Thursday, July 05, 2012

Western banking model is flawed

It took two phone calls to the outgoing Chairman of Barclays to oust Bob Diamond, the CEO of the embattled British bank. One was from the governor of the Bank of England. The other was from the Chairman of the Financial Services Authority. The calls followed what has come to be called the rate-rigging scandal in which Barclays (and, supposedly, other banks) tried  to manipulate the Libor to suit their ends.

This is not the only brush Barclays has had with regulators in recent years: it has faced charges of tax evasion and mis-selling of products. It invited strong criticism when its CEO was awarded a large pay packet last year despite the bank's poor performance.

For bankers, this is the second big blow in recent months. Earlier, we had JP Morgan Chase's huge trading loss, now estimated to be in the range of $5-9 bn. The blow is especially hard because Diamond and Dimon- the phonetic similarity in the names of the two CEOs is striking- were in the forefront of bankers'  counterattack on regulators who had been leaning hard on bankers ever since the sub-prime crisis. Diamond famously said after he took over as CEO about 18  months ago that it was time for bankers to stop apologising and to get on with making money.

Banking reform has focused so far on higher capital requirements and some separation between investment banking and commercial banking activities. There are also 'living wills' for large banks, an early version of which has just been put out.  Alas, it is becoming clear that these will not tackle the problems that beset banking today. Concentration has increased and large banks are proving unmanageable; employee pay as a proportion of income refuses to come down even when returns on equity do not meet the cost of capital; banks are in a deleveraging mode which makes it even more difficult to produce returns; they are exposed to the Eurozone debt crisis; and their orientation towards retail customers especially is appalling.

What is required is a broom that will sweep clean and sweep aside a culture that has come into vogue since the Big Bang in London and in which investment banks dominate the commercial banking side. I am inclined to believe that the ownership structure in western banks has to change. I do not advocate 100% public ownership- that creates inefficiency. But nor do I favour 100% private ownership- that creates instability because bankers face the wrong incentives in a situation of high leverage. What is required a mix of ownership in the banking sector where listed public sector banks compete with private banks. Then you have competition and efficiency, and you also have stability because public ownership, with its innate conservatism, acts as the sheet anchor of the system.

In other words, the time is ripe to export the Indian banking model to the west (or at least to Europe since the US will find it difficult to stomach public ownership of banks). More in my ET column,
West needs Indian bank model.


techeins said...

yup fully agree

droidenquiry said...

good analysis

Vivek said...

The nexus of public office and banks is the problem not the solution.

The call from regulators to fire Diamond is exactly what will fix the problem. We need more of this and sooner. This should have happened in 2007. Along with this, allowing failure of banks, instead of saving them will fix problems. A PSU bank will never fail and will be even worse as it will continue to mask its failures.

Assumption is that public banks in India are great and don't manipulate. That is misleading at best. What about govt bond stuffing at PSU banks, recapitalization requirement at SBI, ONGC divestment save by LIC, Ulip fiasco at IRDA, RBI asking oil companies to buy dollars from PSU banks, etc, etc, etc.

Banks/CEOs should be allowed to fail without much fuss, and there should be greater accountability in the system. That is all that is needed. Public ownership would be far worse.

Anonymous said...

Indian Political and Economic Systen is flawed

Vandhana Karthick said...

We dont know when this will stop..Indian Economy is full of covered with frauds,bribery and scams that people never know the value of money in terms of 17600000000000 hope the amount clearly specifies and many more like this very nearer to this also unable to write all.Good post and I like whoever reads this article to write comments as good thinking from author

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