The Innovation Engine: Free Flow Finance
In Jersey we have some of the best financial legislation and regulation in the world. As an industry, over the past fifty years we have been adept in maintaining and improving our laws and in adhering to international regulatory standards.15 March 2012
In Jersey we have some of the best financial legislation and regulation in the world. As an industry, over the past fifty years we have been adept in maintaining and improving our laws and in adhering to international regulatory standards. This commitment, to the highest quality possible, has held us in good stead. It has resulted in wide recognition from international bodies such as the OECD and IMF, as well as positive feedback from HM Treasury.
This strategy of focusing on quality and standards has been endorsed to some degree by the impact of the financial crisis, which intensely magnified the scrutiny of financial services globally. It has also resulted in a close and positive alignment between the States of Jersey, the Jersey Regulator, Jersey Finance’s Technical Team and members of Industry, who all work collaboratively to achieve what is required. Put simply, providing technical excellence is something Jersey has been doing very well, for a long time. However, as the shadow of the crisis continues to loom, it is becoming clear that the global recession is not a ‘temporary’ environment that we are operating in. Our tried and tested approach towards product development now needs to be considered in the context of the continued slowdown.
This ‘elongation’ of the global recession is partly because the central banks have got better at managing this sort of crisis (believe it or not!). All of the actions taken to stabilise the economy, from keeping interest rates low, to bailing out banks and releasing additional currency, have prevented things from being as dramatic as they could have been. But it also means that the impact will go on for longer.
The impact of the UK financial crisis of the 1970’s, with the intense struggle between the labour market and Thatcher government, was in some respects worse than what we are facing now. No two recessions are alike. In the 1970’s the crisis didn’t last long; it was dramatic, cut deep, and although the pain was over relatively quickly, had tremendous social consequences. The slowdown we are seeing today is taking much longer to play out. Lehman’s went to the wall in 2008 and in 2012 we are still extremely concerned about stability, job security and the impacts of austerity.
Of course, the causes of the previous financial crises are also very different – increasing oil prices for instance directly contributed to the price shocks of the 1970’s. Today’s situation has been caused by a huge build-up of debt and a sharp reduction in the availability of credit. It is of course a global crisis, not just a national one. All of these factors mean that we now find ourselves in a situation where we are going to have to accept living in a recessionary environment for quite some time. But does this mean we can’t prosper?
In Jersey we have already been making efforts to diversify our business model by targeting the BRIC nations that are still seeing growth. But with the imminent introduction of so much new regulation, including measures from the Vickers report, we need to ensure we have the flexibility to adapt further. While we are confident that our banking model will remain functional despite Vickers, this is an opportunity to review the way that we do things. In Europe and the US, where markets have flat-lined or are even declining, we should be considering how Jersey can still win business. One obvious way is to increase the volume of our voice through investment in promotion, to compensate for a shrinking market. The other is to innovate, by solving a need or creating a demand.
While there is little doubt that the ongoing work being done to improve our existing product offering is worthwhile, this sort of activity provides steady, incremental benefits – not breakthrough innovation. Even the Jersey Foundation, an excellent addition to our product offering, was a move to match (and improve on) something that was already offered elsewhere, rather than the creation of something brand new.
When some markets show no growth and others are so price driven we would not choose to compete, we have to be more creative. While maintenance is good and essential, innovation needs to become the driving force of our technical development. So how do we do this? There is always some merit in simply putting creative people in a room together and seeing what happens! Ideally though we need to begin spending our time regularly anticipating future or emerging trends in the world, which may not directly relate to financial services, and then considering what products we can develop that meet the needs these trends generate. We need to become an innovation engine.
A good example of this sort of trend is Credit. ‘Leverage’ has been the big bad word since Lehman and accumulating debt is no longer seen as attractive in the way it once was. Accordingly, everyone is now trying to retrench. As a result we are now in a situation where corporates are actually very cash rich because they have reduced borrowing. This is a notable across the board – over the last two years personal debt has also gone down overall. The BRIC nations aside, the whole of the developed world is in a place of “battening down the hatches”. While in many ways this is an understandable reaction, one of the net effects of this trend is that it makes it harder for businesses that want to grow and need lending to do it. Even buying premises with secured borrowing can be very hard to negotiate right now.
This situation is creating a demand for different types of lending, which means bankers are simultaneously being driven in two different directions. On one hand, global regulators (supported by governments) are pushing for safety and the need for banks to have large amounts of capital and liquidity in order to operate, which makes it much more difficult for them to lend. At same time governments are telling banks that they want growth and for them to lend more money. While many may lack sympathy for this plight, bankers are effectively being labelled the villain and asked to be the hero at the same time, but with the powers to operate in a way that would make heroic rescue possible taken away from them, with regulatory kryptonite!
Ironically, banking has fundamentally changed very little over the years – deposits are taken in one place, lending is given in another. What is often forgotten is that for hundreds of years, banks have failed. There is no such thing as ‘risk free’ banking. Risk is a natural part of the process and in our efforts to respond to the crisis we have lost sight of this. There is an impression being given at the moment, that central bankers and politicians can ‘solve’ everything, which is simply not the case. The attempt to regain control of risk, via the Basel Committee rules, remuneration controls and countless other new regulatory standards is creating a banking system that is constrained and very different.
So the real question is, what else can we do? How can we supply the demand for credit, to support growth in a different, more acceptable manner? Is there a new way to provide lending to small businesses so they can become engines of growth in the economy? With the right ingenuity and innovation, I believe Jersey could be well placed to do exactly this. If for example, we used our existing skills and experience to create a new source of funding, via the Private Equity community, or simply investors looking for a return, we could create a totally new channel of credit that wouldn’t have to be processed through the hobbled banking model. In a manner similar to Private Equity, we could find ways to assess businesses models and offer lines of credit or lending. While banks continue to have a constrained ability to lend, this type of funding model could potentially become a new conduit for debt, and therefore business growth. The UK government has a massive task on their hands to provide enough stimulus to prevent de