Sunday, October 12, 2008

Taking risk out of banking is the wrong approach

This* letter in the this week's Economist sums up the over reaction to the credit crunch:

SIR – Surely the present crisis offers a chance to remodel banking as a highly regulated industry that takes few risks and accepts low levels of profit. A duller banking industry with fewer brilliant managers could help to support more sustainable growth for everyone.

Daniel Currie

Not only is this attitude patronising, it is also undesirable and dangerous.

It is patronising because it assumes that none of are capable of making our own investment decisions and that only Government appointed bankers can make investments that are Government approved. Well I can make my own decisions and work out my own risk profile, thank you. I have been doing this for a number of years and frankly don't want my money invested in politicians pet political projects in pursuit of their own re-election.**

It is dangerous for a number of reasons. Firstly, it gives the false impression that there is a way to reduce risk to a point where there isn't any. This takes away moral hazard and means that should there be any failure, whatsoever, the Government will have to reimburse all losses, no matter how incurred.

Secondly, it dangerous because it will shuffle money into doomed projects in the name of political expediency. Yes, I know that goes on now but if politicians can direct banks it will hide the mistakes off balance sheet and we won't be able to hold ministers to account. A classic example would be the car industry where £billions of tax payers money was pumped in to British Leyland and DeLorean.

But its not just that the investments are wasted, there is the opportunity cost. By investing in lousy projects good projects eg computers, mobile phone networks, drugs R&D and even charitable investments will go without, making our lives in poorer.

What we should be calling for is greater transparency and more education, and I don't mean in schools. All people have to know is that the higher the return the higher the risk and that they are responsible for their own decisions. Yes we need some level of deposit guarantee on banks, if only to protect them from a run, but it doesn't need to be on all accounts and should be clearly flagged which accounts carry it.

Make people responsible and they Will act responsibly***. And by that I include bankers. If they know that the risks are high and that they won't be bailed out by politicians they will figure out which risks to take far better than any politician or bureaucrat, but if they fail we all know the the risks we took.

*I think is part of the subscription service so you may not be able to link to it so I copied in full

** And yes I have made a few bad choices, I bought a Japan PEP fund a few years ago that is now at about 50% of the original value! My choice - I would have enjoyed the upside so I don't expect anyone else to cover the down side.

*** If that isn't a quote by a famous person it should be.

No comments: