As a ‘banker’ for half of the past 30 years (Citibank, HSBC/Midland, ANZ) including at senior executive levels reporting directly to the Group Chief Executive, I conclude that ‘culture’ comes mainly from personal principles and ethics. And these mainly come from within, driven by childhood and family values. In the old days of ‘careers for life’, some culture might have come from the formative years in a career job. Now, in the era of frequent job and company hopping, it is more about beating the numbers to look good for the next bonus or employer, which inevitably means short-term gains. These often involve papering over problems, deferring expenses, accelerating revenues, etc. Just like short termism with our two- to three-year election cycles, it is extremely difficult to change.
Remuneration is key
Add the 20:1 to 30:1 gearing in banks plus the leverage in executive option packages, there is the potential to make big dollars fast, as rewards guide behaviour. That will only change when fractional reserve banking is radically wound back to say 5:1 gearing (such as former Bank of England Mervyn King’s plan) and either banks or bank salaries are nationalised, which tends to be the European way. I believe both of these radical outcomes (nationalisation and lower gearing) will eventually happen, but only after a very major crisis, much more serious than the GFC.
An early sign what is coming is the statement by the Australian Bankers Association, in response to the call for a Royal Commission, which includes:
“We intend to strengthen the alignment of remuneration and incentives and customer outcomes. We will work with regulators to implement changes and, where necessary, seek regulatory approval and legislative reform. Each bank commits to ensure it has overarching principles on remuneration and incentives to support good customer outcomes and sound banking practices.”
The model of choice today is denial and doing the minimum to delay the problem as much as possible (Japan, Europe approach) or water down reforms so they are minimalist (US approach). The same old banks are even bigger and badder than they were before the GFC and the regulators have not helped. We will see what is achieved by the new funding and determination by ASIC and its boss Greg Medcraft.
The economic system relies on public confidence in banks
I think banks already have a super-fiduciary duty. Not legislated but implied by their central role in the whole economy. Banks (not governments) create most of the money in the economy, and bank deposits (ie unsecured bank debt) are assumed blindly by the public to be ‘cash’ and unquestionably reliable, liquid and safe. Maintaining public confidence in bank debt (deposits) as cash is the central core of all public confidence in money, and underpins all spending, which in turn underpins employment. Bankers should not forget their fiduciary role, or the economy will fail.
What does that mean? Recall that the evaporation of confidence in money thanks to the money-printing inflation in the later years of the Roman Empire plunged Europe into a thousand years of barter and feudalism (5th century to the 15th century, aided and abetted by the Catholic Church’s outlawing of lending at interest). Trade and commerce ground almost to a halt for a thousand years in Europe. Most people returned to living from hand to mouth and there were no economic surpluses to fund arts and sciences, so innovation and productivity gains stopped (hence the ‘Dark Ages’). China and India flourished far better than Europe until Marco Polo brought back tales of wealth and wonder and triggered a resurgence and renaissance in Europe in the 15th century.
The fragile myth that allows society and the economy to function
Today, everybody is paid their wages in bank deposits, and people believe that bank debt is cash. Public confidence in bank debt is absolutely critical to the functioning of the entire economy. If today’s bankers’ greed and self-interest results in a breakdown of public confidence in banks (ie money), people will once again resort to barter. It will encourage alternatives to banks, such as peer-to-peer lenders, bitcoin, etc.
Thus far, the banks have managed to keep public confidence but assisted materially by the government guarantee. This must be removed. It creates a moral hazard and take bankers’ minds off the central importance of their super-fiduciary duty.
Thus far all the bank scandals in Australia have been at the periphery – financial planning, FX trading, bank bill swap rate rigging, over-charging of fees, credit card interest rates, isolated cases of staff skimming from accounts, isolated rogue traders, occasional insider traders, etc. People don’t regard these as important enough to erode their basic view of bank debt as ‘money’, which is the core of banker’s super-fiduciary duty. The core asset and liability management of Australian banks is still pretty sound.
Bankers’ memories fade over the decades
The core of banking is asset and liability management (ALM), ensuring bank assets (mainly loans) are there to meet liabilities (mainly deposits) when they are needed. In my experience on ALM committees, most of the attention is on the liability side. The process is usually run by the bank treasury departments (liability side of the equation). The problem is that the rogue element is credit growth, which is on the asset side of the balance sheet.
Australian banks learned the lessons from the disastrous experience of the 1893-94 bank collapses, and this served them well in the 1930s depression when they were the bastions of conservatism, unlike US banks at the time. But after 50 years, memories fade. Westpac and ANZ came near to insolvency in the early 1990s recession following the late 1980s lending binge. It was pure luck that it wasn’t worse. RBA Governors Bob Johnston and Bernie Fraser (whom Paul Keating boasted was ‘in his pocket’) defied Keating and fortunately jacked up interest rates fast enough in 1988 and 1989 to stop the mad bank lending binge just in time, otherwise AGC (Westpac) and Esanda (ANZ) would have blown up their parent banks.
The RBA would have been stretched to bail out depositors. In the late 1980s lending binge, not only did Westpac and ANZ do their best to blow themselves up with bad lending, the state banks of every state of Australia (except Queensland, which didn’t have a state bank) also went mad and were closed and sold off by governments. Most of their assets were picked up by CBA (then owned by the Commonwealth Government) without loss to depositors but at great cost to state governments and their tax payers. The early 1990s experience following the late 1980s bank lending binge taught us that we cannot rely only on central bankers to watch over and regulate the banks. Monetary policy saved the day but the supervisory function was asleep.
Rather than rely on well-meaning but under-resourced regulators and legislators, the most powerful force is the bankers’ existing super-fiduciary duty, which is implied by their role as creators of money and custodians of the illusion of the safety and unquestioned liquidity of bank deposits.
Credit and ALM are all that really matters
Credit quality and growth are the key to the asset side of the balance sheet, but it is overall ALM that sets gearing and exposure levels. It is essential that the top levels of all banks understand the power of strong ALM.
The problem is three-fold. First, the current batch of bank CEOs have no deep experience in either credit or liability management. Second is the highly geared nature and short-term structure of their remuneration packages and this cannot help but skew their decision-making. Third is the existence of the government guarantee and the implied guarantee of their jobs and bonuses, which takes their mind off balance sheet management. The guarantee was probably warranted for a very short period in late 2008 but it entrenches complacency.
The current level of gearing is scary. Take no notice of those fictitious ‘risk-weighted’ capital ratios. They are artificial numbers based on banks setting their own rules and ratings, and on ridiculous myths like ‘you can’t lose money on housing loans’. What about the US sub-prime crisis, or in Portugal, or in Ireland, or in Greece, or in Spain, or in Iceland?
Unfortunately, the free market does not work, especially in Australia where we have a cosy cartel of four big banks controlling the market. The bank ‘culture’ issue would be solved if all bankers understood their existing super-fiduciary duties to the whole community. They are simply not equipped to handle the current 20:1 to 30:1 gearing ratios without tax-payer funded safety nets. Until they are, we need tighter regulations to restrict the damage they can do to the economy.
Ashley Owen (CFA, BA, LLB, LLM, Grad. Dip. App. Fin) has been an active investor since the mid-1980s, a senior executive of major global banking and finance groups, and currently advises wholesale investors and advisory groups. This article is a personal opinion and the general information and historical facts are for educational purposes only.
As with all articles in Cuffelinks, we welcome any contrary views.