced by something that can.

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    3. Still wrong, I'm afraid, Neil. I was discussing Lloyds and the Co-Op. Both are retail banks and have little or no investment banking activity. And the investment bank was the most significant contributor to Barclays' profits this quarter. The fact is that vanilla retail banking IS NOT PROFITABLE at the sort of interest rates and fee levels that customers are used to paying. Society has to consider whether it really wants to continue to have banks as private institutions at all.

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    4. Businesses that can't make a profit because they can't charge enough have to be allowed to go bust, which allows those that can to survive.

      Are you actually suggesting that Lloyds doesn't lend money to the finance sector? You don't need an investment banking arm to be in investment banking.

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    5. Neil, all banks lend to each other. It's called the interbank market and it is the lifeblood of the banking system. Lloyds is part of that. But otherwise, no it is a net borrower from the broader finance sector - as are most retail banks. Check their accounts.

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    6. The interbank market is about central bank reserves and clearing, the net flow position doesn't free up risk capital and the accounts show a consolidated position.

      Surely you realise that.

      What I'm getting at is how much of the £49,190 million lent to 'Financial, Business and other services' is actually to push speculation, and how much of that could be stopped by regulation and redirected to more rational ends.

      Now admittedly Lloyds is relatively conservatively run. The rest of the banking sector less so. They are tying up capital doing stuff society doesn't require doing.

      And yes they are doing that because those elements are more profitable and they are desperate for a return.

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    7. I'm well aware how the interbank market works. But it is still lending between banks and at the individual bank level is accounted for as such. You surely know that.

      The idea that Lloyds is conservatively run is laughable. This is the bank that jumped at the chance of taking over HBOS without doing proper due diligence.

      My point is that if you stop banks doing profitable activities, you make them riskier, not less risky. Low profitability is itself a risk.

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  3. Small point surely banks do not raise acpital by 'reducing the overall size of their asset base' merely improve their capital ratios - good post

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    1. Thanks Andrew.

      Of course only the first two of the "three ways" actually increase the nominal amount of shareholders' funds. But as bank capital is always expressed as a ratio of shareholders' funds to risk weighted assets, not a nominal amount, it is correct in my view to describe reducing risk weighted assets as "increasing capital".

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  4. Forgive me if I'm misunderstanding you, Frances - but is the jist of this article that we should relax banking regulations; that we've in fact tightened too far and now should loosen up the system again?

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    1. I do think that the lack of regulatory focus on the needs of employees and shareholders is a serious omission. However, the underlying issue is far more fundamental. It concerns the fact that core retail banking is not profitable. The more banks are restricted in the extent of added-value products and services they can provide, the lower their profits will be, the harder they will find it to raise capital and the riskier they will be as commercial organisations. Society really has to consider whether banking as we currently have it is a viable business model at all. If banks cannot make profits without taking unacceptable risks and/or treating customers badly, then the model is broken.

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  5. I welcome the current unprofitability of banking, and any consequent contraction in the industry over the next few years.

    In recent decades, banks have managed to boost profitability by taking risks that the taxpayer pays for (when such risks go wrong). The reining in of that profitable but parasitic activity is to be welcomed.

    The banking industry has expanded a whapping TENFOLD relative to GDP over the last 30 years. And far from the UK economy being a disaster 30 years ago, economic growth was far better than over the last 5 years.

    If banks are restrained, and any loss in GDP is made up for by general stimulus, the result will be less economic activity based on bank lending, and more activity based on equity and lending by non bank entities (e.g. one member of a family lending to another to start a small business).

    Plus there will be less investment. But that’s no problem. Investment based on risky lending by banks with taxpayers footing the bill for investments that go wrong just doesn’t make economic sense.

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    1. You have a poor memory, Ralph. Thirty years ago the UK was just emerging from deep recession after a decade of hell. We had high unemployment (I was one of them), bank failures and near-failures, high inflation, poor output, decaying infrastructure, strikes and industrial unrest. I'd say that was pretty similar, really.

      Less investment is "no problem"? Heavens above. I CANNOT agree. A large part of the current stagnation is caused by serious lack of investment by both private and public sector.

      You allow your hatred of banks to cloud your understanding of economic fundamentals.

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    2. If you go back EXACTLY thirty years i.e. to 1983, then economic growth was about average for the last century and rapidly rising, if the chart (link below) is any guide.

      http://www.economicshelp.org/blog/2688/economics/data-on-economic-growth-in-uk/

      As to the “strikes and industrial unrest” as I’m sure you know, that that had nothing to do with banks. It was caused by the inflationary spike and stagflation of the 1970s and Thatcher’s attempt to escape that via strict monetarist principles (which 365 economists predicted, quite rightly, would result in high unemployment).

