Digitalisation would have happened with or without the Covid-19 crisis. Price transparency and competition would have lowered returns with or without ultra-low bond yields. Why should we be concerned about banks if they are supposed to disappear as inefficient archaic institutions unable to thrive in an increasingly digital world? Why not move straight away to a fully decentralised model where peer-to-peer lending is the norm and open markets match offers and the demand of financing?
One could argue that, in Europe in particular, banks are a legacy of the past and should be dismantled carefully. The sector, with a large number of direct and indirect jobs, has to be maintained for social reasons, and then there is the economic culture which links banks and their customers. In that case, why are there banks everywhere in the world, including the most advanced economies? Why do emerging economies need to create bigger banks as they grow?
Banks have a specific economic role. They provide three main services -- deposits, payments and credit -- and have three main purposes: the safekeeping of assets, checking information (avoid moral hazard) and money creation.
Banks’ ‘magical’ powers…
The reason is that banks have a specific economic role. They provide three main services -- deposits, payments and credit -- and have three main purposes: the safekeeping of assets, checking information (avoid moral hazard) and money creation8. While safekeeping of assets and information checking can ultimately be outsourced to third parties, money creation is a prerogative of banks9. With or without a central bank, with or without financial markets, this purpose can only be fulfilled by organisations called banks. Since money creation is the liability of assets and requires accurate information as to for whom and for what money is created, the three purposes are ultimately linked10.
The safekeeping of client assets, the gathering and protecting of client information, and the creation of money for the benefit of the economy without financing criminal activities are big challenges.
… need to stay in safe hands…
The safekeeping of client assets, the gathering and protecting of client information, and the creation of money for the benefit of the economy without financing criminal activities are big challenges. Regular breaches of large digital platforms or social networks, leading to millions of credit card numbers and large amounts of client information being stolen, remind us of how difficult it is to protect client information and keep assets safe. Banks are particularly vulnerable to cyber-attacks given the large number of interactions with external entities, such as customers and vendors. But vaults and papers were not more secured than digital systems: indeed, they had their own weaknesses, starting with the loss of a key.
The idea that banks are transforming short-term capital or savings into long-term funding is inaccurate, as most of the money we use has actually been created by banks through credit. Asset managers are doing the capital transformation, not banks. Banks have the monopoly on money creation and the ‘magical’ power that goes with that. They provide the money we need today for tomorrow’s wealth; they are like time machines pointing to the future. That’s one of the reasons why Big Tech or fintechs successfully creating their own money would be the ultimate disruption.
… if states and central banks want to keep control of their own fates
Unless states are happy to give away their control regarding banks’ core prerogatives, it is unlikely that Big Tech and fintech will replace them without the banking sector supervision and regulation. The cancellation of Ant Group’s IPO in January 2021 following the Chinese regulator’s request that its consumer finance branch be regulated as a financial institution rather than a technology start-up is a perfect example.
Post Covid-19, advanced economies’ public debt/GDP reached unpresented levels in peace time to finance stimulus plans. A significant part of the issued sovereign bonds is sitting on central banks’ balance sheets as assets, the counterparty of which is the official money. Big Tech multi-trillion EVs with no debt but cash on balance sheets are credible money issuers compared to highly indebted states. Were there be a safer and liquid alternative to official money, the whole financial system could be at risk of a major privatisation. Since states would oppose such a dramatic change, it is unlikely they would allow large-scale digital private money creation and expend banks’ prerogatives to other institutions11.
Client information is digital gold
Early April this year, more than 530mn Facebook users’ personal data (mainly mobile phones numbers and email addresses) have been hacked. Most global digital platforms have had leaks and security breaches, leading to millions of pieces of client information been stolen by cybercriminals. The social network has hundreds of millions of fake accounts. Today, Big Tech isn’t able to protect its most valuable asset, which is client information, and can’t ensure that companies know their customers.
