Back on track?Banks and their function in society

Lars Pehrson, CEOMerkur Cooperative Bank

8. December 2009

Who can count 4,000 billions?

How did we get there?

Who to blame?

- the Americans!!

- and greedy bank managers!

And things were really running so well….

Why did governments get so busy

saving banks?

Why didn’t they just go bankrupt?

Banks are supposed to be businesses, like any other business?

More than hundred years ago

grassroots started to found local saving banks.

They wanted to be able to manage their own savings to the benefit of the local community.

The classic task of a bank is to distribute

savings among entrepreneurs who want to take initiatives and start up something new.

The distribution of capital today creates the society of tomorrow

That is why it really matters what is done with the savings

30 years ago a new type of society

oriented banks started to evolve.

Sustainability for the environment and quality of life for human beings were their main obejctives.

From the developing countries we got the microfinance movement. Their task was fight against poverty.

Banks concentrating on concrete tasks

in society – instead of a shortsighted focus on the financial bottom line - seem to have come better through the crisis

Why?

Let’s go back to the historic overview:

Since the 1980’s a specific economic thinking became dominant:

The neoliberalism – the market fundamentalism

And parallel as a business paradigm: Shareholder value.

In a shareholder value driven company the

interests of the owners (the shareholders) are superior to the interests of all other parties: The clients, the employees, the suppliers, the society

The profit has to be optimized – now!

Much production was moved to countries with cheap labor force and weak regulation.

The stock market is driven by

expectations for the future.

That is why we have to create some positive expectations!

The purchase of a competitor, the sale of a division, restructural measures etc. – all capable to create positive expectations.

The combination of the focus on the bottom

line and the creation of positive expectations can really rise the price of a share.

And then the shareholder can cash not only the profits of today but also the profits to be earned in the future!

The management is bound to the paradigm through remuneration in shares.

The temptation gets big!

Shareholder value has created a transactionbased

business model for banks

It is about to create as many transactions as possible and earn a fee or a spread on each transaction.

Transactions can be currency trade, securities trade trade with real estate and entire companies like in the private equity funds.

More transactions – more profit.

The society oriented banks have a

relation based business model

The focus is the tasks: The tasks of the clients and the overall

task of the bank

This has to happen in a businesslike way, but the business itself is not the task of the bank.

Transparency is key. The clients of the bank

need to know what their money is doing A relation based business model creates

solidarity around the tasks.

Clients get more loyal and interested

The owners are also more loyal – and the society oriented banks are by the way not for sale!

Again back to the historic overview:

Market fundamentalism created a firm belief that regulation is harmful. The market itself is the best regulator.

Financial markets got deregulated, starting from Reagan and Thatcher.

Financial supermarkets became possible – prior to that the functions were seperated.

Example: Deregulation can create a housing bubble

Danish mortgage bank system was based on conservatism, collateral and a fixed interest as long as the loan lasted. No surprises. And originally the mortgage institutions were owned by the borrowers!

Fist step: Floating interest loans – the interest was often lower – but more unsecure. House prices went up.

Second step: Loans with only interst payment, no instalments.

Suddenly one could get a low rent the first years. And house prices went up.

Third step: The government declared ”tax stop”, i.e. the real estate taxes stopped following the rising value. And house prices went up.

And market interest was generally low for a long time, so house prices…

- In the US they went even further

All this brought dramatic rises in housing and real

estate prices.

It was very comfortable for politicians. Real estate trade and mortgages pumped money into the econmy – it created growth. It was simply running so well.

Increased real estate taxation was a way to slow things down

But oh no, no – almost no politician dared to suggest that.

Politicians have a clear co-responsibility because of their lack of leadership

Back to the banks and the banking legislation:

Financial legislation has developed to be very international

One important source is the Basle-committee: Consists of the worlds largest central banks

The Basle-committee sets the standards for EU directives, from which it trickles down to national legislation. But the Basle-committee does not have a formal status as a legislator, nor is it under democratic control.

Large international banks apparently had an easy access to influence the committee.

Market fundamentalism and share holder value are the backgrounds

of large parts of the financial regulation since the 1980’s.

Prior to that the law had the point of view of the citizen: It has to be safe to deposit money with the banks.

Now this point of view is more and more driven back, and in the front we have the point of view of the anonymous shareholder: It should be possible to optimize the use of the capital, and the banks themselves should be easy to buy and sell.

The division of functions was abandoned – we got the financial supermarkets!

From precautionary principle to principle of neutrality. It is not allowed anymore to have ”hidden values” in the accounts – makes the pricing of shares more difficult.

The accountance principles became procyclical.

From objective and transparent rules to self control:

Since a long time most assets simply had to be covered with 8% capital. Now a lot of assets can get a ”weight”, i.e. a factor according to the assumed risk, calculated by the banks own mathematical models. This gives opportunity for much more business on the same capital. The gearing grows!

Loans to large companies with AAA-rating require less capital than loans to smaller companies without a rating

These options are in real life only possible for large banks, since it requires huge resources to develop the mathematical models.

But did the large banks avoid the problems?

The new financial legislation was uniform. It

did not recognize that banks may have a task – that they might be founded to serve other purposes than just earning profits for their shareholders.

The paradox of deregulation: Much more rules!

There have never been as many rules in

banking as we have now. But they are much more complicated and do not add value from the a citizens point of view.

How do we get on?

Do the politicians have the courage to really reform the financial system?

Or is it more about getting happy days back again, with booming shares and real estate prices? And to forget this boaring crisis!

The crisis is a golden opportunity to talk about the

basic structures in the economy and get long term sustainability as the core – we have to live here the rest of the century as well!

7 reform points formulated by

some of Europes social banks:

1. Less or no speculation. Less transactions and more focus on creation of real

value for society.

2. Prevent asset bubblesInflation in commodity prices should not be the only

inflation measure. We have to look at inflation in assets as well. The prices on real estate, shares etc. should only develop moderately.

3. Close tax havens. The ”off shore centres” have to close. It only

requires will!

4. Reduce the size of financial

institutionsLearn from Iceland. A country has to be able to

handle its banks. The risky parts of todays banking business should be kept outside the banking system.

5. More objectivityThe rating agencies provided AAA-rating to complicated

securities which nobody was able to look through. But the agencies were not under supervision!

Objective rules instead of self control.

6. More transparencyRules have to be simple and transparent. The starting point is

the citizen.

7. Less is moreFinancial products have to be simple and have to cover real

needs.

In the end a few words on greed!

Please do not forget- the greedy managers were heroes few years

ago- Greed was praised as an ideal- Politicians promoted speculation and

encouraged and stimulated citizens to become investors and shareholderes.

- Short term thinking is dominant – the dogma of the absolute rationality.

The roots of the mess is in the thinking!

Questions or comments?

pehrson@merkurbank.dk

See more on:

www.merkurbank.dkwww.gabv.orgwww.inaise.org