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Home > Blogs > Anthony Harrington > Ten good and bad things about banking

Ten good and bad things about banking

Global Financial Crisis | Ten good and bad things about banking Anthony Harrington

It has not been fun to be a banker since the crash. If the public have come to understand one thing about the global crash of 2008, it is that it was all the fault of greedy bankers. So the reputation of bankers has sunk even lower than the reputation of politicians in the eyes of the “ordinary person” - that mythical figure who is supposed to represent us all and who is now, presumably, without the benefit of media guidance in the UK at least following the demise of the News of the World, since the “ordinary person” was most definitely a News of the World reader. How else could that scandal sheet (sorry, I meant to say “paragon of the British press”) have clocked up 4 million readers?

The “greedy banker” story, of course, indiscriminately blends together investment and retail banking and tars everyone with the same brush, the tellers on the counter and the commercial bank manager along with the slick boys and girls on the proprietary trading desk. There is a kind of poetic justice in this, in that a number of the larger banks themselves were guilty of betting the entire bank, including all their retail deposits, by taking on what the European Central Bank (ECB) likes to call “mispriced risks”. (The ECB knows all about mispriced risks, of course, since its own portfolio is crammed full of them, Greek bonds, Irish bonds, Portuguese bonds, etc).

Five good things about banks

1. They are somewhere to put your savings – a developed banking system is one of the conveniences of modern living, like running water and electricity. It means if you get burgled the burgler walks off with your TV and your loose change, not a shoebox crammed with your life’s savings.

2. They make loans – if they didn’t how else would you buy a big ticket item like a car? In China 50% of residential property is still bought for cash – not a fun way of doing things.

3. They “intermediate” between what bankers like to call “ultimate borrowers” and “ultimate lenders” – imagine if your pension fund, which has cash and is an “ultimate lender”, had to go door-to-door trying to sell loans at, say 8% interest, to ordinary folk (the ultimate borrowers) in order to invest, instead of buying bank bonds? Banks can stand between ultimate borrowers and ultimate lenders by themselves borrowing in large chunks and then lending that out many times over. The bank makes its cash out of the positive difference between the interest rate that it borrows at, and the interest rate that it lends at. Hence the need for “prudent” lending…

4. They are a primary source of liquidity for business – the various forms of credit provided by banks, from overdrafts and term loans to invoice discounting and asset financing enable businesses to grow faster than they could simply using their own cash.

5. They reduce uncertainty – all the paraphernalia of banking, from term loans to overdrafts to interest rates on savings accounts, is about providing customers with trusted procedures based on clearly-understood processes. Good information is about knowing what you are getting. Commercial life – and everyday life too, for that matter - thrives on good information flows.

Five bad things about banks

1. They can swallow your life savings – the only thing that stops a bankrupt bank from making your savings go “pouf” and vanishing like the vase of flowers under the magician’s handkerchief is the government stepping in with a guarantee, which means your children and their children and so on, pay for your lost savings via the increase in the national debt burden, which has to be funded. (OK, we are assuming here that you haven’t diversified your savings across numerous different investment strategies, but if your savings are less than, say £20,000, which covers most of us, then that is a fairly safe assumption.)

2. They make loans – essentially banks need not hold 100% reserves to support the loans they make. In the US the loan to deposit ratio is sometimes 90:10, creating credit from fresh air. This is why runs on banks scare the hell out of bankers, politicians and, well, all of us… This is called fractional reserve banking, and it is both a good and a bad thing since it opens the financial system up to, well, risk…

3. They “intermediate” between “ultimate borrowers” and “ultimate lenders” – the downside of this is that they lend far more than they borrow, since they create credit. This process enables banks to leverage themselves into a hopelessly insolvent position, at which point they have to fall back on the taxpayer for mind-bogglingly large amounts of bail-out cash.

4. They are a primary choke point for credit to business – if banks lose their appetite for lending, as, for example, when their balance sheets have been wrecked by imprudent investments, the flow of lending to businesses dies away and the economy stagnates or goes backwards.

5. They create uncertainty - If a bank which has both investment and retail banking arms to its business contracts for huge amounts of risk and those risks come home to roost, banks start behaving peculiarly towards depositors. Businesses who are doing very nicely are suddenly asked to repay their overdrafts by yesterday. Ring-fencing investment banking debt so that bad debts incurred by that side of the bank do not affect the financial status of the parent group is proving next to impossible for advanced economies...

Further reading on banks and banking:

Tags: bad banks , bank bonds , bank run , bank runs , banking , bankrupt bank , capital buffers , fractional reserve banking , global banks , global financial crisis , good banks , investment banking , lending , life savings , mispriced risk , mispriced risks , News of the World , overdraft , retail banking , ring-fence , ring-fencing , ring-fencing banks , ringfence , ringfencing , ringfencing banks , term loans , ultimate borrowers , ultimate lenders , uncertainty
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