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Future of Banking [Finance
Posted on October 7, 2015 @ 08:37:00 AM by Paul Meagher

In the begining of the last recession in 2008 when taxpayers bailed out the too-big-to-fail banks, there were some banks that did not suffer similar mortgage default rates as these big banks. These were the community-owned banks, state-owned banks, credit unions and some other financial institutions with a cooperative, mutual, local, or mission-driven focus.

In her book, Owning Our Future (2013), Margorie Kelly points out that one common feature of these alternative banks was that they were not profit maximizing entities and had an ownership design that precluded them from simply wanting to generate more mortgage loans so they could maximize profits by selling them off to bigger banks who were creating mortgage-derived securities from them. If the loan went bad for these alternative banks it often meant they weren't serving their community or their mandate. The care and consideration these banks put into their loans was apparently greater than the first and second tier banks that were geared towards generating mortgage loans to maximize profits.

Profit maximization, it turns out, may be a good strategy for banks in the short run but it can lead to its own demise when it becomes predatory, impersonal, and purely financially driven. In the long run banks with an ownership design that represents the community it operates in and which has a mission beyond profit maximization tend to do better. Consider that many of the larger banks probably wouldn't be around today if they were not bailed out and that many of these alternative banks were not experiencing anywhere near the same level of defaults during the 2008 meltdown.

Ironically, the government fix was to increase the federal deposit insurance requirements, reporting requirements, and auditing requirements for all banks which tended to differentially affect the financial viability of these smaller alternative banks. The regulators apparently did not see, or allow that, the ownership design and community-based mandate of these alternative banks were the controls that prevented them from experiencing the crisis to the same degree as the profit maximizing banks.

The story behind the crisis is obviously more complex than this but the point of this short blog is to draw attention to the issue of whether banks that are profit maximizing are systemically problematic and whether we can correct this simply through regulatory improvement. Or, does it require an ownership design change coupled with a mandate change to create real systemic changes in banking? Regardless of whether you agree with Margorie's analysis and assessment of the banking crisis, I think Margorie's book (which I also referred to in a previous blog) is useful in helping us to see that there is room for innovation on the issues of who owns a bank and what their mandate is. The design of future banks will hinge fundamentally on these two issues.

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