Friday, 29 March 2013

Bank shareholders are pointless.

The traditional view of banks is as follows.
Banks have shareholders, bondholders and depositors. Shareholders allegedly perform a function: they foot the bill when things go seriously wrong. In contrast, depositors and bondholders supply funds on which they expect interest – a reward for forgoing consumption. But they don’t expect to be first in line for a hair cut when things go badly wrong: indeed, depositors don’t expect to take a hair cut at all (though of course recent events in Cyprus have dented faith in the latter idea).
And that “division of labour” as between shareholders and depositors seems to make sense: it seems to give people FLEXIBILITY as regards what risks they want to accept and what costs they want to bear.
But there is a catch in the latter argument, and as follows. There is already a HUGE VARIETY of different forms of saving and investment available. For example in Britain people can put their money into the ultra safe and government run “National Savings and Investments”. While at the other end of the scale, savers can buy shares in a dodgy gold mine in a developing country.
So why would anyone want to put their money into anything other than an ultra safe form of saving, while at the same time demanding 100% safety? Well it can only be because interest rates paid by the more risky savings institutions are better – and precisely because of the additional risk. In short, depositors who put their money into anything other than the ultra-safe are demanding the right to the rewards of taking a risk at the same time as being insulated against the downside of that risk.
Put another way, wherever there is a risk over and above the risk involved in an ultra-safe forms of saving, ALL ADDITIONAL INTEREST should go to shareholders because they are the ones carrying the additional risk.
So savers are being illogical when they lodge their money in anything other than a 100% safe manner. But that raises the question as to why savers ACTUALLY DO put their savings into commercial banks – i.e. less than 100% safe types of saving.
Well the explanation is that they’ve found a “mug insurer” who is prepared to cover the risks those depositors are taking, and at an artificially low premium. The insurer is the taxpayer.
In short, the whole “shareholder / depositor” symbiotic relationship is nothing more than an organised raid on the public purse.
The raid has arisen because of various political and populist forces: the corrupt banker / politician nexus, for example. Plus there are well orchestrated mobs of depositors crying wolf when ever their savings are threatened – or crying: “we want to have our cake and eat it”. Or crying “We’re little old ladies relying on our pitifully small deposits to keep body and soul together.”

If there is little sense in having different types of bank creditor (shareholders, depositors, etc), then that supports the case for full reserve banking: the latter being a system in which depositors who want their money loaned on by their bank have to foot the bill if those loans go badly wrong. Put another way, full reserve is a system under which those depositors are in effect shareholders.
And that ties up with the recent statement by Mervyn King that British building societies are entities in which depositors “are in effect the shareholders”. 


  1. Having now actually read at least some of the evidence of the Parliamentary Commission on Banking Standards which you linked to, I understand the context of that statement by Mervyn King a little better (although I don't know exactly what case it was that Nationwide was trying to make....seems like they want their cake and eat it....they want to behave like a bank, but be treated differently somehow).

    So MK was talking about the "loss-absorbing capacity" of a building society. Having now made a determined effort to read "Where Does Money Come From", (and maybe from some other sources), I know know that in the case of a bank, its capital can be used to absorb losses. (And when it's all used up, the bank is insolvent, which is not so unlikely in times of trouble, given that I think the loan book is likely to be much greater than the capital).

    I assume that mutuals don't have capital in the same way. A building society is "owned" by its members, so I suppose you could say they are analogous to shareholders, but (I think) there is no capital in which they have a share. They just have their deposits (or loans, or both, of course).

    So, I would suggest (until shown to be wrong, which I'm sure is quite likely), then the reason for having shareholders is to provide capital, which can be used as a sort of buffer between assets and liabilities.

  2. Re: my previous posting: reading further down the Commission's evidence, I see: "The banks with the largest amounts of capital have actually increased their lending; Barclays, HSBC and Nationwide have lent more to the UK real economy.".....implying that Nationwide (a building society of course) does have capital, so perhaps I was wrong. hmm...

  3. Again, on building societies, I found this (supposedly "restricted"!) HMRC document on the web:

    Building Societies capital instruments

    An excerpt: Quote:

    Current law
    A building society is a mutual financial institution owned by its members. Unlike banks,
    building societies do not have a concept of share capital which will provide an investor with
    a share in the business.
    Building societies currently raise capital by issuing building society shares into the market
    under the Building Societies (Deferred Shares) Order 1991. Almost all deferred shares
    issued have been “Permanent Interest Bearing Shares” (PIBS). Whilst PIBS and any other
    instruments issued under the Building Societies (Deferred Shares) Order 1991 are “shares”
    for the purposes of the Building Societies Act 1986 (BSA 86), strictly speaking PIBS are debt
    instruments with interest coupons and their taxation reflects this.
    The new regulatory capital instruments will have many features in common with ordinary
    share capital so taxing them in the same way as PIBS (which are very similar to debt
    instruments) would not be appropriate" Endquote.

    Er, so BSs can raise capital, but it's not share capital in the ordinary sense.

    Can it be used to absorb losses? Goodness knows.

  4. Having done some quick Googling on the subject of building society shares, I am equally puzzled. For example, if a building society issues shares, it is no longer strictly a mutual organisation, seems to me.

    This strikes me as just one example of the muddle and complexity that Vickers, Basel III and Dodd-Frank are getting bogged down in. That is, I favour the relatively simple rules that govern full reserve banking. And those rules, if applied to building societies, would not be a big upheaval for them.

    The basic rules are, 1, any depositor who wants interest has to take a hair cut if the loans into which their money goes go belly up. 2, if depositors want 100% safety, they can have it, but their money will be kept in a 100% safe manner, so it won’t earn interest.

    That would mean that in the case of building societies, ordinary depositors would have to accept the possibility (and it’s VANISHINGLY REMOTE POSSIBILITY) that they might take a hair cut. But as everyone knows, British building societies are very conservatively run. I’ve just read a Building Societies Association article which claimed that no mutual building society had ever gone bust, or forced depositors to take a hair cut.

    Moreover, the brute reality is that (absent a government bail out) depositors at a building society would JUST HAVE TO take a hair cut if the society made a series of very bad loans. There is no one else to take the hair cut.

    So full reserve is not just simple: it faces reality. That contrasts with the smoke, mirrors and delusion that the existing banking set up consists of.

    In contrast to building societies and taking the other extreme, EXACTLY THE SAME RULES can apply to a dodgy shadow bank: i.e. “if you want an interest earning account, you carry the risk”.


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