Carlo's Think Pieces

Reflections of a Filipino in the Netherlands

Transform banks to be guardians of financial system

Posted by butalidnl on 29 January 2010

President Obama is proposing to force banks to stop “trading for their own account”, pointing out that they were using people’s money for speculative purposes; and that if their investments go sour, the government will bail them out anyway because of the possible fallout on the financial system as a whole. This would mean that “investment banks” will again be separate from ordinary banks. This was to ensure that banks stick to serving the general public.  And that the government would support these activities of banks, but not their own speculative ventures.

An added advantage of this approach is that banks would not need to hire traders for their speculative ventures – and it is these traders’ bonuses which have raised many an eyebrow among the general public. Let the pure investment banks do this kind of thing – and if they go under, too bad for them.

But it is not only the speculative nature of  bank activities which should be stopped; it is also their sheer size. Banks that become so big become “immune” to failure, and this means that risks of all kinds are taken, in the knowledge that if they don’t work out, the government will bail them off. After all, risky mortgages are not “trading for their own account” activities. But big banks will be able to underwrite such mortgages the next time around, because they’re immune to failure.  Thus, banks should be reduced in size, so that they would be open to failure, and thus, their risk-taking behavior will also become more rational.

Banks should be “boring”, as in reliable stewards of people’s money. They should be stable and base their business on the principle of creating value through their loan policy and business-support services.  Banks should not go after the “fast buck”, looking for profits from short-term transactions. Those kinds of activities should be done by investment houses and hedge funds.

What about banks’ investment activities done for other parties? Well, I guess this would still belong with banks. However, more and more, people will prefer to invest using index funds, for stocks and even for bonds.  Also, there is also a growing tendency for investments through internet banks; making this activity more of a service with low margins.

I don’t know if Obama will succeed in breaking up the banks, and restricting their activities.  But I think that banks should indeed be transformed into stable guardians of the financial systems, and no longer be the financial “cowboys” that they’ve been till now.

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