The FIG Idea: the wizardry of banking
Do we marvel enough at the philosophical and metaphysical nature of the banking industry?
It may have been overstating the case when Lloyd Blankfein called banking “God’s work”, but it’s a lot more profound than simply shifting money around. At its heart, banking is an industry that grapples implicitly with fundamental issues of sociology, philosophy, existentialism and relativity. Maybe financial whizzkids are actually financial wizards?
The wizardry begins with the nature of money. It’s a token of value that requires confidence in order to operate, to facilitate what is effectively a tri-party barter transaction. I sell you my sheep for some dollars and buy some potatoes with those dollars. That confidence in turn requires a grounded yet circular belief in the currency to be able to deliver, an existential question that underlies the current debate about bitcoin. Bankers need to brush up on their Jean-Paul Sartre.
Bank solvency, too, is a matter of confidence and existentialism. To put it quite simply, a bank is solvent until it’s not, as we discovered in 2017 with the failure of Banco Popular Español (BPE). Of course, banking is only a microcosm of universal philosophy. The answer to the question of life, the universe and everything in banking is a mere 8%, which is 525 times smaller than the pan-galactic answer. Bankers need to brush up on their Douglas Adams.
Another lesson from the BPE failure is that the numbers we use in finance are all relative. BPE was solvent while it had market confidence: its last reported CET1 ratio was 10.02%, well above minimum requirements. When that confidence evaporated, the value of BPE’s loan book became a matter of perspective. In the ensuing fire-sale to Santander, the value was deemed to have fallen by €7bn, wiping out BPE’s equity. Loss-bearing bondholders still dispute the figure. Despite the obvious relativity, we don’t have a formula like E=mc2 that gives us the answer. Bankers need to brush up on their Albert Einstein.
Over the last decade, the concept of time has grown in importance in banking. Funding and liquidity regulations have tightened oversight on the essential activity of “maturity transformation”, which enables banks to fund short and lend long. This transformation is a wondrous affair of time travel: it enables me to have a mortgage that is financed primarily by other people’s demand deposits or the lender’s short-term bonds.
More recently, the new IFRS 9 accounting standard has required banks to shoulder losses before they happen, in a manner reminiscent of the superb 2002 movie Minority Report, starring Tom Cruise. The future is everything in banking, but it is such an elusive concept. Bankers need to brush up on their Stephen Hawking.
So, as well as time travel and the existentialist transfer of value, what else can finance do? Not much. The only other functions are the co-merging of risk — think of banks as big CLOs, constantly reducing the high risk of individual investments to tolerable pooled risk — and the splitting of undesirable risks into parts that can be hedged. Risk management too is wizardry: true magic, rather than conjuring or trickery. Bankers need to brush up on their JK Rowling.
The sociological aspects of finance are better understood than the philosophical ones, but still require more attention. Banking sits at the core of the capitalist system and can influence the many pros and several cons of that system. Consequently, banks must consider their role in the economic development of a society but also their moral role in assisting societal fairness, opportunity, equality and sustainability. Bankers need to brush up not only on their Thomas Piketty, but also their John Rawls.
With such a long and varied reading list of clever stuff to read and ponder as they pursue their day-to-day business, bankers should remain humbled by the job they do.
The worlds of finance and the capital markets can be misrepresented as mundane and mechanical. But there is no doubt that, viewed through the philosopher’s lens, they make for scintillating dinner-party conversation.
The FIG Idea is written by a market professional with more than 20 years experience working with financial institutions