Banks must learn to put the customer first


If financial institutions are to survive, they must behave more like supermarkets

This week, we celebrate the first anniversary of the fall of Lehman Brothers. And we really should celebrate. Lehman was not providing financial services to ordinary people or businesses. In fact, it was not providing services of very much value at all. It was a badly run firm – which had already been rescued once, in 1984 – populated by people who were, by any reasonable standard, grossly overpaid. Many of them were also deeply unpleasant, including the chief executive, Dick Fuld, who, even as he defended his nine-figure remuneration before Congress, expressed continuing incomprehension that the US taxpayer had not come to his rescue.

The essential dynamic of the market is disciplined pluralism: good businesses prosper and grow, while bad ones go to the wall. Planned societies – and businesses that are “too big to fail” – lack either pluralism or discipline. They are reluctant to experiment, and also reluctant to end unsuccessful ventures. That is why there is every reason to cheer the Lehman collapse: far from showing the weakness of the market economy, the failure of a bad business shows its strength. That, at least, was the view taken by the US Treasury, when it refused to bail the bank out.

Why, then, is the conventional wisdom that this decision was a mistake? The problem was that Lehman’s activities were so closely intertwined with others’ that its failure had intolerable consequences for the rest of the financial sector. The executives of the other large banking conglomerates could credibly claim that a more general collapse would jeopardise the whole financial architecture that enables us to pay our bills and receive our salaries. As it was, the collapse of Lehman alone caused a freezing of wholesale financial markets, which put the survival of major retail banks in jeopardy and led to a withdrawal of consumer and commercial lending, provoking mass bailouts and stimulus packages.

But if interconnectedness is the problem, the solution is simple: reduce that interconnectedness. In businesses such as the Royal Bank of Scotland or AIG, the largest American insurer, whose near-collapse followed that of Lehman, the activities that crippled the company were a tiny proportion of the whole, involving no more than a few hundred people in firms that employed hundreds of thousands.

In the similarly interconnected field of utilities, significant engineering effort and regulatory attention is devoted to ensuring that things are more robust. Failures are inevitable, but well-designed systems enable problems to be confined and controlled. The electricity grid operates without interruption because engineers constantly monitor its stability, and have devoted resources to making it secure. When Enron went bust, its subsidiary, Wessex Water, continued to send water through the taps, and its bonds continued to attract a top investment rating, even though those of the parent company were worthless. The answer to firms that are “too big” or “too complex” to fail is to redesign systems so that elements can fail without overly damaging consequences.

World leaders, for their part, are longing to reassure us that the crisis won’t happen again. True, tighter regulation probably will ensure that the specific problems that caused so much chaos will not recur. But history never repeats itself exactly: there is no reason to think that the regulators will anticipate and head off the next crisis more effectively than they did the last.

And even if a pledge to prevent future Lehmans were credible – and it is not – the outcome would not be desirable. Imagine a proposal to ensure that General Motors, or British Leyland, or Woolworths would not fail. Such a promise underpins established firms and discourages the entry of new ones.

The better solution is structural – to split the utility banking, the boring bit of the system that meets our daily needs in terms of paying bills and receiving salaries, from the casino. After all, when you think it through, utility banking is not boring at all. Technology is creating a revolution in financial services: it is easy to envisage a world in which all payments can be made with the wave of a card or the click of a mouse, and cash is only used for illegal transactions.

This would create a social and economic transformation. Powerful retailers such as Tesco and Marks & Spencer use their market position to assess the needs of consumers, and to get the required goods at the lowest cost. Their focus is on developing a relationship with customers based on reliability and value for money. That’s a very different business model from the dismal relationship most people have with their banks, and from the petty abuse of retail customers through penalty charges for minor payment lapses and sale of over-priced payment protection insurance.

The focus of such specialist retailers is on the needs of consumers rather than the remuneration of producers. That is what we need from the banks of the future.

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