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What is banking for?

In advance of our event at the Bank of England on 21 March 2017, we asked interested parties to write on the theme: Worthy of trust? Law, ethics and culture in banking…

One of the most searching questions for any bank is ‘What are you for?’ or ‘What is your purpose?’. This question cannot be answered by listing the targets management have set, or by cribbing a line from neoclassical economics and claiming that the purpose of a bank is ‘to create shareholder value’. That, after all, could equally be said of any institution with shareholders: it is at most one among many purposes, and not the purpose of a bank. It is a purpose that many companies that are not banks share, and one that mutuals which provide banking services do not share.

Banks have many purposes, but they always include both corporate and public purposes. The corporate purposes of banks vary. For example, some make it their corporate purpose to provide retail banking services to a particular community or region; others are investment banks with multiple commercial purposes in many jurisdictions; others aim to provide specialised or ethically distinctive financial services. However, banks also have public purposes, such as enabling commercial life, providing capital for commercial and other purposes, or enabling long-term saving. These public purposes are the reason why governments, and ultimately taxpayers, give banks quite remarkable protections and privileges.

Banks (like other companies) are protected by limited liability: commercial life was very different before the days of limited liability, when an individual’s entire assets would be at stake and lost in the event of failure. Banks and their depositors also (unlike other companies and their customers) benefit from additional taxpayer-funded protection from the costs of failure. Public support protects depositors from the impact of bank failure (up to a certain level). Even more strikingly, publicly funded interventions protect banks themselves from some of the worst consequences of failure – even where that failure is in large measure caused by the action of banks and inflicts widespread damage. These publicly funded guarantees are hugely valuable protections. In return banks have duties to the public, who will bear much of the cost in the event of bank failure.

Some of these duties are spelled out in complex regulatory demands, but others go beyond duties of regulatory compliance, which other companies and institutions also carry. The quid pro quo of the distinctive protections given to banks demand more than compliance with the letter of the law and the fine print of regulation. They demand respect for the terms of a broader social licence to operate that banks must respect in return for the special protections they receive. This license demands that banks not take a caveat emptor approach to customers, or assume that it is up to customers to understand the minutiae of terms and conditions, or the risks created by complex financial products. The asymmetry of knowledge and capacity that is typical of relations between banks and their customers requires banking cultures that do not take advantage, but rather see themselves as carrying fiduciary duties to depositors, to borrowers, and to the public. These duties are a fair counterpart to the distinctive protections that societies and their tax-payers provide for banks.

Professor Onora O’Neill