Month: June 2020

One of the interesting differences between European and US banks after the 2008 financial crisis was the strength with which regulators forced them to address capital concerns. In general the US regulatory system forced substantial improvements in capital on US banks. European regulators, under substantial political and industry pressure, were much less aggressive in this area. It has been my thesis that the European approach which on the surface seemed to be helpful to the banking industry instead placed the European banks at a long term competitive disadvantage to the US banks. Taking the pain of capital raising upfront positioned the US banks for growth as well as lending to support their local economies. European banks faced instead a long term challenge of providing the credit that would help the European economy grow.

It was therefore with interest that I read an article in the Financial Times that suggested there may be a softer approach in the US as banks face the impact of COVID-19 on their capital. It was noted that US banks have paid almost twice as much in dividends as they earned in the first quarter of 2020. Of course it is possible to pay more dividends than earned for a short period of time but it is not a sustainable strategy. It is hoped that this is only a temporary occurrence and the article suggests that the FDIC is already focusing on the long term consequences of this non-sustainable dividend policy. But the key lesson is capital is critical to banking success – especially if banks will be able to provide the credit to the real economy to address the challenges of COVID-19, environmental degradation and social/economic/racial inequality.

Black Lives Matter has brought to the fore a discussion on institutional racism. But how does that actually work? An excellent article in the New York Times highlights the challenges of banking for minorities with a focus on black clients. This article documents how individuals of color face significant barriers in getting basic banking services. The article shows how efforts to prevent fraud are too often used to make it difficult for black clients to receive basic banking services. And with police occasionally being called, the very real threat of physical harm to the client exists.

Perhaps even more shocking is that there is no requirement that banks are required to handle all clients equally regardless of race. Since banks were not specifically included in the Civil Rights Act of 1964, it is nearly impossible to hold banks responsible for racist actions. Of course large banks note their commitment to equality and provide diversity training. But in the case that starts the story, Wells Fargo seeks to avoid any damages. They argue “that because she was eventually able to cash her check, a judge should dismiss (the case).” As a matter of law that may be correct. But is it right?

At a time when there is great focus on how justice is dependent on wealth and power, it is not surprising to see again a bank try to avoid being responsible for wrongdoing. Goldman Sachs employees were actively involved in a scheme in Malaysia that looted funds ($2.7 billion in fact) from Malaysia’s sovereign wealth fund. This scheme was facilitated by Goldman employees. As noted in the New York Times, “(t)he fund was meant to finance projects for the benefit of the people of Malaysia, but some of the cash went to buy luxury apartments, yachts, paintings and even finance the movie ‘The Wolf of Wall Street.'” Somehow fitting that a film on the bad behaviour on Wall Street was involved in this scheme.

For its work, Goldman earned $600 million in fees. The fines it is expected to pay in both Malaysia and the US are expected to be well in excess of that amount. And of course some of those fees were used to pay bonuses to Goldman staff. The CEO of Goldman has apologised for what occurred and is typically the case blames it on “rogue employees.”

As one digs deeper into the story as reported, it is clear that there are many connections between Goldman, the law firms involved and the individuals at the US government involved in determining the ultimate fine and plea from Goldman. Or course if it was a much more minor offence, the defendants would not have the advantage of those connections nor the funds to pay for expensive legal advice. So when the top of major banks speak about the need for social and economic justice, it only seems fair to ask them to abide by those same rules.

With ongoing focus from a variety of stakeholders on sustainability, banks need to be looking for ways to focus their operations to be more conscious of sustainable practices. This will especially be needed if the capital regime creates incentives as noted in yesterday’s post. Fortunately there are many examples of best practice available to consider.

There is probably no better endorsement of the importance of focusing on climate risk than having a major consulting company publishing their thoughts. Whilst this has the goal of securing clients to use their services to implement better management of climate risk, it does provide useful insight into opportunities. McKinsey and Company published in depth research on these risk on 1 June. This article is a good summary of issues to address and helpful reading for any bank looking to up their game in managing climate risk in their portfolios and activities.

The Sustainable Financing Platform in the Netherlands is less commercially oriented than McKinsey. They have published a paper highlighting the opportunities and risks for financial institutions from addressing issues of biodiversity. This is a very practical paper with concrete examples from the financial institutions that comprise the platform on their own practices. Thanks to Gijs for sending this link through.

