Finance industry 'years' from rebuilding trust

John Kay, author of Other People’s Money, says industry structure and incentives must lead to new generation of specialist firms.

John Kay, author, academic and contributing writer to the Financial Times, told a Hong Kong audience that the finance industry has years to go before it rebuilds trust.

Kay was in town to promote his latest book, Other People’s Money, and to remind us that the finance industry spends very little of its time on what the public might perceive as its proper role: payments, financing housing and infrastructure, funding retirement and supporting new business.

Instead, most financial companies spend their time trading among themselves, for their own profit, and at arm’s length, with old-fashioned relationships relegated to the dustbin.

Regulation since the 2008 global financial crisis has worsened the problem, not ameliorated it, said Kay, speaking at the Asia Society. It has created complex, proscriptive rulebooks, in a never-ending cycle. “We’ve had Basel 1, then Basel 2, and now Basel 3,” Kay noted. “No doubt we’ll have Basel 4, 5 and 6.”

Kay called for a new approach that focuses on the structure of the industry, and on corporate and individual incentives. The aim should be to reduce conflicts of interest, reduce complexity, and sharpen the liabilities for what happens within big financial institutions on the people at the top, “like Dick Fuld,” he said of the failed CEO of the bankrupt Lehman Brothers.

He doubts many existing too-big-to-fail banks will ever lead the necessary change, and urged people to create new models at new firms. Kay’s ideal would be the emergence of boutiques specialising in the areas now cobbled together within big banks, thereby separating retail banking from trading and other forms of risk-taking.

Kay would go further, however: investment banks should be split up among partnerships, whose partners have skin in the game, so that conflicts of interest among corporate advisory, securities issuance, market making and asset management are reduced or removed.

It is unlikely that governments can regulate such a world into existence. The US law that once ringfenced deposit-taking from risky trading, Glass Steagal, which was signed into oblivion by President Bill Clinton, had already been eroded beyond recognition upon its termination. Regulation has its place, but it is only effective if it promotes simpler outcomes.

Instead, incentives could be designed to reward people to go to new specialist firms and avoid the big banks.

Kay was not convinced that fintech was the answer. Although he said advances in payments are going to be profound, he was less optimistic about the transformative power of other technology trends.

Robo-advisors may find a useful role, but only because the current state of wealth management is such a bad deal for investors, he said. He was outright sceptical regarding peer-to-peer lending and crowdfunding, despite their ability to dodge the big-bank intermediaries. Kay predicted that these would either end up looking like the banks they were designed to undermine (or owned by them), or commit frauds that would ultimately blow up.

“Trust takes decades to build,” Kay said. The incoming CEO at a major bank who simply declares bad behaviour will no longer be tolerated is not going to succeed; instead, such CEOs simply elicit sniggers on the trading floor. Nor is it a matter of PR: the more the public understands banking, the more likely they are to be disgusted by it.

Therefore a major restructuring was still required, despite all of the post-2008 regulation. “The trading culture contaminates the retail banking culture,” Kay said.

He also lamented the loss of banking that was based on personal relationships. The shift to transaction-dominated business, in which banks trade among themselves, facilitated the rise of non-productive businesses such as high-frequency trading.

But he admitted to being at something of a loss when asked how old-fashioned relationship banking could avoid the taint of cronyism, whether it be guanxi style dealmaking in Asia or overly cozy relationships with politicians that took place in bubble-era Iceland and Ireland.

“It’s just a constant battle,” Kay said. “We need to succeed in this battle to ensure that financial services serves us,” as opposed to the narrow interests of financial insiders. “It’s hard to get there.”

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