Old banking model must change to ensure economic survival

Mainstream banking isn’t what it used to be, and it’s never going back, at least not in our complex, economic society. I suspect there will be some fights about how to balance our developmental and commercial imperatives. Banks operate straightforward economic models, taking deposits and investing those in the formal economy. To be granted a licence, banks have to demonstrate sense, conservatism and responsibility in deciding where to deploy the country’s savings.

Rules and ratios were developed in banking that, in the aggregate portfolio of assets (loans), could withstand stress and strain while yielding a sufficient, predictable running return to pay depositors’ interest and provide a reasonable return to shareholders. Nothing too fancy or volatile, mind you; banks are prepared to forgo unlimited upside to ensure limited downside.

In a steady-state world of knowns and boundaries, the definition of a bankable loan became uniform. It was easy to be a bank, and the fight was mainly about client relationships and market share. Banks built huge edifices to give depositors the comfort that they had the substance to be trusted with their money.

Everybody was happy, everybody agreed to the rules and parameters. Yes, it was a club, and there was little to discern between the loan terms of one bank from another. If you could get a loan from one bank, you could get one from any other.

The allocation of depositors’ money has far more complex parameters to satisfy nowadays. Technological advances have put economic power and choice into people’s pockets and made physical footprints practically redundant.

In SA these challenges are compounded by the imperative to expand the definition of what’s bankable, without compromising responsible lending, to address the manifest economic inequality and unemployment in our society. Whether they like it or not, a huge chunk of that need has to be met by the formal banking sector, tasked and uniquely licensed as it is to accept the public’s deposits. Credit assessment and loan oversight have to adapt and technology makes this possible. Asset-based lending is so pre-’94.

This necessity clashes with the DNA of established, old-style banking management, but it is an absolute requirement to provide loan capital to the real (and comparatively less formal) economy, at a price that enables rather than destroys growth. There is no better source of input capital to do this than retail deposits — cheap and abundant.

Banks nonetheless don’t want to go there, not even with government urging and assistance, such as with the all-but-failed Loan Guarantee Scheme promoted by the National Treasury. The risks are not warranted by the returns offered. Arguably, smarter (and certainly more greedy) loan funding does find its way into the informal economy, but at a price that can never be serviced; assets capable of consistently yielding those kinds of returns don’t exist. But we have to get money into the real (and resilient) unbanked economy, to build a middle class that is vital to a functional democracy. The banks can’t do it alone, and neither can the government. A mix of equity and debt capital is required, tailored to the growth profiles of small business. All hands on deck.

If the banks don’t get their collective heads and systems around this, they will be disintermediated. Oversight will be compromised and unscrupulous players will prevail. Whether this new, complex mix will come together, timeously, will depend on extraordinary leadership capacity, and a meeting of different mindsets. We’re going to have to marry the old and new, the tried and tested, and the yet unexplored.

We won’t get there without some disagreement among respected people on how to achieve these balancing acts without a compromise in standards and a threat of systemic risk. There will be some fallout, some parting of the ways.

But we don’t have a choice. We have to find a pragmatic middle ground within the existing, competent oversight regimes, to ensure our social and economic survival. Consensus will need to rise out of conflict; only common cause will get us there. We’ve done this before and it is as necessary now as it was then.