bank – the _

[2565] Do not judge Barclays too hastily

There were two big news over the past two days in the financial world. One was the EU Summit which yet again calmed the market for only the gypsies (Gypsies, get it? GIPSI? Maybe not) know how long. Another was the official fallout of Barclays’ rigging of LIBOR.

The rigging of LIBOR has been an on-going case but this is the first time it exploded in the open. Barclays is unlikely to be the only one guilty here. Everybody is likely to have some kind of involvement in rigging the LIBOR. It appears even the regulators in the UK are in it.

There are several issues with the LIBOR fiasco but the one I find most interesting is the understatement of cost of funds. This was the initial concern when the Wall Street Journal first reported of it in 2008. Banks were suspected of understating their cost of funds during the then credit crunch, hence falsely presenting themselves to the market as relatively healthier than they actually were.

While the wilful misreporting is regrettable, I cannot help but wonder would it be better at that time to report the truth? Would reporting the truthful higher rates have helped everybody in the market, especially in an environment where Blackrock and Lehman Brothers just went under? I could easily imaging contributing to further loss of confidence would not be the wisest thing to do then.

The underreporting of LIBOR might have provided some needed liquidity to the banks than truthful reporting otherwise would. That would relieve some stress off the banking system. In that way, the underreporting was the better way of doing things. It is not only better for the banks, it is good for the so-called main street. What the crisis of the past few years have shown, a sound banking system is terribly important to the short-run stability of the whole economy. That is sad, but it remains a fact.

Because of how lower rates might have helped with liquidity in the market, however unreflective it were to reality of the banks’ situation, I am a little sympathetic of banks found guilty of committing that.

The same sympathy however cannot be extended to the rate setters whom collaborated with the traders, granting those traders with the unfair advantage of inside information. Those are just, plainly wrong.

[2555] What is the best banking system for high-skilled service industry?

During the launch of IMF Regional Outlook a few months ago, Anoop Singh, the IMF director for the Asia-Pacific Region mentioned how the financial system is not ready for high-skilled service industry.

As his argument goes, banks usually demand collateral before providing any loans to businesses (or, mostly, anybody for that matter). This is perfectly fine for capital-intensive businesses but it becomes an issue when it comes to labor-intensive businesses. With little capital, there is little to function as meaningful concrete collateral. There are other things that can replace collateral like personal guarantee but such guarantee has to be credible and eventually means the businessowner’s personal assets. You still require some concrete assets in the end.

But what if you are nobody but you have a great idea that is labor-intensive?

Here, labor-intensive means just you and your partners maybe sitting down writing codes or running some weird but amazing business that, in the extreme for illustrative purpose, is one of pure brainpower, negligible capital requirement and no muscle, manned by individuals of limited wealth.

There are venture capitalists and that is usually the solution to the problem. But imagine a widespread proliferation of such industry that it becomes the dominant industry in an economy. Venture capital setup will be woefully inadequate as a source of funding.

The virtue of a bank (commercial bank) is its capability to pool large capital through aggregation of savings and to redistribute it elsewhere pretty painlessly. Venture capitalists are decidedly not as good as a traditional commercial bank at pooling resources.

This leads to a question, what is the solution?

I am unclear about that.

The banking system is inadequate as Mr. Singh points out but I am unsure if banks should evolve to not require concrete collateral to accommodate for the so-called new service industry if ever we come to that fork. Identifying a problem, while helpful, is very different from formulating a solution.

And an evolved banking system designed to not require collateral sounds like recipe for a banking crisis. A large percentage of businesses fail and without collateral, the banking system of such evolved banks would quickly be brought down to their knees. And a banking crisis, in the modern economy, will quickly turn into a widespread, horrible, economic crisis.

What about the government?

The problem of business failures will still be relevant but at least it addresses the banking system concern by socializing losses. I doubt the taxpayers will be happy with that.