Goldilocks banks: not too big, not too greedy

Britain jumped on a global trend Wednesday. The government launched a type of bank that puts people before profits.

If it succeeds, the new Big Society Bank will be one more example of nations trying to move away from giant, profit-maximizing banks – the kind that pose high risks to taxpayers and often display a low regard for customers and the disadvantaged.

The new British bank isn’t quite a nonprofit or a for-profit. It is an independent “for benefit” enterprise that will help provide low-interest loans to enterprises that can make money on social projects, such as retraining the jobless or running a community bus service. Its initial capital is $1 billion, most of it from unclaimed bank accounts. The government also coaxed four large banks to chip in.

The concept of social investment by banks isn’t new. But it is growing, especially as Europe and the United States continue to cope with their recent financial crises. In fact, 15 of the world’s leading “values based” banks outpaced 29 of the biggest banks in their “return on assets” from 2007 to 2010, according to a study. These people-first banks, which identify a human need to be met and then assess if it can be met on a financially sustainable basis, also increased their lending four times faster than mainstream banks.

The 2008-09 Wall Street crisis led to a new view globally that big banks can be potential liabilities on society. Merely imposing more regulations on them is not always seen as leading to the more important step of downsizing them. And new compliance rules may have the perverse effect of locking out new, smaller banks because of the daunting red tape.

In the US, five banks control more than half of the industry’s assets. That is up from about 17 percent a few decades ago. The Federal Reserve Bank of Dallas also states in its 2011 report that big banks are especially prone to hiding behind their size and complexity and mismanaging investment risks, possibly causing another market crisis that would lead to another government bailout. Downsized banks would better serve customers.

In Europe, too, many of the biggest and often-nationalized banks have become overindebted, causing a rush by officials to shore up bank capital. Japan is home to the world’s biggest banks and their vulnerability to a weak economy has led to a cut in their credit ratings.

In China on Tuesday, Prime Minister Wen Jiabao announced that the four state-run banks that dominate the economy will need to change, allowing private and smaller banks to grow. Without nimble and competitive banks, China will lag in investment in innovation and entrepreneurship.

“Let me be frank,” Mr. Wen said. “Our banks earn profit too easily. Why? Because a small number of large banks have a monopoly.”

The benefits of scale in banking often mask deep problems. A drive for efficiency and profits can erode durability and stability.

The Big Society Bank is just one example of experiments in small, public-private, and values-driven banking. Prime Minister David Cameron wants the bank to “encourage charities and social enterprises to prove their business models, and then replicate them.” Similar examples include the Triodos Bank in the Netherlands and the Bank of North Dakota.

It’s not always easy to focus on social returns over financial returns. But if any benefit can come from the recent financial woes, one may be these new attempts to redefine the best size of banks as well as the social uses.

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