Author: David Korslund

As noted in my last post, a smaller financial sector may be better for the overall economy. That leaves open the question of where should the financial sector shrink. Coincidentally news of a raid on the offices of ABN Amro yesterday provided a reminder of how banks can go about looking for businesses to shrink. This raid was related to cum-ex dividend transactions of ABN Amro and many other banks covered in my blog earlier. As detailed in a New York Times article, cum-ex dividend transactions were essentially structured finance activities that “produced two refunds for dividend tax paid on one basket of stocks” with the double refunds used to provide profits to participants in the activities.

Banks have approval processes for all activities. These look at a variety of issues including the risks involved.  Therefore the cum-ex dividend transactions were approved independently of the individuals doing the activity. To look at ways to shrink the financial sector, I would recommend that the approval processes in banks also ask a very simple question:

• What positive or negative impact is provided to society by the proposed activity or transaction?

If the approval process would have included this question, I believe the only possible answer for the cum-ex dividend transactions would be to note that the transactions effectively take tax funding from governments twice. Although that result may or may not be legal under careful structuring of the transactions, it would certainly be an example of a banking activity that creates a negative impact for society. I suspect that there are many other banking activities for which a positive impact on society can not be found. These are precisely the activities that should be stopped leading to a smaller financial sector but one focused on delivering value to society.

The modern architect Mies van der Rohe is well known for stating that “Less is more.” Whilst he stated that in reference to architecture, it is a very good motto for the financial sector as well. This thought came to mind as I read a Paul Krugman essay in the New York Times. Although his essay related to the US presidential primaries, it also cited a Phillipon/Reshef paper referencing that “the financial sector itself doubled as a share of the economy, which meant that it was pulling lots of capital and many smart people away from productive activities.”

The citation from Krugman and the paper cited got me to look further into analysis regarding the size of the financial sector and its impact on the economy. Benoît Cœuré in a speech in 2014 correctly noted that “(w)hile finance per se is necessary for growth, an oversized financial industry can be detrimental to real economic activity.” This conclusion is further supported in a paper published by the Dutch Central Bank in 2018 found “that the size of the banking sector as a percentage of GDP is significantly correlated with most systemic risk measures.” There is nuance in this paper and the speech by Cœuré that should be considered but both note a large financial sector does not bring only good consequences.

There is now often gnashing of teeth as banks undergo cost cutting exercises to reduce the number of employees they have. But perhaps this reduction in the size of the financial sector although painful for some individuals and some local economies may have a great benefit for society. Bankers should be seriously considering the advice of van der Rohe and find ways for LESS to be MORE.

Following up on my earlier post on new banking opportunities, my good friend Susan was immediately in touch to provide helpful warnings on emerging meat substitutes. As bankers look at financing these opportunities for lower carbon footprint meats, it is critical to look at all aspects of the production process to be sure that we are not reducing a carbon footprint at the cost of creating other environmental challenges.

Specifically Susan linked me to an article highlighting the potential for high levels of glyphosate in the “burgers” now being sold as meat substitutes. As bankers look for new opportunities, a review of potential negative impact needs to occur so that decisions can be taken on the basis of full due diligence. A holistic and detailed approach is needed if we want to be sure that banks do not finance activities with meaningful negative consequences.

At the same time bankers should be looking for new opportunities and lower carbon footprint food production should be one. Vox in August 2019 provided a very helpful guide to these efforts in meat substitutes. Yet another example of the importance of looking for information from a variety of sources.

The discussion over the cause of the financial crisis continues more than 10 years after it happened. This week in the New York Times, Christopher Caldwell provides support to the idea raised by Michael Bloomberg among others that the Community Reinvestment Act is one of the key reasons for the crisis. Caldwell correctly notes that this idea as put forth by Michael Bloomberg “(g)oes easy on bankers: Complex derivatives, swaps, “tranching” and opaque offshore deals play no role in (Bloomberg’s) account.” He further states that studies support this view but cites no specifics related to this thesis.

