Wednesday, April 14, 2010

Banking profits up ... but what is the value proposition?

Dear Colleagues

Over the last few months the very big banks have started once again to report huge profits ... in the case of JP Morgan Chase, profits in the first three months of 2010 have been at the rate of more than $1 billion a month ... and the CEO is a hero based on the prevailing corporate profit metrics.

For a society that only uses corporate profit as its metric of progress and performance, this is a stellar outcome ... and, of course, that is what is being used at the present time, and has been for the most of the industrial era. Social issues were not the subject of rigorous metrics ... or really any metrics.

Net net this allowed the corporate industrial sector to do everything at minimum corporate cost, and therefore maximum profit, no matter what the cost to society. In the "robber baron" days the clear cutting of timber to fuel the demands of the railroads was eventually seen as being a "bad thing" ... but similar environmental destruction now goes on more discreetly, but with even more devastating consequences, if for no other reason than that economic activity is an order of magnitude bigger than a few decades ago.

So the banks are now reporting great profit performance ... but what exactly have they done to achieve this profit. Certainly there is little evidence that they have had much of a role in rebuilding the global economy ... and if news reports are anything to go by, a lot of the profit is to do with "proprietary trading" and the continuing use of complex financial instruments that nobody seems to understand. Bottom line, the banks seem to be earning profit without doing very much that seems to have any value.

I would like to find someone in the banking industry who would like to work with me to profile the value proposition in what banks do. I think I understand the way banks used to work with money deposited being a source of money for investment ... and the earnings being a function of the spread between the interest paid on deposits and the interest earned from loans. I think I understand the fees that the bank charges for its services ... some of which are very large relative to the associated costs. I think I understand the way profits arise from trading in securities. But I think it is fair to say that none of this does much directly to make society a better place ... the value chain for banking is that it is the bank's clients that have to make the value adding, and then some of this value is reduced by the banks' charges.

In my simple view of the world, the whole of the banking sector is essentially nothing more than the "overhead" of a successful economy. When the economy has a lot of overhead, the economy is stifled. If the overhead is helping to get good big decisions right is earns its keep ... but the underlying health of the US economy, for example, has been deteriorating for a very long time and the banking leadership does not really seem to have noticed, and certainly does not seem to have done very much about it.

Simply put ... the value proposition for the banks is that their profits represent value that has been sucked out of the broader economy ... a very unhealthy sort of profit!

Peter Burgess

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