Last year a single sector of British industry was responsible for generating 12 per cent of government tax receipts, with just 4 per cent of the workforce. You would think the government would be grateful to these hyper-productive worker bees, at a time when it needs every penny of tax. Solicitous even, as it is with ‘clean tech’ firms and Silicon Roundabout start-ups, which deliver nothing close to this kind of tax revenue. Not a chance. Because the sector is financial services, and three years after the financial world imploded — with Britain still plodding its way through the valley of economic death — banker bashing is still considered political gold.
Even when giving his new year’s message, David Cameron was careful to include his now customary swipe at the ‘few at the top’ who ‘get rewards that seem to have nothing to do with the risks they take or the effort they put in’. No major statement is complete without the coded swipe at evil men in pinstripes. One hopes this is just cynical electioneering on the Prime Minister’s part, because if Britain is ever to recover its economic stride, the bankers must play a major role.
Depressing as it may sound, financial services is one of the few things that Britain still does better than almost anyone else. And in spite of all the ruin caused by their CDOs, CLOs and hybrid derivatives, we need bankers to start innovating again. Instead of berating financiers for their Cotswold country homes and indoor salt-water pools, we should be encouraging them to find new ways of making money. We need them to show more of the creativity that landed us in this mess to start with, but in a way that does not risk bankrupting the country. And this means acknowledging that Britain’s problem was not wicked financiers, but inept bank regulation.
More than 40 years ago while at graduate school, Michael Milken, the financier who would later create the market for junk bonds and go to jail for what he subsequently did with them, wrote a formula which applies to both booms and busts: P = Ft(HC+SC+RA). It says that prosperity equals the total of human capital, social capital and real assets multiplied by the effect of financial technology.
Milken’s point is that when you take great people, great physical assets, such as buildings and cash, and a healthy society and apply some advanced financial thinking, the rewards can be extraordinary. For example, in the wake of the 1970s oil bust, many companies and individuals struggled to tap the usual forms of credit. What emerged were new kinds of debt, shorter term or with higher interest rates or linked to different forms of collateral. The markets derisively called this debt ‘junk’ but it served a vital function in giving businesses access to capital when they badly needed it.
We are now seeing a similar pattern today in retail banking, albeit on a much smaller scale. Wonga.com, based in St John’s Wood and funded by millions of pounds in venture capital, offers high-interest, short-term payday loans averaging £150. It is growing rapidly by providing services not offered by high-street banks — perhaps inhibited by how quick politicians are to denounce all short-term creditors as ‘loan sharks’. New online platforms which allow lending between individuals, such as Prosper.com, are becoming increasingly popular and robust as people develop credit histories with each other.
In the United States, frustration with big banks is driving more and more people to small local banks and credit unions, which offer lower transaction fees and don’t try to bully their customers into buying an ever larger selection of useless products. A new vision is suddenly coming into view, in which we do away with most bank services altogether and pay our bills, spend and save without an intermediary on the high street dipping into our account at every opportunity to extract fees. We can start to live financially through websites like PayPal rather than our banks.
The good news for Britain is that its retail banks are already among the most innovative in the world, at a time when the world is looking for financial innovation. Britain’s banks, if allowed to emerge from their self-protective foetal position, could provide exactly the kind of innovation Britain is looking for. They should be encouraged to innovate and lead changes in how the whole world does its banking.
Financial innovation and technological innovation have been forever intertwined. When Britain’s railways were built in the 19th century, the first investors were those closest to the industry who understood this novel and unproven technology. When more money was needed, specialist groups of investors and financiers devised screening processes to bring in new funding and ensure investments could be closely monitored.
Another model of screening, pricing and monitoring was developed for the high-tech industry which began to emerge in the 1970s. Many investors did not understand what these companies were up to and doubted whether the scientists who founded them could turn a profit. It took a new class of venture capitalists to develop innovative screening and funding models.
Today, there is a constant need for financial innovation to fund hard-to-value but possibly hugely profitable investments in biotechnology and alternative energy. Anyone who calls for growths, and for the banks to lend — while assailing financiers — misunderstands how economic progress occurs.
I recently met an angel investor in London, who crossly told me that he had lost money in every angel investment he had made. There were no good young businesses in Britain, he told me. No good ideas and no good entrepreneurs. There he was dangling his cash in front of start-up businesses, and he couldn’t find a good one. What he hadn’t considered was that he and his money and his terms might be so unappealing that no good entrepreneur would want them.
The challenge in Britain is not a shortage of ideas or entrepreneurs. They seem to be bursting out of the pavement. What needs updating are the financial models for funding them, novel ways of balancing risk and reward, of developing the networks of trust essential when taking punts on new ventures. This is the kind of innovation which stokes growth, and which seizes up when all a society seems to want to do is nut bankers.