Clara Raposo: Do we still need banks?
Speech (virtual) by Ms Clara Raposo, Vice-Governor of the Banco de Portugal, at the
Webinar "Do we still need banks?", organised by The European Money and Finance
Forum (SUERF), in cooperation with BAFFI, Bocconi University, 5 September 2024.
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Presentation accompanying the speech
First, let me thank you for the invitation to participate in this important event, with such a
provocative title.
My panel colleagues have already added quite a few insightful and thought-provoking -
and provocative - remarks. Given my current job, I'll try to refrain myself from getting
into too much trouble-
I guess that, as a central bank vice-governor, no one expects me to say that we no
longer need banks.
Indeed, I will not. But I also don't believe that anyone here would dismissively agree
that we no longer need banks.
The issue is then: WHY do we need banks? WHAT for? And where are banks currently
not fully delivering on their role?
To address such a pinnacular question this panel was asked to answer, we probably
need to go back to basics. What is a bank? How does it work? What does it deliver? Is
this still necessary? And can it be improved?
When we think about a bank, we immediately consider a wide array of products and
services being oered.
At their core, the role of banks is to operate as nancial intermediaries, channeling funds
from savers to borrowers. Firms and households can "safely" deposit their savings in
banks, who will then use them to lend to those who need to borrow in order to consume
and invest.
I emphasize the "safely" because this requires a stable banking system, protected with
backstops - notably, with deposit insurance.
Through this core nancial intermediation role, banks also play a key role in maturity
transformation: depositors often prefer liquidity and shorter maturities; whereas
borrowers need longer horizons to make investments.
So, Banks create liquidity with this maturity transformation, then generating growth in
the economy.
Now, Regulation puts a break in this maturity transformation. Both the Liquidity
Coverage Ratio and the Net Stable Funding Ratio - that were introduced in Basel III as
a response to the shocks faced during the global nancial crisis - although not perfect in
assessing banks' resilience to liquidity shocks, do impose limits on banks' ability to
borrow short-term (from depositors and from the market) and to lend long-term.
After the 2023 U.S. banking turmoil, no one disputes that having these breaks is helpful
to preserve nancial stability. But of course, by limiting one of banks' core functions,
regulation limits their protability.
Actually, one of the (often alleged) reasons for the weakest market performance of
European banks when compared to their U.S. peers is that tighter regulation may be
hindering their protability.
We could have a long discussion on this, and perhaps more research is needed, but the
truth is that we might be missing the crux of the problem. Going back to simple things in
our basic training in nance, we should remind ourselves that there is a tradeo between
risk and return.
So, if it is the case that regulation decreases the level of risk, then we cannot expect
returns to remain the same.
Setting up ROE targets based on the levels that were seen 15 years ago, before the
global nancial crisis, would then be an absurd demand, as the banking system has
profoundly changed, both due to regulation and to a change in risk management culture.
The upside of this change? A stronger, more resilient banking system, better able to
withstand shocks and to nance the economy, and that way fostering growth.
That said, and coming back to banks' core functions, taking risk is certainly one of them.
Banks make decisions about who to lend to. To maximize prots, they are expected to
grant loans to borrowers with positive net present value projects.
But this prot maximization objective is not an unconstrained problem.
Banks need to strike a balance between the need to take risks to maximize prots (and
contribute to economic growth) and the need to protect the funds lent by trustful
depositors.
Regulation and supervision are there to push for this balance and limit risks. Of course,
we can ask if we have gone too far? Is banking still an interesting investment? Well, it is
certainly a dierent one from that seen 15 years ago, appealing to an investor base with
a dierent prole.
Consequences of this change?
By putting a tight leash on banks, that are operating within the regulatory perimeter,
there are incentives for competitor non-banks to grab low hanging fruits and oer
competitive nancial products and services.
The importance of non-banks has increased signicantly, both in the U.S and in Europe.
This boosts competition and should increase eciency and consumer welfare.
But there are, of course, risks.
Deposits and other investments in non-banks are not protected by deposit insurance,
making them much more vulnerable to panic runs.
The fragility of their funding also creates uncertainty on their ability to lend, possibly
amplifying market distress.
Perhaps more worryingly, there is convincing evidence that non-banks are deeply
connected to banks. A shock to the non-regulated part of the nancial system may pose
destructive risks on the regulated part.
An obvious solution would be to regulate (and supervise) nancial institutions based on
their activities rather than by name, i.e., based on their legal form. Of course, if that was
as easy to do as it is easy for me to say it, we would not be discussing it here today.
Let me bring to the discussion something related which we do not discuss as often:
proportionality.
Banks undoubtedly face a heavier burden than non-banks, in exchange for an
increased charter value. How? By oering a more diverse and complete set of products
and services than what any non-bank is allowed to do, and by beneting from deposit
insurance and access to the lender of last resort.