Overall the increased interest in the issue of climate risks shows that the banking world is in transition. It is increasingly focused on how to address this risks. Hopefully banks have not waited too long to develop this focus.

Finance Watch has put out a meaningful report today on breaking the climate change doom loop. This report, written by Thierry Philipponnat, provides very concrete suggestions on how regulators can use capital regulation to encourage banks to reduce their financing of companies and projects that rely on fossil fuels. If implemented, this approach will make fossil fuel financing more costly to the banks. That should be encourage banks to either pass the costs on or refrain from financings that have long term negative impacts on the environment. Most importantly the recommendation works within the existing framework which should make it more likely to be implemented – although there will be challenges in doing so.

In its coverage of the report, the Financial Times noted that “tackling (climate change) through changes to global regulation may prove difficult.” But the pressure on large banks in this area is growing as evidenced by other actions cited in that article including earlier reports from ShareAction and BankTrack as well as comments from Huw van Steenis and Christopher Hohn. Clearly banks should be thinking about the impact on their capital from continuing to finance fossil fuels.

Although this blog is focused on banking, a key banking function – lending – is also provided by non-banks in many countries. In the US community development finance institutions (CDFIs) are a major source of credit for businesses operating in disadvantaged communities. These businesses are often owned and operated by minorities or individuals facing a lack of credit from banks that see them as too risky. And CDFIs often provide not only credit but other forms of support to strengthen these businesses that help build healthy communities and address the inequities in the US economic system. A good source of information on CDFIs is the Opportunity Finance Network, a trade association for CDFIs.

The importance of CDFIs was highlighted in an article in today’s New York Times. This article provides examples of how CDFIs mobilised people to protect businesses in communities facing violence during the current unrest in the US. CDFIs provide an example of client focus that should be taken on by all banks. If the US is going to address the deep seated issues of inequality, banks need to look beyond their current models and support individuals and enterprises that can make a positive difference in communities of need – even if it requires taking on more risk and being more actively involved.

I am catching up on older stories and having spent time yesterday in the Americas, realised it was time to return to Europe on the other side of the pond. One of the most notable results of the reactions of banks and their regulators to the financial crisis of 2008 was the focus on building capital. In general the US banks were forced to quickly increase their capital levels, even if it meant pain for their shareholders. As a result the large European banks continue to have lower levels of equity to assets than then large US banks. This comparison can be seen clearly in the research of the GABV (page 12). In fact the level of equity to assets for the large European banks at the end of 2018 was just over half of the level of the US banks.

With this comparison in mind, a recent declaration by the European Banking Authority should be taken with a very large grain of salt. As noted in the Financial Times, the EBA is “hopeful” that there is enough capital to survive the COVID-19 driven economic downturn. I would be very cautious on that conclusion but we should all be “hopeful” that the EBA has it right. More importantly I believe that this situation shows that deferring the pain of building strong levels of capital is not a good idea. As with any treatment for an illness, taking immediate needed action although painful is likely to lead to better results.

It is with sadness that I watch from Amsterdam the social unrest in the US. Coming on top of the economic crisis resulting from COVID-19, the challenges facing society and its banking system is only greater. Therefore I read with interest the proposed regulatory change from the Office of the Comptroller of the Currency regarding the Community Reinvestment Act. That act was intended to address the conscious discrimination by banks relative to lending to communities where housing ownership was shifting to people of color. Banks and government agencies that provided guarantees for mortgages would literally draw a red line around certain communities noting that no mortgages would be allowed within those red lines. Needless to say that led to decreases in property values and ensured that home ownership, a classic source of wealth accumulation in the US, was not available to many.

Whilst it may be time for revising and improving the rules implementing the Community Reinvestment Act, as noted in the New York Times, the Comptroller of the Currency seems to be forging his own path. That path seems to be based in part on challenges he faced as a banker. More importantly he has been unable to secure support from the other US regulators and even the mainstream American Bankers Association. It seems to me that pushing forward on this initiative at a time when the negative results of racial and economic inequality are being evidenced every day in the US is wrong. These changes are not going to provide support for banks but only perpetuate a system that creates an unhealthy and unsustainable economy – never good for banking.