“The Great Divide” by Andrew Haldane

This speech by Andrew Haldane (Chief Economist at the Bank of England) was given in 2016 but is sill worth reading for anyone interested in the question of what role banks play in society and why their reputation is not what it once was. Some of my long term correspondents will be familiar with the paper and may have seen an earlier draft of this post.

“The Great Divide” refers to a gap between how banks perceive themselves and how they are perceived by the community. Haldane references a survey the BOE conducted in which the most common word used by banks to describe themselves was “regulated” while “corrupt” was the community choice closely followed by “manipulated”, “self-serving”, “destructive” and “greedy”. There is an interesting “word cloud” chart in the paper representing this gap in perception.

While the focus is on banks, Haldane makes the point that the gap in perceptions reflects a broader tension between the “elites” and the common people. He does not make this explicit connection but it seemed to me that the “great divide” he was referencing could also be argued to be manifesting itself in the increasing support for populist political figures purporting to represent the interests of the common people against career politicians. This broader “great divide” idea seemed to me to offer a useful framework for thinking about the challenges the banking industry is facing in rebuilding trust.

Haldane uses this “great divide” as a reference for discussing

  • The crucial role finance plays in society
  • The progress made so far in restoring trust in finance
  • What more needs to be done

The crucial role finance plays in society

Haldane argues that closing the trust deficit between banks and society matters for two reasons

  • because a well functioning financial system is an essential foundation for a growing and well functioning economy – to quote Haldane “that is not an ideological assertion from the financial elite; it is an empirical fact”
  • but also because the downside of a poorly functioning financial system is so large

Haldane uses the GFC to illustrate the downside in terms of the destruction of the value of financial capital and physical capital but he introduces a third form of capital, “social capital” that he argues may matter every bit as much to the wealth and well being of society. He defines social capital as the “relationships, trust and co-operation forged between different groups of people over time. It is the sociological glue that binds diverse societies into a cohesive whole”. The concept of “trust” is at the heart of Haldane’s definition of social capital.

Haldane cites evidence that trust plays an important role at both the micro and macro level in value creation and growth and concludes that “… a lack of trust jeopardises one of finance’s key societal functions – higher growth”.

In discussing these trends, Haldane distinguishes “personalised trust” and “generalised trust“. The former refers to mutual co-operation built up through repeated personal interactions (Haldane cites example like visits to the doctor or hairdresser) while the latter is attached to an identifiable but anonymous group (Haldane cites trust in the rule of law, or government or Father Christmas).

He uses this distinction to explore why banks have lost the trust of the community;

He notes that banking was for most of its history a relationship based business. The business model was not perfect but it did deliver repeated interactions with customers that imbued banking with personalised trust. At the same time its “mystique” (Haldane’s term) meant that banking maintained a high degree of generalised trust as well.

He cites the reduction in local branches, a common strategy pre GFC, as one of the changes that delivered lower costs but reduced personal connections thereby contributing to reducing personalised trust. For a while, the banking system could reap the efficiency gains while still relying on generalised trust but the GFC subsequently undermined the generalised trust in the banking system. This generalised trust has been further eroded by the continued run of banking scandals that convey the sense that banks do not care about their customers.

What can be done to restore trust in finance

He notes the role that higher capital and liquidity have played but that this is not enough in his view. He proposes three paths

  1. Enhanced public education
  2. Creating “Purpose” in banking
  3. Communicating “Purpose” in banking

Regarding public education, there is a telling personal anecdote he offers on his experience with pensions. He describes himself as “moderately financially literate” but follows with “Yet I confess to not being able to make the remotest sense of pensions. Conversations with countless experts and independent financial advisors have confirmed for me only one thing – that they have no clue either”. This may be dismissed as hyperbole but it does highlight that most people will be less financially literate than Haldane and are probably poorly equipped to deal with the financial choices they are required to make in modern society. I am not sure that education is the whole solution.

Regarding “purpose” Haldane’s main point seems to be that there is too much emphasis on shareholder value maximisation and not enough balance. This seems to be an issue that is amplified by the UK Companies Act that requires that directors place shareholder interests as their primary objective. To the best of my knowledge, the Australian law does not have an equivalent explicit requirement to put shareholders first but we do grapple with the same underlying problem. Two of my recent posts (“The World’s Dumbest Idea” and “The Moral Economy” touch on this issue.

Regarding communicating purpose, Haldane cites some interesting evidence that the volume of information provided by companies is working at cross purposes with actual communication with stakeholders. Haldane does not make the explicit link but Pillar 3 clearly increases the volume of information provided by banks. The points raised by Haldane imply (to me at least) that Pillar 3 might actually be getting in the way of communicating clearly with stakeholders.

This is a longish post but I think there is quite a lot of useful content in the speech so I would recommend it.

Author: From the Outside

After working in the Australian banking system for close to four decades, I am taking some time out to write and reflect on what I have learned. My primary area of expertise is bank capital management but this blog aims to offer a bank insider's outside perspective on banking, capital, economics, finance and risk.

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