Banks build a close relationship with clients and maintain high levels of information granularity to build trust, limit risks and fulfil regulatory requirements. Indeed, client information processing, protection and accuracy is one of the key pillars of banks’ activities for their own risk analysis. It is also maintained due to regulatory requirements, the aims of which are to protect the integrity of the financial sector and avoid money laundering or terrorist financing, for instance. In many jurisdictions, banks have a duty to provide this information at the request of regulators or investigators, although it is private data.
Since states would oppose such a dramatic change, it is unlikely they would allow large-scale digital private money creation and expend banks’ prerogatives to other institutions.
We can think about this data collection as a mean to contrast the addressable population and the market. It brings intimacy with the client, accuracy regarding a situation, and a better understanding of behaviours and risks which is far more pronounced than with social media or classic digital services. This is actually one aspect of the fight between the PBoC and Jack Ma’s Ant Group, which owns key information on the the creditworthiness of more than 500 million Chinese people through its two consumer-lending products, Huabei (credit card) and Jiebei (small unsecured loans).
Among the reasons why there are very few global players in the consumer credit segment is the fact that it is a local business which requires good data with limited scale effect.
Although this information collection can be done by third-party specialised firms, it is more efficient to ask banks to do it since they need similar data for their own business. Among the reasons why there are very few global players in the consumer credit segment is the fact that it is a local business which requires good data with limited scale effect. A good knowledge of German households and national regulation doesn’t provide an edge regarding the United Kingdom or Japanese consumer credit market. Despite databases, models and scale, a deep understanding of local economic and social situations is key to success in lending12. And, the principle of banks’ secrecy is an important source of trust. Therefore, there are economies of scale and security benefits when banks look after client information. Banks in Europe play a key advisory role with regard to savings, investments and household financial protection. They have a social role on top of their economic duties which shouldn’t be underestimated. Relevant and legitimate advice is often as important as products or prices for wealth management. In that context, robot advisors are powerful tools when combined with personal interactions and a nice way to mix digital and artificial intelligence with a human approach.
ESG is the other revolution
Banks’ positions in the economic architecture mean they are the main (if not the only) conduit of ESG at the global level. The end use of money created, the impact of investments on climate change and social inequality are now of paramount importance for customers, shareholders, stakeholders and regulators. Investment banks and commercial banks with their asset management arms are the main players in the Green bond market.
According to our research, the cumulative issuance of Green bonds has multiplied tenfold since 2015, to $1tn. Social bond issuance moved from $19bn in value in 2019 to $153bn in 2020, and we believe this nascent market will catch up with Green bonds over this decade. Our analysis shows that ESG is a change of paradigm, with significant influence on investor behaviour13. Equity funds with ESG as a core pillar of the investment process are seeing a greater share of inflows and the inclusion of responsible equity options is associated with higher equity allocation. In this context, regulators’ and central banks’ recent decisions to include climate change in their policy are acting as strong support mechanisms. Taken on board, ESG becomes a key competitive edge and an addition to banks’ purposes that cannot be easily challenged by new entrants and technology alone. Big Tech is actually often seen as ESG unfriendly (see energy consumption, lack of product recycling, employee social rights, tax avoidance, etc).
ESG is a change of paradigm, with significant influence on investor behaviour.
Banks are by nature the gatekeepers of the ‘G’ of ESG, not only for big corporates but more importantly regarding small local businesses. Accounting rules and adequate decision-making processes are de facto cross-checked by banks in the lending process which has a governance role in credit creation. They also play a key role in the ‘S’, as they ensure access to payment, funding and savings to the broad population and act as an institutional presence in many locations that are at the periphery of decision centres.
Point 6: There are at least two reasons why we still need banks in a post-Covid world: they constitute the backbone of official money creation for the right purposes and they protect client digital information and assets.
Point 7: Banks are a meaningful conduit of ESG: they enforce good governance, contribute to social linkages, and foster the energy transition.
There are at least two reasons why we still need banks in a post-Covid-19 world: they constitute the backbone of official money creation for the right purposes and they protect client digital information and assets.