Everyone has criticized financial institutions for be too conservative or taking on to much risk. What one needs to understand is that a particular financial institution through their range of products is deliberately designed to be conservative or progressive high risk takers. Any financial crisis is therefore based first and foremost on miscommunication more than any clever misuse of funds and this is clearly a failure of regulators to protect the sector.Commercial or Retail Banking operations, whether serving a small community or networked into a global organization, are designed to be conservative, with a minimum spread between lending and deposit rates. Protecting depositors’ funds by only investing in low risk Government (local or national) bonds or other highly rated fixed income instruments, while lending to consumers and business – based on their ability to repay and having personal assets to offer as collateral. The recent sub-prime mortgage disaster has brought to light the dangers of operating Merchant and Investment Banking business from within a Commercial or Retail Bank and regulators must learn from the lessen.
There is a vast difference between Commercial or Retail Banking operations and Merchant Banking, which primarily deals with business to business activities, trade financing, letters of credit, bridge financing and other credit lines for business opportunities. Merchant Banking operations traditionally have produced better rates of returns and should be capitalized by equity shareholders (the owners) and depositors, that are fully inform of the increased risk on their deposits. For many years cash depositors have earned returns based on the combination of high and low risk without being fully informed until their CD is loss.
Commercial or Retail Banking operations are even more further removed from Investment Banking, which principally underwrites innovative or new solutions to financial issues targeting the sophisticated investor who thoroughly understands portfolio management and the risk to reward scenario. Investment Banking operations includes venture capital, mergers and acquisitions activity, funding research and development, finding high risk projects to generate that somewhat elusive high return.
Commercial or Retail Banking operations are also to some extent dissimilar from other task-specific financial operations, such as, infrastructure expansion, real estate development, agriculture lending, education loans, and insurance, mortgage and pensions activities. Regulations must be strengthened to make this clear to all stakeholders. So that the lure of above market returns or higher deposit rates are separated from normal commercial banking operations and its established brand-name recognition.
Yes, it will even be better for regulators to divide, with clear rules, all non-consumer banking activities. For instance, all high risk financial products; must be promoted under a different legally registered business name limiting exposure to lawsuits, must require disconnected office premises offering a clear distinction to the general public, must use large print warning and disclosures in the same size and font as the promoted rates to inform depositors as to the risk and must ban all sale calls – similar to tobacco products – customers or clients must seek out financial services only when the need arises. Consequently, regulators must continue to promote and provide free public financial education.
Rationale
T.A.J & Associates Company Limited uses this occasion to comment on topics that have been covered, both academically and by the mainstream media, to add its opinion and point out investment opportunity, not to invoke any social action.
