Simplicity is a complex issue
In the past, complexity has been a classic component of globalization and the economic needs of stakeholders, but going forward it sits uncomfortably with the principles of how a ‘good bank’ should operate in terms of efficiency, innovation and trustworthiness in that monolithic banking organisations selling complex products are no longer seen as the future of banking.
Fearing a repeat of turbulence in financial markets, indeed a collapse in the financial system, since 2008 policymakers have sought to eliminate doubts about the solvency of individual banks through capital injections or other guarantees. This has led governments to bail-out banks, and regulators to insist on ever greater stocks of capital and liquidity to shock-proof the financial system.
Yet this more complex regulatory environment in which the banking industry now finds itself is at odds with the simple principles of banking industry enshrined in French law, which, at its most basic level, is to receive funds from both the public and corporations.
In the past, complexity has been a classic component of globalization and the economic needs of stakeholders, but going forward it sits uncomfortably with the principles of how a ‘Good Bank’ should operate in terms of efficiency, innovation and trustworthiness in that monolithic banking organisations selling complex products are no longer seen as the future of banking.
Over concentration
But with the European banking industry experiencing an intense phase of concentration in the last 20 years, size remains a factor. It’s a factor that has become more pronounced in recent years as a result of the financial crisis, particularly in some countries such as Belgium, Ireland and the Spain. Even if regulators take other factors into account, the size of a banking institution and its interaction with other players has become a key element in the definition of systemicmmetrical risk.
While this concentration of banking services through acquisitions, issuer services or asset management roles has led to significant synergies between related trades and core activities such as deposits and loans, the evolution of such financial conglomerates has introduced structural complexity to how banks operate.
In particular, there are potential conflicts of interest and an increase in regulatory uncertainty between how competing organisations within the same banking group are valued, as well as the implementation of different strategies used by organisations within the same group, such as the use of open or closed architecture.
An important question going forward as banks refocus on core activities and simplify operational structures will be how this stripping away of non-core activities and services to offer a more transparent process to the public and investors alike will affect the banking sector overall.
We have already witnessed some examples of jockeying for position. This is as an example reason why, Natixis, the investment banking arm of France’s BPCE Group, announced its intention to sell holdings in the form of cooperative investment certificates back to BPCE Group.
[pukka_pullquote width=”300″ txt_color=”#ffffff” bg_color=”#2d2d2d” size=”24″ align=”left”]An important question going forward as banks refocus on core activities and simplify operational structures will be how this stripping away of non-core activities and services to offer a more transparent process to the public and investors alike will affect the banking sector overall.[/pukka_pullquote]
Product complexity
But complexity not only exists in the operational structure of banks, it also exists in the innovation of banking products and services. Indeed it can be argued that much of the increase in banking performance up to 2007 was due to such financial innovation.
And while levels of product innovation have been supported by deregulation and a favourable monetary policy, there is a further argument that demand played a large role in increasing the level of innovation and complexity of products offered.
Whether or not the risks of such innovation have been fully integrated by banks continues to be a bone of contention between the banking sector, regulators and consumer interest groups alike. But even Good Banks will need a certain level of innovation, which means inherent risk in banks is unlikely to be removed completely, nor is this desirable if the banking sector is to survive.
What is becoming clear is that there will be more of a focus on the type of risk a bank takes. It is envisaged that the innovative bank of tomorrow will pay more attention to supporting the financial needs of consumers by introducing products and services that are transparent and simple to understand, rather than launching increasingly complex products based on financial instruments.
We have already seen an example of this in Kenya in the late 2000s, with the M-Pesa project. The project exploited innovation in information technology to introduce an agent- assisted mobile phone-based person-to-personal payment and money transfer system at community level. The study not only gave valuable information on how banking systems affect local economic expansion, security, capital accumulation and business development, but helped improve the level of banking in Kenya overall.
In future, Good Banks will use such innovation in information technology to aid and improve the services it offers rather than innovation through the manipulation of financial instruments, at least at consumer level.
Regulatory Tsunami
Yet as banks simplify operations, there is a question mark over what impact the regulatory landscape will have. The regulatory tsunami faced by the banking industry since the outbreak of the sub-prime crisis was an attempt by politicians and regulators to ensure such a crisis does not occur again.
But is a regulatory system that relies on taxpayer buy-in and involves complex financial instruments to underpin guarantees of non-failure an adequate answer? The new regulations implemented, particularly in Europe and the United States have introduced an extraordinary amount of complexity into the banking sector.
For instance, banks not only face a certain form of insecurity about the future and their main role of financing the economy, but have to sustain an explosion of costs related to compliance and control.
As we can see from all the reforms carried out or ongoing at the European level since the outbreak of the crisis, banks have had to sustain a new reform per month at European level, as well as additional reforms at national level.
Overlapping and contradictory rules and interpretation at regional level have also added to the complexity. The only common ground being the high level of complexity that now exists.
A prime example is the Dodd Frank Act, which is the cornerstone of the new banking regulation in the United States which applies to both resident and non-resident banks. This Act alone comprises a framework text of 848 pages, as well as 9,000 pages of new regulations which currently represents only one third of the entire Act. It also incorporates the Volker Rule which establishes the principle of the prohibition of proprietary trading, while at the same time providing 300 pages of exceptions to this principle.
It is clear that the Good Bank needs good regulation. But effective regulation does not have to be complex, so long as it is based on a relevant and sound supervision. Whether it’s the implementation of a single supervisor in the European banking union or reform of the auditor market under discussion in the European Parliament, it is the quality and control of supervision that should be at the heart of ongoing reforms on the European agenda.