Regulators are keen to make the banking sector more stable and reliable, but by eliminating risk they are stripping banks of their most useful function.
No risks please, we are bankers. That could be the unhappy outcome if regulators continue to pile the pressure on banks without appreciating that banking is about assessing and taking risk.
A recent survey of bankers, conducted by the Institute of International Finance together with professional services association Ernst & Young, revealed that 65% of respondents were evaluating their portfolios, 30% exiting lines of business, and 13% packing up and leaving entire countries. Basel III’s capital and liquidity requirements are key to this reassessment.
But the kinds of businesses that banks are getting out of are exactly the ones that from an economic development standpoint they should be in – project and infrastructure finance, trade finance, and lending to small and medium-sized enterprises (SMEs).
Banks were invented to take in short-term deposits and give out long-term loans. By standing in the middle and transforming maturities in this way they take on the risks that no other economic actor is able to do – or at least on a long-term and broad basis.
There is talk now of non-banks stepping into the breach. Pension funds and asset managers are taking over long-term loans that banks can no longer economically hold. Crowd funding and peer-to-peer financing are all the rage for SMEs. Structured credit is a business that now sits better within a hedge fund or boutique than inside a bank.
These developments are going to tax the new breed of macro-prudential regulators in ways they have not really considered. Just wait until the non-bank action starts taking off in a frothy housing market. The regulators will tell themselves that the non-banks are not a systemic threat and so can be allowed to leverage up and fail. But when it happens the chaos will be such that politicians demand government intervention and rescue.
Banks need to change their culture and improve their risk management and the signs are that they are doing just this. Without this, no amount of regulation can make banks safe, but it could make them ineffective.
