Instead, what it would require is a self-generated sea-change in the structure and strategy of banking. So what changes in structure and strategy might be desirable? Without suggesting definitive answers, let me discuss three areas where further debate might be useful: banks’ size in  10  David Tuckett provides a fascinating account of the crisis and its aftermath using psychological theories and evidence (“Addressing the Psychology of Financial Markets”, Institute for Public Policy Research, May 2009). 11  “Is the US Sub-Prime Crisis So Different? An International Comparison”, Carmen Reinhart and Kenneth Rogoff (2008), NBER Working Paper No.13761. BIS Review 108/2009  5  relation to the services they provide; banks’ strategy in relation to their resilience; and banks’ governance in relation to the incentives this creates. •  Structure – size versus service provision  Economies of scale typically arise in the production of goods and services which are homogenous and replicable. Henry Ford applied this principle to car manufacture through his Ford Motor Company, established almost a century ago. It was a success. That model has since served many industries well. But manufacturing loans is not the same as manufacturing cars. Loans are neither homogenous nor replicable. Making loans relies on bespoke, customer-specific information. This information is not obtained by computer algorithm or credit rating agency but through a banking relationship, ideally a long-term one. Despite the advent of social networking, economies of scale are not something we typically associate with long-term relationships.

The resulting financial landscape would, however, look rather different. There would be greater specialisation and diversity. The shopping experience for a banking customer would be more farmers’ market than supermarket. •  Governance – stakeholders versus shareholders  In deciding appropriate corporate governance arrangements, economists have tended to focus on the relationship between shareholders (as principal) and managers (as agent). Principal-agent problems arise when these two parties’ incentives are misaligned. Profitrelated pay is one means of achieving alignment, with managers remunerated in line with shareholder returns. In addressing one incentive problem, however, this approach may risk worsening two others – between shareholders and depositors on the one hand and between shareholders and the public sector on the other. Limited liability means that returns to shareholders are capped below at zero, but not above. That provides a natural incentive for owners to gamble, pursuing high risk/high return strategies from which they import the return upside but export the risk downside to depositors or the public sector. During this crisis, the pursuit of those strategies has resulted in the public sector picking up the cheque for the downside in an effort to reduce risks to depositors. A mutual model of corporate governance gives rise to a rather different set of incentives. Instead of external shareholders, savers and borrowers become the owners, with profits remitted directly to them in the form of higher deposit rates and/or lower borrowing rates. For that reason, measured profit margins appear consistently lower for building societies than for banks.