These benets accrue to all banks, but perhaps more so to the larger ones, which can
exert more market power over their charter value and are often too big to fail (despite all
the regulatory eorts to put an end to this market failure). But the regulatory and
supervisory costs are proportionally much stronger for the small and medium-sized
banks.
If we add to this the management of cyber risks and the need to invest in technology to
keep up with competition, the overburden is clear. Small and medium-sized banks are
forced to dedicate a disproportionate volume of resources to these requirements and
challenges, being left with little room for strategic decisions that allow for a solid growth
strategy.
Should we worry? Well, there are trade-os.
On the one hand, larger banks are supposedly more diversied, more ecient and better
able to take and manage risks.
On the other hand, smaller banks may be more willing to nance smaller businesses that
are uninteresting to the larger banks due to their scale. These smaller, often innovative,
businesses, if successful, may have a strong growth potential and large spillover eects
in the economy. Furthermore, less competition may hurt consumer welfare and even
nancial stability.
Let me leave capital markets aside, for later.
Coming back to the list of critical roles played by banks, we cannot forget about their
role in payments. This is perhaps one of the areas where banks' market power has
become more eroded.
Both traditional players, like Visa and Mastercard, and newer ones, such as Paypal or
Revolut, have taken away a lot of the role played by banks in facilitating payments.
Even central banks actively oer innovative payments solutions. As an example: Banco
de Portugal has recently launched a secure and innovative instant transfer system,
named SPIN.
But banks are not out of this game, and they continue to play a key role, sometimes
partnering up with technological disrupters, other times preserving unique roles, such
as those in cross-border payments.
And Payments are also often the entrance door to nancial inclusion, and traditional
banks may be more willing to oer these services. Or at least they can be subject to
regulation that requires them to do so, as is the case in Portugal with basic deposit
accounts, which are designed to oer a low-cost payment and deposit service to
individuals that may be otherwise excluded.
Related with this role, banks also play another important one, in helping to ght nancial
crime and money laundering.
Last but not least, I would like to highlight another critical reason for the existence of
banks: their role in the transmission of monetary policy.
For central banks to be able to deliver on price stability, a stable and functioning
banking system is critical. This was, actually, actively discussed only a few weeks ago
at Jackson Hole.
Non-banks also play a role in the transmission of monetary policy, but it appears to be a
much weaker one.
If banks are not operating as expected, central banks would have more diculty in
achieving price stability, which inevitably would lead to less investment and growth.
I have already talked about challenges to bank protability coming from regulation.
Monetary policy also aects banks' protability, itself a transmission mechanism.
During the previous easing cycle, unconventional monetary policy tools boosted banks'
prots, but a low interest rate environment created pressures on protability.
In contrast, as we see during the recent cycle, quantitative tightening creates pressures
on the protability of banks with sizeable maturity mismatches, but boosts prots of banks
with traditional intermediation proles, at least in the short run or for as long as liquidity is
abundant.
Let me conclude by coming back to the question we are addressing in this panel.
Do we still need banks? We, denitely, do.
We need banks to intermediate funds in the economy, to make the nancial system
work, to help us achieve price stability, to allow us to make payments, and many other
functions.
We need banks to make choices about the ecient allocation of funds in the economy,
taking informed risks that will allow the economy to grow.
Should the nancial system be entirely bank-based? Absolutely not.
Non-banks oer innovative and competitive solutions. Perhaps more importantly, even
though in Europe we now have a working (though incomplete) Banking Union, there is
still a lot to be done in terms of achieving a similar level of development and integration
in capital markets.
Banks have the skills to monitor and screen viable projects, but they should not carry on
their shoulders the entire responsibility of nancing the economy. A more diverse nancial
system, with dierent levels of risk preferences, should allow for a more diversied set of
investment opportunities, necessary to foster growth.
Especially if you want growth coming from riskier, more innovative, projects and
industries, then you probably want that to be funded outside the banking system - and
equity should play a huge role in this. Of course, that would mean higher risk taking
outside the banking industry and an overall "general equilibrium" allocation of nance to
dierent risk classes, in and out of banks.
But that is also the "beauty" of it: to reach a level of nancial literacy and maturity that
diverse
sustains a new responsible (but ) risk culture.
So, do we still needs banks?
A nal word to those that are more skeptical: Imagine not having them. And all
intermediation being Non-Bank Financial Intermediation (NBFI) as we know it.
Imagine that society and that economy. Guess what? In a few years time, after leaving
the central bank and after my cooling o period, I would put in my best eorts to innovate
and- create a bank! An institution that takes deposits, with deposit insurance, with
access to the lender of last resort, that's regulated and supervised. "Wow!" I'm pretty
sure I would attract a decent number of customers.