James Saft, Reuters Columnist
Just as Esperanto, born in the late 19th century and touted as increasing international understanding, failed to do much to stem the bloodiest century in human history, so the imposition of new codes to make clear who does what to whom in finance faces a huge hurdle: those who might use it won’t think it is in their best interest.
Andrew Haldane, the executive director of financial stability at the Bank of England, thinks that the use of new global codes to track counterparties and financial products in markets has the potential to transform banking, rendering it safer, more competitive and easier to regulate.
By convincing clients that Banker A is smarter than Banker B and can contrive a product or transaction which, while more complex and harder to understand, will make more money, banking is able to avoid the apples-to-apples comparisons which are Haldane’s endgame.
So it does, if only we can ever overcome the huge resistance from the practitioners of finance, who will rightly see this as a sure way to kill margins and with them compensation. This growth of technology, perhaps, will allow banks to be theoretically cut out of the process of capital formation and allocation, or at the very least drive down margins, as has the use in some parts of Africa of mobile telephone-based payments systems.
“With open access to borrower information, held centrally and virtually, there is no reason why end-savers and end-investors cannot connect directly. The banking middle men may in time become the surplus links in the chain. Where music and publishing have led, finance could follow. An information web, linked by a common language, makes that dis-intermediated model of finance a more realistic possibility,” Haldane said last week in a speech in New York.
It would be lovely if this came true, but this is going to be a battle to establish, one which many have an entrenched interest to fight.
That is not to gainsay the benefits Haldane cites of the new system, which essentially creates a unique code for every financial counterparty and for every financial product, thus allowing theoretically for tracking of how the global dominoes might fall in a crisis.
That would certainly make oversight easier. Common codes would also make it easier for banks themselves to run more rigorous internal controls. I’d argue that internal controls at Lehman Brothers were weak in large part because controlling those risks wasn’t in the collective best interests of the people within the firm with the power to do so. No one likes risk managers, they get in the way of racking up bonuses. No one wants to take them to lunch, and if they do it is for exactly the wrong reasons.
Selling hope
Expecting technology to increase transparency and thus reduce risk in finance is like expecting technology to reduce the cost of diamonds during the days of the De Beers cartel. Sure it will work, but as it isn’t in the interests of those who control and benefit from the current state of affairs, it isn’t going to happen. Haldane might argue that the diamond cartel just happened to die shortly after the birth of the Internet, but it was a long 100 years or so getting there.
It is also true that while the implications of better technological tracking of activity are similar for banking as they are for, say, retail, there are huge structural differences between Wal-Mart and a global investment bank. Wal-Mart has been successful using the technology of the global supply chain to manage inventory and cut costs, but within that chain there are clear business relationships and well-established tensions between players.
The genius, or pity, of finance is that it is not selling a commodity like soap, but hope. By convincing clients that Banker A is smarter than Banker B and can contrive a product or transaction which, while more complex and harder to understand, will make more money, banking is able to avoid the apples-to-apples comparisons which are Haldane’s endgame. So long as clients buy the premise of deliverable out-performance they will be over-charged and under-delivered in a way undreamt of in the retail sector.
This hope, when combined with government support, results in a huge lack of competition. Death rates in banking are correspondingly low, with an average mortality of only 0.2 percent per year over the past 70 years. Even more shockingly, as Haldane points out, no major new bank has come into existence in the UK for 100 years.
It may be that regulators, such as the U.S.’s Office of Financial Research and efforts such as the European Markets Infrastructure Regulation reforms ultimately succeed. It will be a long and bitter fight, but one worth the effort.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)