The Economist’s flawed logic
The Economist this week accused global banks of being “badly managed and unrewarding” (also see its second, more comprehensive article here). It is true that banks have been hit by the crisis and the following regulatory outburst. But the logic underpinning the two articles of the newspaper in this week’s edition is badly flawed and only seems to demonstrate the paper’s bias against banks.
The newspaper admits that
on paper global banks make sense. They provide the plumbing that allows multinationals to move cash, manage risk and finance trade around the world. Since the modern era of globalisation began in the mid-1990s, many banks have found the idea of spanning the world deeply alluring.
Indeed. Global banks evolved from a need: the need to maintain a single (or just a few) banking relationship throughout the world. Globalisation of trade and capital flows inherently implies the globalisation of banking. The current de-globalisation trend that we witness among Western banks is dangerous as this will not help corporations grow their business and hence generate growth.
However, the Economist’s bias appears in that it does not distinguish between banks that are truly global and the rest, and between banks that suffered from the crisis, and the rest. Comparing HSBC, Standard Chartered and Citi with the likes of RBS or Societe Generale doesn’t make much sense. Some have a truly global presence in both retail and investment banking operations, while others only have representative offices or limited product ranges. They do not have the same business models and, despite this, all struggle to generate meaningful RoEs. Moreover, tiny to medium-sized domestic banks also struggle to generate RoEs that cover their cost of capital. Accusing global banks of underperformance thus makes no sense. Identifying some banks that perform relatively well because they focus on regulatory-advantaged businesses such as mortgage lending is irrelevant.
The Economist also targets both banks that needed bailouts and others that did survive the crisis with limited damages. That bailouts mostly involved banks that were not global and that some global banks indeed were saved by their diversified operations doesn’t seem to have rung a bell at the newspaper.
This is unfortunate, as The Economist does acknowledge the impact of regulatory changes:
The wave of regulation since the financial crisis is partly to blame. Regulators rightly decided not to break up global banks after the financial crisis in 2007-08 even though Citi and RBS needed a full-scale bail-out. Break-ups would have greatly multiplied the number of too-big-to-fail banks to keep an eye on. Instead, therefore, supervisors regulated them more tightly—together JPMorgan Chase, Citi, Deutsche and HSBC carry 92% more capital than they did in 2007. Global banks will probably end up having to carry about a third more capital than their domestic-only peers because, if they fail, the fallout would be so great. National regulators want banks’ local operations to be ring-fenced, undoing efficiency gains. The cost of sticking to all the new rules is vast. HSBC spent $2.4 billion on compliance in 2014, up by about half compared with a year earlier. A discussion of capital requirements in Citi’s latest regulatory filing takes up 17 riveting pages.
Indeed. Though regulation isn’t ‘partly’ to blame. It is the primary factor (along with low interest rates) driving the underperformance of banks of all sizes and shapes. The Economist itself several times attacked current regulatory reforms as being unnecessarily costly (see here and here). It now seems to have forgotten and ‘mismanagement’ has become to culprit. For any other industry, The Economist would have blamed regulatory overreach for the industry’s poor performance, in turn pleading for growth-liberating liberalisation. But not for banking. The Economist still hasn’t come to terms with the fact that banks were not the origin, but only the tool, that led to the financial crisis, and as a result remains a ‘classical liberal’ newspaper only when it wants to.