November 4, 2013
What is a good banker? What is the economic value added of banks? The economics literature on financial intermediation focuses on the role of banks as deposit-taking institutions and as delegated monitors of borrowers. But this description barely begins to represent what banks do in a modern economy. Besides commercial lending, large banks are engaged in a number of other activities ranging from cash management, trade credit, swaps and derivatives trading and underwriting of securities. In recent decades banks have increasingly relied on fee income generated from their activities other than lending. The financial crisis, and the concerns about “too-big-to-fail” banks it has exposed, has led to a re-evaluation of bankers’ speculative practices and of the economic benefits of banks’ non-lending activities. Do trading activities undermine sound banking principles and core lending functions? Do they provide economic benefits, or are they simply an undesirable side-product of deregulation? The main argument of this article is that trading activities are an integral and desirable part of modern banking. These activities enhance banks’ traditional lending role, and regulatory attempts to separate lending and nonlending activities are mostly counterproductive. The main cause of bankers’ reckless behavior is rather to be found in out of hand compensation practices, which exacerbate bankers’ pursuit of short-run profit opportunities at the expense of financial stability and their clients’ interests.
View the paper here: The Good Banker