The banks’ lost credibility
Banking is an essential activity in a market economy and it is one that rests on credibility. Banks collapse when depositors, customers, investors or regulators withdraw their confidence. The present crisis was triggered to a large extent by banking practices of dubious propriety from the purely financial point of view, with some of them crossing the line into illegal territory. Banking, after all, is an activity based on the “honor system.” No bank can function properly without honorable bankers one can trust.
Banks have actually become a major impediment to economic recovery, especially in the Eurozone. We are witnessing three especially troubling and troublesome episodes ― the manipulation of the London interbank offered rate (Libor), money laundering and continuing losses at some banks due to ill-conceived investments. Each of these undermines confidence in banks, multiplies the calls for more regulation, and makes the general public skeptical and suspicious about banks, bankers, and their motives. Untrustworthy banks are the last thing that’s needed if we are to overcome the crisis.
The manipulation of inter-bank interest rates is particularly harmful. The Libor happens to be the most important one because it has become the reference rate for so many deposits, loans, and derivative products. Each day, at 11 a.m., a group of large banks share their estimates and the British Bankers Association uses them to calculate the rates for 15 loan terms ranging between overnight and one year in 10 different currencies. Given that the rate is not based on any transaction but on the banks’ expectations for the day, it is essentially subject to manipulation. Thus, investors, borrowers and lenders around the world use it because they trust those 20 banks that participate in it. Confidence then is everything. If shattered, there goes the Libor.
Ironically, banks allegedly underreported their rate expectations during the worst years of the financial crisis in order to signal to the market that they could borrow at relatively low rates and thus boost confidence in their creditworthiness. The practice has obviously backfired, not without undermining confidence throughout the global financial system.
Money laundering at HSBC, certainly the world’s most global bank, is a second episode that further taints the reputation of banks and bankers around the world. The revelations contained in a report by the U.S. Senate’s Permanent Subcommittee on Investigations are massively damaging not only to the reputation of HSBC itself, which faces losing its U.S. banking license, but to the entire banking community.
Bank losses caused by traders and other employees routinely characterized as “rogue” are also undermining the confidence of regulators and the general public in the banks’ ability to follow prudent practices and police themselves internally. The recent losses at JPMorgan clearly indicate that little has changed since 2008, when the world realized the massive repercussions of subprime losses throughout the global financial sector.
These and other confidence-busting events come at a very delicate time, especially in Europe. After years of credit drought and economic recession, eurozone banks cannot afford any further deterioration of their reputational capital. In Spain ― the present epicenter of the euro crisis ― banks did not participate in rate fixing, money laundering or exoteric investments. Still, they face two continuing problems: a lack of sufficient capitalization and, for some of them, a damaged reputation due to their close relationships with local and regional governments. In banking, confidence is everything. And without trustworthy banks, the market economy can’t operate.