Sent: 10-03-2009 12:49:01
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Global Banking: Facing Up to the Changes
Governments will have to reappraise their commercial roles as a result of the failure of banks in the USA and the UK. The Commonwealth Bank of the 1950s could be a model for the future.
Governments are being confronted by choices about how they should manage the banking crisis. The basic choice is between letting markets work to reprice assets and force the closure of the least well performing institutions, on the one hand, and intervening to prevent or slow this adjustment, on the other.
Generally, governments around the world have been too afraid to let markets work. Their reasoning is that, in many instances, banks were too big to fail. The detrimental impact on national welfare from letting them fail would be too great to countenance. The costs of shoring them up would be less.
If banks can become too big to fail, logic suggests one of two courses for governments to follow in the future.
- Banks should not be allowed to grow so large.
The activities of banks should be constrained to ensure that the risks they take cannot result in commercial failure.
Both these policy alternatives were discarded around the world in favour of the opposite outcomes. National governments were persuaded to let banks grow so that they could be competitive on a global scale. Constraining their activities was also shunned so that they could be as innovative as possible.
Even today, these regulatory responses are likely to result in a hostile reaction from banks and commentators concerned to minimise government intervention.
However, this regulatory response is likely to be only one element of a policy response which fully takes account of our new understanding of the risks banks can impose.
Governments now seem set to carry commercial risks which, until recently, were thought to reside exclusively with shareholders. The different distribution of risks now evident needs to be priced into whatever arrangements are going to apply going forward. This would mean banks also having to accept one or more of the following alternatives.
- Banks will need to accumulate reserves during good times to cover the subsequent possibility of a deterioration in their business environments. Distributions to shareholders will have to be cut back.
- Non-government bank shareholders will need to settle for a lesser share of the profits to compensate governments for incurring a part of the risk.
- Failing acceptance of the first two, governments will have to take over all the risk and parcel it out to the private sector after it establishes new market arrangements for the pricing of distressed assets (as well as performing assets).
In responding to the crisis, nowhere has a government set about starting again. They are all in danger of committing the Japanese mistake of using public capital to prop up banks to avoid repricing assets.
This approach risks leaving the large money centres in the US and the UK, particularly, reliant for many years on banks which will be preoccupied with restoring their balance sheets rather than contributing to growth.
This was the predicament we had in Australia, albeit on a smaller scale, in the early 1990s when there were strong grounds for believing that the recovering banks were retarding business investment. This is likely to be a global debate for much of the next 10 years or more.
These policy changes should also apply to Australian banks. There is nothing special about them that has allowed them to escape this time. They had their near death experiences in the late 1980s and early 1990s. That experience and subsequent recovery was like a tetanus jab which left them immunised temporarily but at risk once the effect of the vaccine has worn off. Australia's banks are living off their earlier treatment.
The world needs a small number of good banks now not a large number of banks struggling for the next decade. A model akin to the Commonwealth Bank of the 1950s might be the way to go. We need banks which can undertake the basic tasks of safeguarding savings and using the deposit base to lend for low risk activities.
Well capitalised government owned entities can set operating standards and pricing and impose a competitive environment which will help ease the effects of the recovering banks rebuilding their profitability at the expense of the rest of the economy. Such a role for government has become highly unfashionable over recent years but might be the model for government involvement going forward.
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