      Also, on revisiting the source of my “30 year” point (which is Mervy King’s “Bagehot to Basel” speech, p.3) I see that I should have said “50 years”, not “30 years”. But even there it would be silly to take just one year, i.e. 1963. Far more relevant is the PERIOD over which bank assets were far smaller relative to GDP than today. And that period stretched from the century from about 1860 to 1960. And economic growth during that period was certainly far better than over the last five years.

      Next, you claim “A large part of the current stagnation is caused by serious lack of investment by both private and public sector.”

      First, your statement may well be true in the sense that investment simply as a constituent of demand is probably subdued at the moment. But then spending on beer, cars and housing is probably equally subdued. But that is a very unimportant point: it’s not the central point at issue here.

      The central question, and the point I made above, is that investment which is funded by risky banking practices which has to be subsidised by taxpayers will result in more than the optimum amount of investment.

      If concrete is subsidised, we’d get more than the optimum amount of concrete produced wouldn’t we? Unfortunately the concept “optimum” is way beyond the tiny brains that inhabit Westminster. They’re all convinced that “investment is good, so more investment must be better” - in the same way as “Vitamin C is good for you, twenty times the daily recommended dose must be even better”.

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    3. I don't think it is reasonable to compare the GDP growth of the last five years with the average over a period of 100 years that included the Industrial Revolution, two world wars and the Depression. For the record, however, the UK's GDP fell off a cliff after the first world war and did not return to its 1918 level until 1935. I would say the initial cause of that was probably the shock to the labour market caused by the loss of nearly an entire generation of young men, followed by catastrophically stupid economic policies and towards the end of that period the failure of banks (had you forgotten that bank failure was part of the cause of the Depression?) Frankly today's troubles pale by comparison and you do those who lived through that period a great dis-service by suggesting that what we have now is worse. We are a GREAT DEAL richer than we were then.

      The cause of the strikes and unrest is frankly irrelevant. However, there was of course a banking crisis in 1973-4....as a consequence of which bank regulation was significantly tightened and licensing of banks was introduced for the first time in 1979, the legislation coming into force in 1982. It took SIX YEARS on that occasion even to pass legislation to reform Britain's damaged banks. We have played this scene before within your lifetime (and mine). Charles Goodhart recently said he had lived through FOUR banking crises, three of which were caused by property market crashes.

      I am not recommending malinvestment. Far from it. But LESS investment than what we have now would be disastrous and I'm astonished you are suggesting it. I'm quite happy to have a debate about how we get damaged and risk-averse banks to lend productively, or whether we should bypass them completely, or get rid of this lot and start again. But less investment? No way am I going to agree with that idea.

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    4. First, details about what happened to GDP in the 1920s or any other decade are near irrelevant. The real elephant in the room is the one I referred to above, namely the fact that the banking industry in the century prior to about 1960 was ONE TENTH the size it now is relative to GDP. That, at least on the face of it, is a major flaw in the idea that shrinking the banking industry would pose any problems.

      The only potential flaw in my above “one tenth” argument is that the expansion in the banking industry over the last 50 years in Britain has to a significant extent been an expansion in international banking business, rather than domestic business. And I’m not sure how those two compare. If the expansion is explained entirely by an expansion in international business, the obviously I can’t use the one tenth argument.

      Re your last paragraph you say you don’t want malinvestment, while claiming that the banking industry should still be subsidised: i.e. that it should be allowed to continue taking the sort of risks it took prior to the crunch, with the taxpayer footing the bill when it goes wrong (not to mention the ongoing TBTF subsidy).

      The general rule, widely accepted in economics, is that market forces should determine the size of an industry - unless there is an obvious case of market failure or there are obvious social costs to consider. So if you want to justify subsidising banking, I suggest you need to make a good case for saying there is market failure, or that social considerations are involved.

      Also I’ve read a large amount of material connected with Basel III, Vickers and so on, and I’ve never known anyone claim the TBTF subsidy is desirable. But I look forward to suggests as to why it might be.


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    5. Ralph,

      1) It was you who compared the performance of the last 5 years with the period 1860-1960. I merely pointed out the irrationality of such a comparison.

      2) Where exactly have I suggested that the banking industry should be subsidised? Or that the taxpayer should foot the bill when it goes wrong? Nowhere in this post, or indeed in any other. I have been a vocal opponent of state subsidy for private banks and taxpayer bailouts.

      You have completely missed the point - which is that vanilla retail banking (you know, the sort that everyone thinks is safe & simple and wants banks to concentrate on) is fundamentally unprofitable and therefore not viable as a private sector industry.

