According to Ismail Ertürk of the Alliance Manchester Business School at The University of Manchester, banks and regulators are mis-selling the free banking argument, implying that consumers should not have to pay for the outdated technologies of banks and prop up their ill-designed profit models. Here, Ismail introduces Finance Monthly to a history of banking regulation and potential solutions that exist in eliminating this consumer-bank barrier.
Before the global wave of deregulation and liberalisation of banking industry and products since the early 1980s a typical commercial bank would earn its profits mainly from credit intermediation- collecting deposits from public at low cost and lending these to borrowers at a high margin. The name of the game was: 3-6-3 (borrow at 3% lend at 6% and go to play golf at 3pm). The well-meant but badly realised deregulation and liberalisation reduced net interest margins in banking to very low levels forcing banks to search for business models to increase fee income by selling financial products ranging from insurance to asset management. Around this time, a new global bank regulation called Basel Capital Adequacy Accord came into effect too shifting the focus in bank financial performance measurement from net interest margin and return on assets to return on equity. Stock markets started to use return on equity as the key financial performance metric to value banks. Fee generating businesses including securitisation of loans- like sub-prime loans that caused the financial crisis of 2008- do not require capital under Basel risk algorithm and make it easier for banks to achieve high return on equity targets.
Such historical understanding of bank business models and the role of net interest income in bank valuation by investors is very important because today's discussion about free banking being detrimental to bank profitability cannot be sensibly made without understanding how we arrived here. Currently with banks in the UK and Wells Fargo in the US paying substantial amount of fines for mis-selling products to their financially illiterate customers it is absurd to argue that bank retail customers have been enjoying free banking. Banks have been using free deposit products as a bait to charge all sorts of unjustified fees and commissions to their customers from mis-selling borrowing related insurance products to overcharging for overdrafts. Therefore, the argument that banks provide free banking for deposit customers needs to be factually supported. The issue could be that banks are under pressure from stock market investors to achieve unrealistic return on equity targets under the current low interest rate environment and therefore are looking for ways to overcharge their retail customers. Regulators should first fully understand this shareholder value-driven bank business model before supporting banks for the end of so called “free banking”, which really is more like banks asking for a licence to overcharge consumers.
At a time when developments in digital technologies make electronic payments almost costless and globally available 24 hours the demands by banks, regulators and international official institutions like IMF for uncontrolled charges for payments in the name of ending the sol-called free banking look unjustified and not supported by facts.
What we need is not the end of so-called “free-banking” but a new non-bank shared public technological infrastructure fit for purpose for our digital times for payments. The cost of this infrastructure should be met by a public body that recoups its costs from banks and other users. With big data analytics, it should not be difficult to do maths for transparent costing and pricing under such system. Therefore, ending the “free banking” is a false debate that is likely to support outdated bank IT infrastructure and bank business models that promise to the stock market unrealistic return on equity targets. With the developments in payment technologies the regulators should creatively think a payments infrastructure that is run in the interest of consumers of retail financial services. In addition, regulators should scrutinise shareholder value-based bank business models and ask justifications for profitability targets that banks promise to their investors. It is time to reshape banking radically to introduce digital technological developments in payments for fair pricing and economic efficiency. Consumers should not be paying for banks’ ill-designed and not fit for purpose business models.
The latest Global Economic Conditions Survey (GECS) from ACCA (the Association of Chartered Certified Accountants) and IMA (Institute of Management Accountants) released last week shows economic confidence rebounding in the first quarter of 2017, an improvement driven by the US where investors are hopeful that a combination of fiscal reform, increased investment in infrastructure and deregulation will provide a boost to economic growth.
The report is the largest regular economic survey of accountants around the world, and noted business conference at its highest level since the second quarter of 2015. Though driven by the US, the improvement in confidence was widespread, with most countries and regions, including Western Europe, Asia Pacific, and Central and Eastern Europe showing improvements.
The survey of finance professionals and business leaders worldwide noted that Q1 2017 displayed the fastest rate of growth in global trade since 2015. The survey found that the biggest concern for companies over the past three months was increased costs (a problem for 46% of respondents), consistent with rising headline inflation rates in many parts of the developed and developing worlds. Despite this there are significant improvements for employment and investment, with 22% of firms planning to create more jobs and raise capital expenditure (up from 16% and 14% respectively in Q4 2016).
"The rise in confidence, combined with strong economic hard data, offers genuinely encouraging signs for the global economy: with an increasingly optimistic mood in the US and a stimulus-led recovery in China driving prospects for world trade," said Faye Chua, head of business insights at ACCA. "This strong start to the year has taken place against a backdrop of potential threats facing the world economy at the start of 2017."
Added Raef Lawson, executive vice president at IMA: "The US economy has maintained an elevated level of confidence from Q4 in 2016, with 37% of firms feeling more confident, although there was no uplift from the previous quarter. An expectation of increased infrastructural spending and tax cuts has contributed to a buoyant business mood even though they are yet to materialise into policy."
However, Mr. Lawson continued: "Inflation and currency fluctuations, however, are a cause for concern. 43% of US firms are troubled by rising costs, and 22% by exchange rate movements. Despite the Fed's interest rate hikes, borrowing costs in the developing world remain low, and the dollar is likely to continue growing in value. That could pose a challenge to US firms' competitiveness, and the White House's determination to reduce the trade deficit."
The survey found that in the United States, confidence remained flat but elevated; in Q1 2017, 37% of respondents were more confident about the future, compared with 24% who were less confident. This buoyant overall level of confidence comes on the back of a surging stock market, which has risen to record highs on the back of confidence that a fiscal stimulus and wave of deregulation will provide a boost to economic growth.
US respondents reported confidence that a big increase in government spending is on the way. Other components of the GECS – government spending, capital spending, and employment – also rose in the first quarter. The main concern for US companies is rising costs—cited by 43% of respondents—which is consistent with a recent, sharp rise in inflation and wages as the US economy moves closer to full capacity.
The negative impact of exchange-rate movements (cited by 22% of respondents) was another concern. US interest rates are set to rise this year, but borrowing costs in the rest of the developed world are likely to remain very low, so, the survey noted, it's possible that the US dollar will appreciate in the coming months; this will erode the competitiveness of US-based companies.
GECS is the largest regular economic survey of accountants around the world. Fieldwork for the Q1 2017 GECS took place between February 24 and March 13, 2017 and attracted 1,334 responses from ACCA and IMA members around the world, including more than 150 CFOs.
(Source: ACCA)
