Are banks necessary?

Are banks necessary?

On September 15th, 2008 the Great Recession, officialy started in December 2007, materialized in the financial world with the bankruptcy of Lehman Brothers Holdings Inc., one of the oldest and largest investment banks in Wall Street.

The fate of the famous financial firm has shown to all the world the fragility and the weakness of the current economic system, centered on the banking institution.

Since that moment, doubts have risen as regards to the role of banks in our system and many questions have followed: are banks absolutely necessary? Do governments really have to save them in case of need? Are their positive features more than their negative ones?

Obviously, to answer to these questions is neither easy nor immediate.

First of all, we must consider that since 1999, year of the abolition of the Glass-Steagall Act, American banks have grown a lot, abandoning their role as commercial banks and embracing that of universal banks (already present in Europe at the time).

Taking advantage of the new opportunities available to them, many private financial institution (to be honest, almost all of them) have become more involved in risky investments (for example, subprime mortgages), whose implosion, as we already know, have been the primary cause of the last great financial crisis.

Having said this, we must also remember that banks have not only accepted to be involved in this kind of risky businesses, but they have also been the creators of other dangerous financial instruments (for instance, CDOs, Collaterized Debt Obligations), which have transferred the risk to other agents (or, at least, tried to).

Finally, we have to keep in mind the behaviour of banks in the case of financial distress: being certain that a LLR (Lender of Last Resort) would have immediately run to help them financially in any difficult situation, because of concerns about the stability of the whole economic system, banking institutions have shown a very low attention to the risks connected with their investments and greedy actions.

After having pointed out the negative side of banks, let us consider their – probably – only positive aspect: they provide liquidity to the other agents of the system.

How?

By issuing loans to firms, which can in turn enlarge their activities, create new productivity, and reinsert it into the markets; by allowing people to obtain the money to buy a house through the signment of a mortgage; by enabling individuals not to sleep with their banknotes under the mattress (quite uncomfortable and uneasy, I guess).

In short, banks are the necessary engine of our economic system.

Without banks, the system does not work.

So, until the day we will find a better way to organize our society under an economic point of view, we are obliged to rely on banks in order to keep money circulating.

It is true that sometimes they behave in a very unbearable and annoying way,: that is the reason why governments, as well as central banks, have to regulate and control them (as the Glass-Steagall Act successfully did), enforcing Acts and laws forbidding questionable practices like subprime mortgages and investments in NPLs (NonPerforming Loans).

Even though we may dislike them for their attitudes, errors and, sometimes, illegal actions, we must always remember that they are completely necessary to the proper functioning of our system.

In the end, if you think that the real problem resides in our economic system itself, read the following words of John Maynard Keynes, who thought that Capitalism:

“[…] is not intelligent, it is not beautiful, it is not just, it is not virtuous and it doesn’t deliver the goods. In short, we dislike it and we are beginning to despite it. But when we wonder what to put in its place, we are extremely perplexed.”

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