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How To Increase Revenue: - Part Two

Read Part One
But deregulation means more than a few changes to the domestic financial system. What is happening in Britain is one aspect of changes taking place across the world’s financial markets. Changes in the way money is borrowed and lent, changes in the way investments are traded. On the global scale deregulation means the breakdown of restrictions on different types of financial institution in the main financial centres, but also a breakdown of the barriers between the centers themselves. The abandonment of foreign exchange controls — Britain’s were suspended in 1979 and later abolished — is one part of the process. Opening up domestic stock exchanges to foreign members is another.

Widening the range of investments that can be traded in each financial centre is a third, opening the way for round-the-clock trading in investments and currencies. The time zones are such that British markets are opening around the time Tokyo markets close and New York opens while London is still going strong. The main securities houses which deal in investments are of necessity international, with representation in each of the main financial centers.

Why is the world obsessed with financial markets and the ability to trade round-the-clock? It comes back to another aspect of deregulation — the changing role of traditional banking institutions combined with the need to handle massive cross-frontier flows of money seeking investments. Traditionally, if someone had spare cash he lent it to the bank and the bank in turn lent it to someone needing to borrow money. Today, the name of the game is often to cut 9ut the middleman: the bank. Would-be lenders seek out would-be borrowers direct — a process known as disinter- mediation — and they need markets to bring them together.

Moreover, the way investors put up the money has changed. Instead of simply making a loan they often prefer to exchange their money for pieces of paper they can later sell if they want their money back. And the markets in which the pieces of paper are bought and sold have blossomed. The banks have had to take on a new role: arranging the issues of these pieces of paper, putting the buyers and sellers together, organizing and participating in the markets where the pieces of paper change hands. It is a different business from simply borrowing and lending money and to an extent has replaced it. The banks have also, sometimes to their cost, become more active dealers in the financial markets on their own account, seeking to replace the lost traditional income with volatile trading profits.

Companies, too, have had to adapt to a new climate. Interest rates can move up and down with frightening speed. Rapid changes in the value of one currency against another take place as the mass of speculative funds washing round the world financial system changes its allegiances. Businesses need to protect themselves against these swings which, in the worst case, could wipe them out. Hence the massive growth in recent years of derivative products: financial products that can be used to provide protection against interest rate, currency and price movements. But if derivatives can provide protection, on the other side of the coin they also provide limitless opportunity for outright speculation. The merchant bank Barings discovered this to its cost. So did a number of industrial and commercial companies in America, Britain and mainland Europe.

If there is a financial nemesis stalking the world’s banking system in the second half of the 1990s, it is probably lurking in the derivatives jungle. Some of the derivatives products marketed by the banks and some of the trading techniques used in the futures markets are now of a complexity that may have outrun banking management’s ability to impose controls and assess risk. The 1980s were a period of illusions. Not least among these was the notion that ever more frenetic trading in securities could in itself create lasting value, almost regardless of the product that was traded. Another was that competition in financial products brought nothing but benefits. A third was summed up by the aphorism that ‘greed is good’.

These ideas have not entirely disappeared in the greyer climate of the 1990s, nor are they necessarily without an element of truth. But they have needed to be re-examined in the light of experience. The securities houses’ dreams of ever-rising volumes of share trades were knocked on the head by the market crash of 1987. The business has seen considerable retrenchment. When merchant bank Warburgs — one time City leader — sought a well-heeled parent in 1995, it questioned whether Britain’s investment houses any longer had the financial clout to go it alone. The high-street banks, too, are cutting back their staffing as competition and technical innovation reduce manpower requirements.

The outlook for employment in the financial services industry is not entirely good. Competition has certainly widened the choice among financial products for the consumer but it may also have brought higher charges for, say, investors in unit trusts. Competition has certainly brought interest on current accounts for bank customers, but it also brought a range of new (and far from transparent) penalties and charges as the banks sought new sources of revenue. And while enlightened self-interest may be no bad principle in financial affairs, greed has also been surfacing in some less constructive forms. The rocketing salaries, bonuses and share-option profits of company directors are by no means always justified by performance.

They have begun to feature frequently in general news reports, not solely in the financial pages. Insufficiently-regulated greed also played a large part in the financial speculation that brought Barings down, in the commission-driven poor selling of pensions and in the business practices of the 1980s that contributed significantly to the present problems of Lloyd’s of London. The Bank of England’s refusal to rescue Barings by signing a bill of unknown size at the taxpayer’s expense marked the end of an era in the City. No institution, however august, could automatically count on a bail-out from the authorities. The City contains much that is competent, innovative and of world class. But the events of early 1995 showed that this is not the full picture.

If, in future, the public is less ready than it was in the 1980s to take the City at its own estimation, this may be all to the good. Thus, the transition to a more competitive financial system has not been without its problems. Above all, time-scales have shortened. In the days before deregulation, each financial institution tended to know its place and the extent of its legitimate pickings. Customers may have had to pay too much, but by and large they knew what they must expect to pay. In the cartelized atmosphere of the day there was limited incentive to break long-standing business relationships in search of a better deal.

In contrast, today’s business is transaction-driven. The industrial company may shop around for the best deal on the loan that it wants to raise, rather than sticking with its traditional banker. The bank that gets the business will be rewarded with the fees for arranging the loan. The bank that advises on a takeover may get a fee only if the deal goes through. The profit on the deal is often more important than the long-term relationship with the client.

It does not always lead to the best or the most impartial advice. And the employees of the bank or securities house may be rewarded with a one-off bonus for short-term performance rather than with a stake in the business or a move up the corporate hierarchy. It encourages risk-taking. It does not always foster an equal attention to the long-term health of the employer.

The former directors of Barings would probably understand this very well. Private individuals, too, are inundated with competing financial products and competing salesmen and for them the problem of finding sound, impartial advice grows daily more difficult, as the personal pensions debacle demonstrated. Thrown back on their own resources in the competitive environment, they need more than ever to glean what information they can from the financial pages. And to acquire sufficient knowledge to evaluate what they glean.