Banking and social justice don’t mix very well
I recently came across the following piece from Tony Greenham on the RSA website: “Banks should serve the real economy – How?”
It’s something I have often read in the media, most of the time written by people who don’t really understand the purpose of banking in the economy. It often comes from a certain part of the political spectrum, and seems to be a cover for ‘social justice’ applied to banking. And it’s a recipe for disaster.
The argument is typical: banking should be ‘fair’ and ‘serve the real economy’. Yet, as with social justice in general, no definition is ever provided of what ‘fair’ banking is and how it can more adequately help the real economy. As with ‘social justice’, all criteria of fairness inevitably remain very subjective and variable in time, place and individual mood. Moreover, what a number of people view as ‘fair’ is often in direct contradiction with the rule of law.
All this logic comes down to the view that banking is another type of ‘utility’. That it should provide services for all that need them. No, it isn’t. Banks do not have a duty to provide credit on demand. Forcing them to do so would inevitably lead to bad lending decisions and hence large losses, and politicians and the public would once again blame those ‘greedy’ bankers who took senseless risks (despite encouraging them in the first place). This is what happened in the US with subprime mortgages (and the Community Reinvestment Act Greenham seems to find useful). See Calomiris and Haber’s Fragile by Design to understand the serious implications that ‘fairness’ had on the US banking system before the crisis.
Greenham’s post falls into the same trap. Let’s leave aside the fact that his post is technologically quite backward-looking (branches and transactions are now increasingly replaced by mobile phones and technologies like blockchain, and the shrinking number of customers using branches can continue to do so) and also avoid any discussion of modern constraints on banking; that is: regulation (branches are great if you can cover the cost of operating them).
He blames banks, free markets and ‘co-ordination failure’ for the disappearance of branches whereas he should have focused on ballooning regulatory and compliance bills that accelerate that change beyond the pace justified by technological transformation.
But where I am really worried is when I read this:
But bank deposits are underwritten by the state. Their acceptability depends on the state. They are arguably therefore a public good. Certainly, how much money is created in total, and to which economic sectors it is lent, are matters of the highest public interest. So here is the problem – there is no guarantee that if you add up all the individual lending decisions of banks that you will arrive at the optimal level of credit growth and allocation for the economy.
In fact, theoretical and empirical evidence suggests the opposite. We see too much credit creation during booms, and too little during recessions. Too much credit flowing to real estate and financial asset speculation, and too little to SMEs and infrastructure investment.
Individual banks cannot solve this problem. More competition cannot solve this problem. Rigid free-market ideology cannot solve this problem.
This is the sort of superficial thinking that I have tried to fight since I started writing on this blog. Typically, this sort of ‘social justice’ reasoning never tries to dig a little deeper below the surface. This would lead to dreadful conclusions: that the proposed solution (i.e. often government intervention) would actually target outcomes of previous government intervention. So better avoid digging altogether and coming to terms with unpleasant findings, and continue to believe that banking is ‘inherently unstable’ and doesn’t know how to efficiently allocate capital in the economy without the guiding hand of government officials.
The usual Public Choice and Hayekian critiques also apply. The information fragmentation and political incentives prevent policymakers from taking the right decisions in a timely fashion. Moreover, the highly subjective and fluctuating ‘social justice’ criteria lead to discretionary decision-making and regulatory uncertainty. This does not represent a recipe for economic success.
So what to do? Set banking free. The ‘invisible hand’ behind bankers’ lending decision will, on aggregate, allocate credit in more effective manner than any central authority and its distorted and ever changing incentives ever can. There is a reason behind the financial and real estate booms of the last few decades. And it lies in artificial rules designed by a number of ‘great minds’. Not in a ‘rigid free-market ideology’ that never was.
PS: we could say a lot about his assertion that deposits are a public good, but it isn’t the topic of this post.