Bookmark and ShareSargon Nissan is a researcher in nef‘s Access to Finance team.

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The financial system must contain a diversity of institutions with different structures and focused on specific market niches, something more like an ecology than a monoculture. | Photo by Panoramas, via Flickr

Quantitative Easing. Bank bailouts. Building society rescues. Fiscal Stimulus packages.

What do they have in common? They are all preventative measures. That is to say, they are trying to stop something bad from happening; in this case stopping the financial crisis metamorphosing into an economic depression.

While the jury is out on how well they succeeded, it is clear there is widespread acceptance of the need to have done something.

Now the question becomes, what next? Prominent commentators and regulators have weighed in but without providing a huge amount of detail. Adair Turner, head of the Financial Services Authority, defined the problem succinctly when he reminded us that

British citizens will be burdened for many years with either higher taxes or cuts in public services – because of an economic crisis whose orgiins lay in the financial system, a crisis cooked up in trading room swhere not just a few but many people earned annual bonuses equal to a lifetime’s earnigns of some of those now suffering the consequences. We need radical change.

But that doesn’t take us any further to understanding what needs to be done. The Treasury’s summer white paper, Reforming Financial Markets, set itself this task and concluded that to achieve a well-functioning financial system that would be stable and effective, what was required was greater scrutiny, competition and diversity. Increased scrutiny, especially of ‘systemically important institutions’ (bailed out banks that were too big to fail), greater competition and an increased role for diverse institutions such as building societies would ensure that a crisis of this kind would not happen again. Yet if we scratch the surface of this gathering consensus, it seems there is little substance underneath.

Despite almost two million people excluded from even having the most basic banking services, the Treasury’s solution boils down to more money for financial capability training rather than difficult decisions about what financial services should be for, and which ones are exploitative. As Faisel Rahman, chief executive of Fair Finance in London’s East End that battles predatory lending amongst excluded and vulnerable communities, reminded me last week; there are almost eight million people reliant on ‘unorthodox’ credit in the UK, meaning often doorstep lending at rates of several hundred per cent, yet while this problem grew we in the UK celebrated having the most sophisticated financial sector in the world, on the doorstep of the communities Fair Finance works with.

Released yesterday, The Ecology of Finance: An alternative white paper on banking and financial sector reform tries to take up this challenge. We argue that radical reforms are needed, but preventative measures will not be enough. To deliver a landscape of financial institutions capable of lending and investing a manner consistent with fairness, inclusivity and long-term economic sustainability an entirely new approach is required.

To achieve the ambitions of a competitive and diverse sector, The Ecology of Finance breaks down what the finance system should be for and used to provide. The short-term profit models of ‘plc-finance’ needs to be constrained by a diversity of institutions with different structures and focused on specific market niches – more like an ecology.

Don’t just take it from me either. Andrew Haldane, the Bank of England’s Executive Director for Financial Stability, has identified the need to look to ecological and epidemiological lessons for better understanding how complex systems – be they ecosystems or the financial system – behave. It is not simply a question of more complexity is always better, but rather that there are lessons to be learned from the robustness and the vulnerability of things as diverse as rainforests and outbreaks of epidemics.

Hence, to create a financial system fit for our complex society and economy, we identify preventative and positive financial reforms that could ensure the health of our economy and also enable a greater diversity of institutions to flourish.

We recommend

  • Separating retail from other banking and preventing deposit-taking banks from engaging in other, risky activities
  • Setting up a social investment bank, a green investment bank and a Post Bank
  • Regulating financial institutions according to their functions and how risky their activities: the bigger the bank the higher the capital requirements
  • Reforms to encourage more mutuals,  co-operatives and community finance institutions
  • Legislation to force banks to be open about their lending and to lend to the financially excluded.

 

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