The social role of banks is banking

Since fox-hunting became illegal, banker bashing has become a new blood sport. Not only is the typical banker portrayed as being greedy, much of what he produces is said to be ‘socially useless’. The behaviour of our bankers, it is argued, needs to be reined in and the economy should be rebalanced so that we have fewer bankers and more people ‘making things’.

It would be highly desirable if bankers did rein in their excesses, of course. In my view, this is best done by the market mechanisms of punishing failure and ensuring the bankruptcy of failed institutions. Some of the reforms proposed in the wake of the crisis will improve matters in this respect, though I am sceptical about many of the measures being proposed by the ICB.

But what about the more general issue: is banking socially useless and should we be rebalancing our economy?

It is, in fact, difficult to imagine a modern economy without a large financial sector. The chattering classes and intellectuals often seem to think that it would be better
if much more of the British workforce were engaged in manufacturing and we had fewer money-men supervising superfluous transactions that have nothing to do with the real business of creating wealth.

But life would be intolerable without banks. Not only
do banks provide mechanisms to ensure that we can pay each other immediately for the goods and services we consume, they also provide crucial economic functions. These include screening risk, diversifying risk, reducing transaction costs and providing capital for businesses and credit for consumers. The flip side is that they also provide safe returns for savers. Without a modern financial system, retirement from work would be more-or-less impossible.

The costs and risks involved in investing, say, £10,000 without banks would be enormous. The lender would have
to seek out potential borrowers. The lender would then
have to check their credit worthiness and the viability of the projects in which they want to invest. All but the very rich would have little chance of diversifying their risk between different borrowers. And, without the mechanisms that banks use to maintain liquidity, lenders would have to wait years to get their money back. With a developed banking sector I only have to find a reliable bank and it will provide all these services. The bank screens the risk, ensures that risk
is effectively diversified, reduces transaction costs and ensures that I can have my money back more or less when I like. There are corresponding benefits for borrowers, of course, who have cheaper and easier access to finance.

Indeed, saving, investment and the financing of transactions through the payments system would be more difficult without banks than trying to survive by growing your own food.

Banks are intrinsically social institutions. They make money by providing services that people want and which would be extraordinarily expensive to procure without banks. Supine corporate social responsibility (CSR) departments
do not have to justify the social role of banks by ensuring that they give part of their profits to charities – the social role
of banks is banking.

Would we be better off with a smaller banking sector and
a more diversified economy? Probably not. It is possible that, without the implicit taxpayer guarantee to banks, our banking sector would be smaller, but certainly we should not try to ‘rebalance’ our economy artificially. It makes no more sense for Britain to diversify its economy than it does for me to diversify my working week and work for a day in a butcher’s shop, a day stuffing teddy bears, a day as a nurse and a day teaching. In advanced economies we do what we are best at and trade with others who do what they are best at. Indeed, it is the export of services that allows us to enjoy manufactured goods in abundance. The UK had a £46 billion trade surplus on financial and professional services in 2009. Even if banking were socially useless, Britain seems to make a good living from exporting such services and using the money to buy manufactured imports.

It is about time those in the banking industry educated people about the fundamental economic value of banks. In my view, there is no room for taxpayer-funded bailouts in this or any other industry. Ensuring that we have a legal framework so that broken banks don’t break the taxpayer is an important step in winning the PR battle. But, until the banks are able
to justify their existence and explain their economic functions to the wider public, the left-leaning intellectual elite will have a field day from undermining banking and financial services. If they succeed, we will all be much poorer.

This article originally appeared in the Autumn 2011 edition of Balance, the magazine of the British Bankers' Association