Harry Geels: 'Banking sector has become insider business'
This column was originally written in Dutch. This is an English translation.
By Harry Geels
In a recent interview with Financial Investigator, Professor Casper de Vries argued that banks have become an insider business and need more competition. This ties in with one of my hobbyhorses, which is that banks are actually no longer private organizations. Moreover, investing in bank stocks is a black box.
In an outspoken interview, Professor Casper de Vries, also a member of the WRR, stated that the banking sector has become an "insider business". 'Insiders' know that actually two points are being made. On the one hand, that banks have a powerful lobby. For example, De Vries speaks outrage that Basel IV regulations have been watered down. And on the other, that there are close ties between banks, regulators and government. For example, jobs are exchanged back and forth, several bank officials are politically active and banks perform the gatekeeper function.
There is probably a third dimension of “insidership,” which is that when dealing with systemic crises, such as the 2008 credit crunch or the 2010 euro crisis, governments act together with banks, with (indirect) bank bailouts often part of the plan. Another important point: banks and government are jointly responsible for money creation. Officially, banks' money creation is called private money and the government's is called public money. But given the close ties between the two, this separation is diffuse.
Figure 1
To properly visualize the entire system, I created Figure 1. Two clear conclusions can be drawn: the entire system is strongly driven by government and central banks, and commercial banks occupy a special, central position. A further complication, as De Vries also states, is that the banking sector has become an oligopoly in many countries, especially in our country. Our mortgage rates, for example, he says, would be too high as a result, which is effectively a “wealth transfer” from mortgage borrowers to banks.
Solutions
The answer to whether the system described above is desirable depends on whom you ask. From a free-market perspective, banking oligopolies are not a good thing for private entities, that is, consumers and truly private businesses. Too little competition generally leads to less service and higher prices. Good regulators could, of course, counter this. Given the “insider business” discussed earlier, we cannot fully rely on this. More is needed.
De Vries suggests more competition, stricter market masters (or better supervisors) and a consummation of EU capital union. Moreover, as an expert on risk management, he seems to suggest that banks' risk models should better account for tail risks. Then banks would hold more capital and the financial system would become more stable. He also thinks the introduction of a public, digital euro would lead to more competition.
Fortunately, competitive forces are in place, including the rise of Fintech and private markets. Increasingly, smaller companies are financing themselves through investors such as pension funds, insurers and family offices. Fintech, by the way, concerns not only the smaller digital banks, the so-called neo-banks, but also the large IT companies, for example through applications such as Apple Pay and Savings. As a final (partial) solution, I myself once gave seven arguments for breaking up the large banking conglomerates.
Black box investment
Investing in banks poses challenges. Not only because of the diffuse (insider) model, but also because the business model is being tampered with from all sides, for example by Fintech and regulation. Profit is also partly driven by monetary policy and supervision: the stricter, the less profit, and vice versa. Donald Trump is going to push for less regulation. That could help the profits of U.S. banks and perhaps in its wake, Europe's as well, if the EU - if only because of the “level-playing field” - deregulates as well.
Thanks to the scaling down of Basel IV, banks continue to have poor balance sheets. The discussion of bank buffers has been foggy for decades. Investing in bank stocks with a long horizon is therefore not obvious, because there is actually too little certainty about long-term profitability. However, it is interesting to invest in bank bonds, investment grade and CoCos. They pay a relatively high interest rate and in practice will be sufficiently protected in the event of the next banking crisis. It is effectively investing with a government or supervisory guarantee.
This article contains a personal opinion of Harry Geels