Banking on Change
Impenetrable global megabanks plus an interconnected network of smaller shadow banks. A surge in supremely complex derivatives understood only by a tiny elite. And a growing feeling that fractional reserve banking is inherently bad and impossible to control…

With the Global Economic Summit in Davos at an end, it’s already two years since the collapse of Lehman Bros and the unprecedented bail out of other banks. As bankers’ bonuses make headlines again, there is much debate about what – if anything - has changed.

As global expert Georges Ugeux1 points out, before the crisis the financial sector accounted for 10% of employment but 25% of earnings. And that continues. The Financial Times reports that Goldman Sachs, Morgan Stanley and JPMorgan recently set aside a combined £22bn for payments to investment bankers.

On a more encouraging note, banks like Barclays and Credit Suisse are at least considering novel ways to pay top bonuses – namely ‘CoCos’2, innovative bonds that convert into equity in times of stress. This makes them appealing to regulators because they act as capital buffers and also to banks because they do not dilute shareholders upfront. Meanwhile to many observers it seems only logical to introduce a general bonus system recognising longer term performance rather than short term risk taking; and rewarding star performers rather than every average journeyman.

Admittedly, the Basel Committee has made some progress in increasing the amounts of protected capital that the banks are forced to hold. But at the time of writing, there is still much to decide on the shape that the sector will take in the future. Some experts propose the break up of these banks and insulating high risk overleveraged activities from low risk, retail banking. With the same incentives, people and structures, of course the banks are going to do it again, suggests Professor Simon Johnson of MIT.

Thankfully governments seem increasingly intolerant of underwriting an oversized and interconnected banking system. Despite much rhetoric they still appear unsure what to do with a maze fraught with legal inconsistencies. But find a way soon, they must - on behalf of the people who elected them and who are banking on change.

1. Chairman of Galileo Global Advisers, and formerly Group Executive VP of the NYSE.
2. CoCos are Contingent Convertibles or Enhanced Capital Notes - a new form of fixed
income security which have arisen out of the need for banks to increase their capital ratios as a result of the banking crisis. The first UK issuer of ECN’s has been Lloyds Banking Group plc. This was under an Exchange Offer announced on 3 November to exchange its existing Tier 1 and Upper Tier 2 securities into new ECN’s. The key feature of the Lloyds ECN’s is that while they carry mandatory coupon rights they may also be mandatorily converted into ordinary shares if the Core Tier 1 capital ratio of the bank falls below the 5% level (known as the trigger).

 
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