Given recent events and the continuing travails of the world economy, widely seen as having their origins in the financial sector and the troubles of the banks in many parts of the world, it is not surprising that there is much discussion of banking as it now is and of what it might become. There is in fact an extended conversation taking place around the subject of how banking might be reorganised in the future, of changes to its legal framework and therefore of what banking in the future might look like.
These discussions have thrown up a wide range of proposals and suggestions, some thoughtful but many either futile or wrongheaded. More to the point however these discussions miss one basic fact: the future of banking is being shaped and will continue to be shaped, less by public policy and decisions by politicians and regulators than by spontaneous changes, often barely noticed by people in the sector, that are steadily transforming it.
The bulk of this discussion centres on these areas: the patterns and levels and forms of remuneration within banks or financial services more generally; the relationship between various types of banking activity, in particular investment and retail banking; the kinds of products that banks can or should sell; the number and size of banks (as opposed to the range of activities any one bank could carry on); the legal and institutional structure of banks; and the general tax and regulatory framework that banks should operate under.
I am not going to dwell on the details of the many proposals that have been made. They all have certain common elements; a desire to constrain or limit the operations of finance; to make the financial system more stable; and to ensure that in future banking does not destabilise wider economic activity and above all that it does not leave taxpayers on the hook for errors made by people in financial services that leave banks and other institutions in an unsound position.
Many of these proposals are either futile or will be counter-productive.
Thus attempts to tighten regulation or to impose limits on bankers’ pay or the forms it takes will simply lead to a movement towards a less flexible system of compensation that will make employment and banks themselves less stable. Efforts to split up different types of banking activity will prove almost impossible to enforce and will lead to a great deal of wasteful activity as banks try to game regulations. However many are likely to be tried because they are politically popular.
Some popular measures will actually be useful because they go with the grain of natural change, such as moves to make it easier for depositors to switch accounts.
Other suggestions are more reasonable – these tend to be the more radical ones. These include - limiting deposit guarantees; changing the institutional form of banking to try to revive the partnership model, especially in investment banking; trying to recreate the club based regulation that was swept away in the 1980s in both New York and London; limiting the role of central banks in credit creation or even abolishing them. These will be unlikely to command political support and so are unlikely to see the light of day. Even so, we should never underestimate the role of crises in making the ‘politically impossible suddenly highly possible so we may see some of these happen.
However the really big changes with one exception are the ones that will not come about because of political acts but because of market change. The changes that will shape the future of banking are rather ones driven by technology, market forces, and the spontaneous evolution of the world’s market economy. One is a basic change in the nature of much financial services because of the spontaneous growth of things such as peer to peer lending, which means that traditional banks will no longer be needed for a whole range of financial services such as personal loans, credit for small firms and venture capital investment.
Another is a global shift of the world’s centre of financial gravity from Europe and North America to the Middle East and Asia that will also bring about institutional innovation as new actors draw upon local traditions and practices. (This has happened before as for example with the shift from Genoa and Northern Italy to Amsterdam and the Low Countries at the end of the sixteenth century). There will be a dramatic empowerment of ordinary consumers through technology that will make many financial transactions more transparent and lessen the need for layers of well paid intermediaries. There may well be a revival of other forms of corporate organisation such as partnerships brought about by the need to ensure alignment of incentives and the direct interests of investors. Last but not least, there will sooner or later be a major hit to bank bondholders as a result of a banking crisis, which they have so far escaped.
Banking in twenty to thirty years time will most likely be radically different from what it now is. This however will have little to do with politics or political reactions to the present crisis. Instead it will be brought about by an unplanned and often unforeseen process of change, driven by technology and markets and the process of entrepreneurial discovery.
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