Standard Chartered's Peter Sands on the value of universal banks

The outlook for the global economy remains fragile. While there are certainly encouraging signs of recovery, particularly in Asia, significant risks remain around global imbalances, deleveraging in the West and the unintended consequences of stimulus packages and regulatory changes. Unemployment across many countries remains stubbornly high.

Meanwhile, questions continue to be asked about the role of banks in society and how best to structure the financial sector to facilitate growth, investment, trade and job creation. We must do our bit as bankers to restore trust in the financial system. This means acknowledging what went wrong during the financial crisis and articulating the essential part banks play in the economy.

Politicians, regulators and bankers in the West have wrestled with two equally desirable but sometimes seemingly conflicting objectives: reinvigorating growth and job creation; and reforming the global banking system to avoid a repeat of the financial crisis. We have seen fiscal and monetary stimulus packages of unprecedented scale to support the economy, and we are seeing huge changes to the regulatory architecture governing global banking.

However, the combination of stimulus packages and new rules for banks has become unbalanced. Imposing too great a regulatory burden on banks in the pursuit of financial stability risks undermining growth, and launching further rounds of monetary or fiscal stimulus to spur the economy risks causing further instability in future. We need more of a focus on economic growth in the regulatory agenda and on systemic risk in macro-policy.

Nowhere is this more true than in the rather confused debate among politicians and in the media as to whether 'universal' banks - institutions that cover both retail and wholesale clients and whose products span current accounts to mergers and acquisitions - should be split into 'narrow' and 'casino' activities to create a safer financial system.

Reaching the far-out places: Standard Chartered's universal status and commitment to cross-border investment has been crucial to businesses in many frontier markets otherwise denied such banking services, such as Afghanistan.

Safety first

A safe and resilient banking system is in everyone's interests. Enforcing structural changes that are likely to damage growth and could endanger financial stability benefits no one. Despite all the assertions, there is no evidence that universal banks are more prone to failure than institutions with a narrower focus. The facts suggest the opposite.

History is littered with hundreds of examples of supposedly safe narrow retail banks failing, as well of more buccaneering investment banks and brokerages. We must not forget that the first four banks to fail in the recent crisis were two purely retail institutions, Northern Rock and Washington Mutual, and two of the purest investment banks, Bear Stearns and Lehman Brothers.

Universal banks can fail if poorly or recklessly managed, particularly if the overall financial system comes under huge stress. But their diversity of earnings streams, breadth of balance sheet and heterogeneity of funding sources gives them a degree of intrinsic resilience that far exceeds more narrowly based institutions.

At this point in the conversation, the critics of universal banks normally seek refuge in the 'too big to fail' argument. Universal banks, it is asserted, have an unfair advantage: because of their size and systemic importance they cannot be allowed to fail, so their funding costs are lower. In other words, they unfairly exploit an implicit public guarantee.

There is no doubt that big universal banks had funding costs that were far too low before the crisis. But analysis of credit spreads before the crisis shows this was true for every financial institution, big or small, however unsustainable their business model. It was not that everyone believed some banks would be bailed out if they failed; no one believed any bank could or would fail.

When the crisis hit, all sizes and sorts of institutions were deemed too big to fail, particularly after the demise of Lehmans. When the credit bubble collapsed, nothing could fail without fuelling the turmoil, since the house of cards was far too tall and too precariously balanced.

Yet no bank, narrow or universal, should be considered too big to fail. It should be possible to wipe out the equity and impose losses on other capital providers without disrupting essential operations or causing contagion. Precisely how this is done will depend on the context. Idiosyncratic failure must be treated more harshly than failure within the context of systemic stress.

What banks are for

Too big to fail is unconvincing as an argument against universal banks. There is negligible evidence that universal banks benefited unduly from such a categorisation before the crisis, and the right answer, in any case, is to remove the perception. In this context, we are very supportive of the efforts to devise more effective mechanisms for the resolution or recovery of troubled banks and the development of 'bail-in' mechanisms.

More fundamentally, the whole thrust of this debate loses sight of what banks are for.

Banks exist to intermediate between those who have money, whether individuals, companies or investment institutions, and those who need it, whether companies that want to invest or individuals who want to consume. Banks enable people to buy goods and services, to save and invest, buy homes and grow their wealth. They help businesses set up, expand and trade internationally.

Banks also make payments and help customers manage risks. These are crucial roles, but it is the core intermediation function that defines a bank. Performing this function inherently involves credit risk - the risk that those you lend to will not pay the money back - and mismatch or liquidity risk - the fact depositors may want their money back before borrowers repay their loans.

Managing these risks well requires considerable insight into the behaviour of customers, which points to focusing on specific segments. However, what kills banks is correlation - the likelihood that certain groups of customers will behave in similar ways in certain circumstances. So being too concentrated on a specific group of customers with similar behaviour - whether borrowers or depositors - increases vulnerability.

The strength of universal banks lies in the fact that they have a broad range of customers on both sides of the balance sheet. This is particularly true of those with international scope. A narrowly focused retail bank or pure investment bank tends to be more vulnerable to concentration risk.

Part of what went wrong in banking is that the industry became too fixated on products and transactions as opposed to thinking about the underlying needs and behaviours of the customers. Too much of the industry got into a mode of selling products and winning transactions rather than focusing on providing solutions within the context of long-term, trust-based relationships.

Regulation undoubtedly, if inadvertently, fuelled this bias, since the whole language and structure of regulation revolves around product types. Structural solutions that divide the selling of different product types between different categories of institution increase the focus on products rather than customers. They also generate myriad opportunities for regulatory arbitrage, as players in different categories create economic substitutes for each others' products.

A bank for everyone

A well-managed universal bank that is focused on the needs of its customers can deliver greater benefits to these customers and be more resilient. However, while universal banks play a vital role in the world economy, every bank need not look exactly the same. There is room for many variations of size and scope and there is strength in having biodiversity in the world of banks. But it is competition, innovation and, above all, the needs of customers that should determine which models succeed, not regulatory diktat.

As a distinctively international universal bank, Standard Chartered's core business is helping customers conduct trade and invest across borders. Given the ever-increasing globalisation of the world economy, such flows of goods, services and capital are vital to economic growth, development and job creation. Facilitating such flows cost-effectively requires a broad range of capabilities that blur the traditional boundaries of commercial and investment banking.

We take very seriously our impact on the broader economy. We aim to create superior value for shareholders, but we must achieve this by making a positive contribution to the economy and society as a whole. We have to be 'socially useful', and to do this we have commissioned independent studies of our economic impact on our markets, starting with Ghana and Indonesia. These underscored the importance of our support for small and medium-sized businesses and trade.

For example, Standard Chartered was the first bank in Ghana to offer clients commodity, interest rate and currency hedging. We also play an important role in financing Ghanaian exports and supporting large-scale projects such as the Jubilee oilfields that are set to transform Ghana's economic prospects. We also asked the researchers to suggest ways in which we could enhance our contribution. For us, the sweet spot is where we can find opportunities to do something with substantial sustainable positive impact on the economy while making money for our shareholders.

The world deserves better, safer banking. It needs banks that are focused on customers, not products. It needs banks that can support the trade and investment that underpins growth and job creation. Well-run, large international universal banks are part of the solution now, not part of the problem.

Peter Sands is group chief executive at Standard Chartered