This discussion was quickly countered by Robert Kuttner in The Washington Post. He correctly notes that the references to governmental legal requirements ignore specific elements intended to maintain the ability for banks to ensure credit quality whilst eliminating discriminatory practices including “red-lining” used in the US to identify on maps with red lines neighbourhoods where mortgages were not to be provided. Kuttner continues to note:

“It wasn’t until the 1980s and 1990s that Wall Street investment bankers and local mortgage originators came up with the scheme that led to the subprime collapse. This was all about inflating profits and passing along risks to someone else. It had nothing whatever to do with the Community Reinvestment Act.” A far better analysis of the cause of the crisis – bankers seeking to make short term profits to provide personal bonuses with any risks to be paid by others.

Kuttner continues to note: “As the authoritative report of the Financial Crisis Inquiry Commission later revealed, the lenders and brokers who participated in the subprime scam did it to make scads of money with no risk, not because of prodding by the CRA — which expressly prohibited unsound loans. The report explained: “They competed by originating types of mortgages created years before as niche products, but now transformed into riskier, mass-market versions.” The CRA, according to the report, was not a factor.” Thereby citing a detailed and authoritative report.”

This discussion highlights the continued desire to characterise broad based access to finance as dangerous rather than being critical for economic and social development. Values-based banking seeks to make finance accessible to all without diminishing the focus on responsible underwriting of credit and other risks.

It is easy to focus only on the negative so it is helpful to seek out the opportunities for banks to contribute positively to addressing climate issues. Two New Yorker articles over the last few months provide examples of business ideas that should be sources of good bank lending opportunities. Both are in the area of food production – thereby also meeting a core human need of sustenance. In September 2019 the New Yorker had extensive coverage of the emerging meat substitute industry. In its most recent edition, the New Yorker covered an alternative approach to farming that seeks to work with nature whilst delivering sustainable and substantial returns. These are both areas where bank financing will be need to encourage the transition to food production that meets the needs of a large population whilst maintaining the environment. Food related bankers should be focusing on these opportunities.

Nicholas Kristof in the New York Times covers a story that reflects poorly not only on the bank named but also on the banking industry. The story focuses on the application of policies, often installed for good reasons, but with no flexibility for treating a client as a person. Whilst one can be outraged by the results of the personnel policies highlighted in this story that led to the dismissal of a call center employee and her supervisor, there is also the underlying reason for the client problem. In the very first paragraph it notes that the client “had deposited a $1,080 paycheck into his account at U.S. Bank. The bank put a hold on most of the sum.” At a time of increasing technology, is it still necessary to hold funds for long periods of time and prevent clients from accessing their money? Or is this just a way for the bank to profit from a client’s money?

Many centuries ago Plutarch noted: “Thus, I do not see what use there is in those mills of the gods said to grind so late as to render punishment hard to be recognized, and to make wickedness fearless.” This lesson continues today as justice for misbehaviour in banking occurs slowly as highlighted in articles published today.

In the New York Times there was an extensive article on the use of financial engineering to effectively “steal” taxes from primarily European governments. These transactions were supported by many major banks, consultancies, legal firms and accounting firms and led to an estimated loss of $60 billion in tax revenues. Of course some of those funds went to the profits of the banks but also were undoubtedly use to pay substantial bonuses and fees to all involved. These activities are further covered in the Financial Times with yet another bank being in the spotlight of prosecutors.Paragraph

Meanwhile in the US there was a substantial fine assessed against senior bank managers for their role in fostering “a toxic sales culture that foisted unwanted products and sham bank accounts on millions of customers.” This article in the New York Times noted that further fines and other enforcement actions are likely against additional senior managers at the same bank.

The common thread through these stories is an internal culture on focused on making profits with no apparent regard as to whether the activities served any positive society purpose. Is it any wonder that bankers have poor reputations?