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  6. At the heart of the problem is the UK consumer has got used to a free banking model that fundamentally is not sustainable. As you say plain vanilla high st. retail banking is not profitable. That is not profitable enough to generate acceptable returns as a plc. Gary Gorton has mentioned this unprofitable aspect that applied to UK and US banks. Hence over the last thirty years they have had to consolidate and make money from selling other financial products. Not one de-mutualised building society survived as a plc tells us everything we need to know. You need scale to make money and they did not have the scale. Same reason why there is no flood of new banks to serve all these alleged profitable lending opportunities that the banks are supposed to be refusing. Consolidation has its efficiency and universality benefits but it has also concentrated risk on fewer balance sheets. There is never free banking because someone somewhere is paying. Retail banking is not going to improve until the explicit free banking model is abandoned with predictable howls of public outrage.

    Without a doubt UK retail is somewhat dysfunctional. How much so is not as easy to tell as some people suggest. Just looking at rough lending aggregates can be deceiving when firms are accessing other funding streams. But what if the dysfunctionalism is not just with the banks but the business models of the private sector complaining about the cost of finance. Less than 2% of all UK profits end up as interest payments to banks. It is over 10% in Germany. You know maybe the new normal is just a reversion to mean and the banks are charging a realistic price for finance. But the non-bank private sector are still operating with unrealistic business models and expectations of how much funding should cost them. There is almost a default assumption with policymakers that the fault lies entirely with the banking system. That alone should alert us to the distinct possibility that it does not.

    Almost the entire regulatory position of the UK authorities is procyclical. When they should have been increasing capital ratios is in the run up to the financial crisis. Utterly useless and counterproductive to be doing it now. They should now be engaging in countercyclical measures by reducing capital ratios. We are typically fighting the last war with predictable outcomes.


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    1. Perhaps the State should offer free banking?

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    2. The banking sector as currently constituted doesn't work. That is very clear.

      Free banking is one of the great successes of the British banking system, as is the LINK cash machine network. But it was brought about by mutuality and state intervention. National Girobank brought about free banking.

      There is huge inefficiency in the current oligopolistic banking structure and I suspect it is irretrievable. And that sort of suggests that we have to go back to something along the lines of National Girobank and National Savings with mutual lending.

      The solution to increased margins is to reduce the funding cost. And the central bank can do that by giving regulated banks an unlimited overdraft at 0%.

      To get that I would suggest they have to give up collateralisation of loans, any lending to the finance sector, any investment banking businesses and have to run the transaction account system for free.

      Almost certainly we'd be better off making that facility available to credit unions to get development capital out there in the field.

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    3. Neil, again this is simply wrong. The major drivers for introduction of free current account banking were:

      1) IT innovation - in which Girobank was indeed a leader but certainly not the only "mover and shaker": the first ATM was actually introduced by Barclays. IT innovation massively cut the costs of processing payments, enabling banks to cut transaction charges.

      2) the move to the "sales" model in retail banking, with current account customers becoming the target market for loans and for added-value products such as insurance. Free banking was introduced as a means of attracting current account customers, particularly those who had not previously used banks - typically blue collar workers who had been paid in cash. It was, and remains, a cost to banks, but this was more than offset by the benefits to them from the products they could sell to their new customers and the cheap funding they got from idle balances on current accounts.

      Mutual lending is NOT "free banking". Banks don't just have funding costs. They have overheads - particularly in the branch network, which is expensive. The transaction account system itself is not free - banks have to pay to use it. The things you want to close down are their most profitable actitivies. Vanilla retail banking simply IS NOT PROFITABLE in a free banking model - it always depended on being able to cross-sell other products. If banks are forced to close down more profitable activities, free banking will become a thing of the past. It is already heading that way.

      As for credit unions - I suggest you have a look at their failure rate, and who pays to bail out their depositors when they fail (which they frequently do). They do not have the scale or the capitalisation to offer "development capital". And the thoughts of them offering transaction account facilities fill me with horror, frankly.

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    4. Girobank was a state bank that introduced free current accounts - as you say to get the blue collar workers to take out bank accounts. Everybody else had to follow and drop their charges slowly over time to avoid losing the low cost funding current account money represents.

      That is what happened. That was what drove the market.

      Nationwide Flexaccount introduced current account interest which was to attract customers to cross sell to - that came about as a result of deregulation.

      The result of the mutuals offering savings accounts with cash cards was the LINK network which slowly managed to get the old retail banks and Halifax into the club.

      I know how much it costs to do transaction banking, and I also know how ridiculously inefficient the internals of the current retail banks are. I've consulted on an awful lot of work in that area over the years and its pretty mind boggling how the scale inefficiencies add up.

      " I suggest you have a look at their failure rate, and who pays to bail out their depositors when they fail "

      The loss is always with the central bank. That's how an insured fiat system works.

      So you cut out the middleman and have the central bank as the main depositor. Having these operations 'in the bank' allows you to manage how effective the outsourcing agents (cos that's what they are) are at underwriting loans.

      Somebody has to make the lending decisions, and that includes the possibility of getting it wrong - perhaps catastrophically wrong. It which case the bank goes bust and the investors lose their money.

