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Margaret Heffernan Headshot

A Simple Cure for the Banking System

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We bailed out the banks because we couldn't afford not to. We award absurd salaries and bonuses to bankers because we think we can't function without them. In any other context, being made to do something you know is wrong is a crime called blackmail; in banking it appears to be normal. But it doesn't have to be this way.

We feel ourselves to be at the mercy of the banks because they are so big. But that is also why they go wrong. So why don't we just make them smaller?

A recent study, funded by the Rockefeller Foundation and the Global Alliance for Banking on Values (GABV) compared the performance between 2007 and 2010 of 17 values-based banks with 29 Globally Systemically Important Financial Institutions (GSIFI) as defined by the Financial Stability Board. The value banks are smaller, mission-focused banks like credit unions, Triodos and Handelsbank. The globally significant banks are 'too big to fail' and include Bank of America, JP Morgan, Barclays, Citicorp and Deutsche Bank.

And guess what they found? The value banks did more for their customers and were financially stronger. "Values-based banks were twice as likely to invest their assets in loans, lending more than 70% of their assets during this period on average. The values-based banks also appear to be stronger financially with both higher levels of, and better quality, capital. The BIS 1 Ratio, an important measure of a bank's solvency, averaged over 14% during the period studied, compared with under 10% for the mainstream banks. The sustainable banks also had an average Equity/Asset ratio of over 9% while the GSIFI banks averaged just over 5% during the period covered." In other words, the smaller banks were less likely to fail.

Even more important, the smaller banks also delivered better returns: "Return on Assets, the measure increasingly considered most relevant for judging a bank's financial performance, averaged above 0.50% while the big banks earned an average of just 0.33%. Values-based banks also had returns on equity averaging 7.1%, compared to 6.6% for the GSIFI banks."

The report argues that what accounts for the success of the values-based banks is their values. They're embedded in their communities, have transparent governance, enjoy long term relationships with clients and pursue a triple bottom line that won't trade off performance for social impact. And it argues that having these values at the heart of the organization makes them stronger and better.

I couldn't dispute any of that but I think the report overlooks something so obvious it's easy to miss. These values-based banks are not huge. They are small. That means that the values they pursue are not just statements posted in reception and left to gather dust. It means that personal relationships - between employees and reaching out to customers - are up close and personal. It means that oversight is actually feasible. And it means that titanic, market-shifting deals are impossible.

Many of the problems posed by the banks derive from their sheer scale. Because they are so vast they can move markets. Because they're huge, they reap enormous profits which then fuels big salaries and giant bonuses. Because the institutions are so mighty, the people running them feel themselves to be immensely powerful. The money and the power both change the way that people think and both work to move leaders ever further away from engagement with society. The executives who go astray inside these institutions don't start off as market manipulators; the money and power that size brings changes them. It's easy to cast stones but the truth is that most of us, given the rewards, status and flattery that surround these positions, would find it impossible not to start believing that we were gifted, brilliant and virtuous; it would require the psychological defences of an elephant not to. The institutions make these people, not the other way around.

Much has been said and written about the need to change the culture of high street banks. I think these motherhood statements are naïve at best and disingenuous at worst. Everyone in business knows that culture is the hardest thing in the world to change. Think about it: most fat people want to get thin and can't. Most people want to save and don't. Changing human behaviour is so unbelievably difficult that there is an argument as to whether it is possible at all. The idea that a vast institution the size of Barclays or RBS or HBOS can change the behaviour of every individual it employs is a fantasy.

You cannot achieve cultural change without structural change. This is the central truth that everyone - bankers, regulators, politicians, economists and pundits - have been willfully blind to now for years. It's about time we stopped fooling ourselves and put an end to this painful economic fiasco. Rules won't change banks. A few resignations won't change banks. Inquiries won't change banks. And cultural change is beyond us. Break the banks up and they won't be too big to fail; they will - finally - be small enough for success.