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Thursday, November 26, 2009

Should Banking Be Made Boring? - An Indian Perspective -

via SPEECHES FROM RBI on 11/25/09

The global financial system has been engulfed in possibly the deepest crisis of our time shaking our world view of the financial sector to its roots. As attention both around the world and here in India shifts from managing the crisis to managing the recovery, the importance of consolidating the lessons of the crisis and reflecting them in our forward plans can hardly be overemphasized. Being at this conference and sharing some thoughts and ideas with you is therefore an opportunity to which I attach a lot of value.

II.  Calls for Making Banking Boring

2. Banks have been at the heart of the global financial crisis and bankers are widely seen as being responsible for the crisis. Quite understandably, there is a deluge of ideas and suggestions on reforming banks, banking and bankers. One of the more influential ideas, one that has generated a vigorous debate, has been the thesis put forward by the noted economist and Nobel Laureate Paul Krugman that the way to reform banking is to once again make it boring.

3. Taking a long term historical view, Krugman argues that there is a negative correlation between the ‘business model’ of banking and economic stability. Whenever banking got exciting and interesting, paid well and attracted intellectual talent, it got way out of hand and jeopardized the stability of the real sector. Conversely, periods when banking was dull and boring were also periods of economic progress.

4. To support his thesis, Krugman divides American banking over the past century into three phases. The first phase is the period before 1930, before the Great Depression, when banking was an exciting and expanding industry. Bankers were paid better than in other sectors and therefore banking attracted talent, nurtured ingenuity and promoted innovation. The second phase was the period following the Great Depression when banking was tightly regulated, far less adventurous and decidedly less lucrative - in other words banking became boring. Curiously, this period of boring banking coincided with a period of spectacular progress. The third phase, beginning the 1980s, saw the loosening of regulation yielding space for innovation and expansion. Banking became, once again, exciting and high paying. Much of the seeming success during this period, according to Krugman, was an illusion; and the business model of banking of this period had actually threatened the stability of the real sector. Krugman’s surmise accordingly is that the bank street should be kept dull in order to keep the main street safe.

5.  The challenge for Indian banks, therefore, is to reduce costs and pass on the benefits to both depositors and lenders. This will involve constantly reinventing business models and designing products and services demanded by a rapidly growing and diversifying economy. As we noted earlier, in the wake of the crisis, there are proposals at the global level to mandate higher capital standards, stricter liquidity and leverage ratios and a more cautious approach to risk. Admittedly, all these safeguards are necessary, but they will also raise the banks’ funding costs. Wha54. Let me now conclude by summarizing the issues that I have addressed today. I have referred to the debate generated by Prof. Krugman’s thesis that ‘exciting’ banking will make for an unsafe and unstable financial system and that an important preventive against future crises is to restore boring banking.

55. I have argued that making banking boring is neither a cure to the ills that the banking system was plagued with before the crisis nor an appropriate path for the future of banking. Banking has to evolve, grow and innovate in response to the developments in financial markets and institutions. The excitement lies in responding to the challenges that this growth brings.

56. From an Indian perspective, what banks do and how well they do it is going to be central to accelerating and sustaining our growth momentum. In particular, I have referred to four challenges that the banking sector has to meet head on - deepening financial inclusion, financing infrastructure, strengthening risk management and improving efficiency. These are formidable challenges, and meeting them is going to be an exciting, rewarding and fulfilling opportunity. Perish the thought of Indian banking ever getting boring.


 
 

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