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    5. Neil,

      Girobank simply wasn't a large enough player to have that sort of effect on the big banks, and there were serious inefficiencies in its business model. Same with FlexAccount, which used to take two weeks to clear cheques. Girobank did indeed introduce free banking before anyone else, but that wasn't the main reason for the others following suit. The principal reasons were as I said.

      Yes, the mutuals drove the LINK network, agreed. But they did not drive the other technological innovations such as cards, EFTPOS, BACS, CHAPS, SWIFT that have transformed bank payment services.

      The central bank does not bear deposit insurance losses. FSCS insurance is paid for by a levy on financial institutions and if necessary topped up by Government. The Bank of England did lend FSCS some money in 2008 on a very short-term basis but this was quickly replaced by HMT.

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  7. In our country banks offer cloud applications integrated with the banking account. Our retail banks are profitable. Maybe the problem with retail banks in Britain is the oligopoly. Agreed retails banks here sell insurances too...

    I am no expert in banking business. I am not very happy with banks listed on stock exchanges. A bank is not a real world economy business. IT business here have a similar problem, we are not allowed to see a development as an asset. It's an asset the moment it sells. The moment it sells the cash flow does away with the need for a loan anyway - you sell something with almost 0 cost - valuation.

    Another point we have to be careful with are bubbles. What is a bubble - a ponzi scheme financed via loans, by the majority of the participants. In contrary the hype phenomenon - trading at higher prices than 'the market allows' - let me say it this way. This is human - about the price. Imo a price can only hype.

    The real big problems do come with real estate bubbles. If you finance purchasing stocks via loans ... matter of self-responsibility. Real estates are different.
    a) Usually you cannot finance a house via money earned in a day-time job with your cash. Not very likely - due to the distribution of wealth
    b) The moment the hype is over a whole area with 'honest' working people is starting to loose 'value' - asset backing. If you invested your own money, maybe savings, and live in the house - it does not matter. You will not sell it anytime soon.
    c) There are other who benefit from what you loose and make money after the 'bust'.
    d) The hype does come when too much money has been flowing into a certain area. (There is a nice film - You don't need money (German language). Someone promised investments would come and the whole area started to prosper, because banks offered loans... it's their job to do so.

    Who is really evil - 'Wallstreet' banks - they create bubbles and push hypes to utmost limits. It is almost impossible to benefit from a money investment. The continuous hypes made 'paper' from almost everything that was a real world investment in the past. Wallstreet banks are money makers.

    I think we will have to learn how to measure value outside the real world economy - practical value. No measure. Time is either price less, free or what a group of customers thinks about the value added for a moment. Enormous hard to estimate the growth - you have certainty about the quantity (hours worked vs. hours billed), no idea about mega trends - in-sourcing for example, very inflationary and hype driven, ... finance transactions, SMS, phone calls. I think it's a challenge for banks to find a way to manage these volatile ways of doing business.

    A bank is always bankrupt and always alive. I have learned that a central bank can always purchase loans and no problem does arise. Think back enemy bonds when WWI started. The Bank of England printed money and purchased the government bonds, it is not really a good idea to attend a war with a malfunctioning banking system...

    Question: It is said that the Pound lost it's status as the leading reserve currency sometime between the 70s and the 80s - This is very likely the reason for the recession or vice versa.

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  8. So low interest rates:
    -Make banks more risky
    -Take away savers income
    -Allow asset prices bubbles to continue
    -Have an impact on pensioners
    -Increase inflation


    ReplyDelete
  9. it integrated with the bank account.thanks for sharing.

    ReplyDelete
  10. I'm wary of being lumped with Ralph as I have a similar headline, but different reasoning.

    Headline - Retail banking is likely not going to get you 11% return on capital.

    Response - Well, 7-8% is the going rate in a lot of industries, I'm unsure that there's any god given right for bank CEOs and bank shareholders to expect more.

    Headline - Retail banking may not in fact be profitable at all.

    Response - Well, that is more serious, but I think if that is the reality, we need to face up to it, rather than attempting to subsidise it by randomised bad risk taking, rather, like other essentials we may need to create different structures.

    You come at this by defining a "Reasonable rate of return" first and then suggesting loosening regulation to allow achieving this, you are asking us, in this post, to ignore the risks. You term them as "reasonable" - but I think that needs justification.

    ReplyDelete
    Replies
    1. Cost of capital in banks is pretty high: Barclays recently quoted a figure of 11.5% as their long-run cost of capital. Return on equity needs to be higher than the long-run cost of capital to be sustainable. So either RoE has to improve or the cost of capital has to fall.

      I disagree with you about risk taking. It is the JOB of banks to accept and manage risk. They need to do it a lot better, not stop doing it. By trying to eliminate risk, we are preventing them from doing their job.

      Delete

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