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Are our banks changing?

Hiba Sameen

14 February 2013

Five years on from the start of the financial crisis, the banking industry is now under more scrutiny than ever. After bailouts of billions pounds from the taxpayer to prevent a total collapse of the financial sector, the financial services industry is undergoing a period of flux. The Independent Banking Commission report, headed by John Vickers, has recommended swift and radical reforms to the regulation of banks. Other reforms, such as increasing capital adequacy ratios and increasing the risk sensitivity of capital requirements for banks, have been introduced for greater financial stability in the face of crisis.  Banks themselves are trying to re-invent the culture of banking (see here), and changing focus on the customer and performance, as opposed to short-term profits and bonuses (Anthony Jenkins speech this week set out a strong agenda for Barclays here).

However, our analysis suggests that this pressure and these reforms may not have changed the way our banks operate. As the figure below shows, securitisation played a major role in the rapid expansion of balance sheets in the run-up to the financial crash in 2008. The data series use aggregate balance sheet data for Barclays, RBS, Lloyds and Santander (Abbey National before 2007) from 2000 – 2011. Worryingly, the figure shows that although loans are still falling, securitisation has resumed on trend. This increase also seems entirely driven by derivatives, and not debt securities (bonds etc.) or equity securities (stocks, shares etc.).

Figure 1: Changes in financing for 4 UK banks

 

Source: BIC calculations using Bankscope data, Bureau van Dijk. Series include aggregate data for 4 UK banks: Barclays, Lloyds, RBS and Santander

Figure 2: Changes in bank financing relative to total assets for UK banks

 

Source: BIC calculations using Bankscope data, Bureau van Dijk. Series include aggregate data for 4 UK banks: Barclays, Lloyds, RBS and Santander

Relative to the total assets of the banks, Figure 2 shows that the loans relative to the size of the bank have been consistently falling in the lead up to the crisis, along with total deposits. Securitisation had risen from 20% of bank balance sheets to over 50% in 2008, and since the financial crash is on the rise again.

One of the core functions of financial markets is to allocate savings to the most deserving and high quality businesses. Financial markets match up household savings with businesses that need investment to grow or to develop new products. This original function of banking, ‘originate and hold’ had in recent years taken a back seat to complex securitisation in the banking industry. Securitisation is the process through which a cluster of illiquid assets are packaged together to produce a tradable asset-backed security (ABS).

Now, securitisation isn’t necessarily problematic. New proposals to increase lending to SMEs have included the securitisation of SME bonds, something likely to be introduced by the new British Business Bank. In principle, the underlying pool of assets for a securitised derivative could be almost anything; in practice, they were almost always collateralised bank loans and often mortgages. Due to this, securitisation led to an increasingly fragile system as seen with the bursting of the housing bubble.

Securitisation also led to a relaxation in lending standards and an incipient increase in credit risk in the system.  In the traditional ‘originate and hold’ model of intermediation, the bank that creates a loan retains it on balance sheet and therefore had a vested interest in screening and monitoring debtors.  With the transition to originate and distribute, banks had much less incentive to discriminate between good and bad credit risks when they created loans, or to monitor credit worthiness thereafter.

So, given this evidence we need to ask if the rhetoric of the banks around reform is matched by actions? Are our banks changing?

Comments in Chronological Order (Total 2 Comments)

This post is both interesting and informative

brooklyn self storage

17 Dec 2014 11:04AM

Lloyds, RBS and Santander