Banks in Question

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By Jean-Pierre Balligand

Virtually each week we see central banks - with the American Federal Reserve in the lead - injecting hundreds of millions of dollars to increase the liquidity of financial markets threatened by the crisis. Despite some people's reassuring projections, that they should be brought in this way to play fireman - on a grand scale and with great urgency - shows that this crisis and the risks it brings to bear on the global economy are far from extinguished.

The central banks' interventions amount to helping out the actors - that is, the banks - that to differing degrees are the cause of the present crisis. From that perspective, and although the means they use are very different, one may compare the US initiative to the British Treasury's temporary nationalization of the Northern Rock bank. Both sets of decisions were based on the old "too big to fail" principle, which maintains that when the consequences that certain banks' failure could provoke are too significant, it's necessary to socialize their losses.

This necessity to alleviate banks' problems with the public's money may understandably surprise when we compare it to the customary litany of profits the major banks realize. To take French examples only: BNP, the Crédit mutuel, Société générale, Dexia and the Banque populaire, Caisse d'épargne and Crédit agricole groups posted cumulative net profits from 2004 to 2006 of close to $75 billion.

Privatization of the profits when all goes well and socialization of the losses when all goes badly raises four questions. First of all, are banks businesses like any other? Some are rediscovering that banks are not businesses like any other: unlike businesses, they are the object of special regulation and must respect specific rules with respect to their capitalization.

We no longer count the number of internal as well as external (public agencies) bank controllers. This special status derives from their place in the economy. Through their lending activity, the banks are at the heart of what makes our market economies work: confidence. Without confidence, the system is blocked and no one can plan for the future any more.

Secondly, have the banks forgotten their calling? In any case, supervision does not prevent them from chronically underestimating risks and succumbing to frequently catastrophic vogues. Take, for example, securitization. The fundamental calling of a bank is to evaluate the risks of the loans it grants and to follow the approved loans throughout their duration. Securitization has led to an overall rejection of responsibility and accountability by banks in favor of techniques designed to transfer risks "repackaged" by rating agencies to investors.

A sad record in the end: close to $400 billion of losses, enormous difficulties in identifying and locating the risks, American borrowers forced to sell their discounted homes at a loss. The crisis is so severe that it has become an issue in the American primaries, with some candidates demanding a return to the regulation of lending.

Third, may investment banks replace commercial banks? It is customary to present bank income as having two components: on the one hand, the so-called recurrent, i.e. stable, activities, for example, retail banking; on the other hand, the so-called sporadic, more volatile activities, those investment banking activities that depend on the development of interest rates or security prices. And we've discovered that the share of non-recurrent activities could represent as much as nearly half of the profits at one of the principal French banks.

The fact that no one is unsettled by such a proportion allows us to discover all the market actors' overestimation of the stability of income actually vulnerable to market hijacking.

It is undoubtedly time to question the balance between different sources of income. It is also undoubtedly time to restore their patents of nobility to the banker's mission: distributing loans and following them during their lifetime without delegating that responsibility to others.

Finally, can we avoid similar dysfunctions recurring in the future? It is urgent that we reflect for good on the future of our banks and their role in financing the French economy. It is difficult to decree a complete scission between commercial and investment banking.

But shouldn't banks' ratios promote their financing of the real economy more, to the detriment of activities such as trading? In this regard, we must urgently question the connections between banking and industry in France, while we continue to deplore the absence of financial accompaniment for small and medium-sized companies.

We would consequently be wrong to cut short debate on the real health of the banks, their strategies, their shareholders and the role of all stakeholders, including bank employees, who, in some cases are their companies' primary shareholders.