The Bankwatch

I continue to be fascinated by product design in western banks and the sheer lack of innovation despite a clear permanently different business and consumer environment.  By innovation I don’t mean higher or lowers fees and interest rates.  What about the substantive design of products? 

The tile of this post is a provocative statement I located at Islamic Finance Expert that will likely meet mostly deaf ears in the US however when we dig beneath the surface , there is merit to the statement when we appreciate it speaks to the methodologies and product design employed by banks to fund business and retail loans.  So US readers, please bear with me.

The western capitalist and financial approach is naturally designed to be one of animosity.  It is a highly one-sided affair whereby the debtor has only one approach available to them which is maintain all the terms and conditions of the debt.  In contrast the creditor owns all the terms and conditions and is always in charge, particularly when the circumstances change and those new circumstances always add to the rights of the creditor.  Whereas there is no change in circumstances that could arise whereby the debtors position could be advantaged over the creditor. 

The opposing capitalist argument would be that positive changes in asset values or profits from business ventures all accrue to the debtor, with no advantage to the creditor.

The very design of this structure is designed to become animus immediately upon a change in circumstances.

What is it about Islamic Finance that it different?

The source of the statement in the title of this post came from someone I was listening to on BBC news.  Linar Yakupov is a financier in the central Asian country of Tatarstan, a state that is part of the Russian federation.  Most Tatars are Sunni Muslims.  The point of the BBC piece was to point out the dramatic shift in commerce here since the opening of Russia and the dramatic increase in importing and consumption of Halal foodstuffs.

The piece continued on to note the increase in consumption of Shariah or Islamic Finance – the financial version of Halal. 

I have noted here before some of the aspects of Islamic Finance back in the 2006 – 2008 period, and it fell off my radar during the credit crisis.  But my approach back then was merely noting the demographic shifts in western countries and the opportunity that created for western banks.  I see now this was a limited view of the opportunity.

Is the economy really that bad that we need innovation in product design?

This is a new normal.  I just do not see how traditional approaches to financing can be the only means to an end in this environment. 

The newer and deeper message promoted by Yakupov and others is that Islamic Finance is a better alternative and one that could navigate the gyrations of capitalist economies particularly as we look out at probably 10 – 20 years of economic re-engineering caused by:

• western business & consumer deleveraging and the impact on asset values
• unemployment absorption & geographic reshaping (think Detroit & Pittsburg)

These shifts are enormous and US, Canada, UK and Europe are all being impacted.  History tells us that post crisis periods create genuine industrial and business innovation.  This occurred in 1870’s and 1930’s.  Richard Florida points out that there is nothing like severe downturns to generate innovation in The Great Reset.  The 1870’s created heavy industry and railroads.  This was a dramatic change.  Innovation such as the assembly line and large factories really took hold post 1930 and the resultant consumer boom lasted until now based on continual growth.  Those innovations in the 1870’s and 1930’s were more than simply the equivalent of a new web model.  They involved systemic shifts in commerce and business.

Financial design worked well so long as everything grew reasonably steadily and bank product design followed along and supported that path.  But what happens now that that bubble is burst.  Does current product design support consumers and business effectively in times of continual doubt and the working out of structural unemployment and the new value of assets particularly housing which have average new price variances across the US of incredible proportions.  (Saginaw-Saginaw Township North, MI $59K to San Jose $630K).  The important note is that the average prices have taken a new form as industry and business changes produced dramatic unemployment where economies were strong prior to the economic breakdown.  I also note that the realtor.org link where I located the average prices above notes NA for Detroit.  Seems a bit ostrich like of them.  Trulia.com is closer to the mark displaying homes in the between < $28K up to >$65K ranges.

It is hard to imagine how banks can operate rationally with such shifts occurring.  The results are neither good for banks nor consumers.  Banks will simply exit the Detroits of the world and that sticks with the one-side model referred to above.

Some specifics on Islamic finance that could work for the post crisis world

Interview with Linar Yakupov.

Principles of investment that support local and infrastrucure: 

• Firstly, according to Shari’ah principles – TIIC doesn’t participate in business connecting with gaming, alcohol and pork production etc. Yet another important moment, to which I would like to draw attention is the fact that TIIC will maximally distance itself from the oil patch. Generally, the investment company will be the additional lokomotive for the diversification of our economy – not only in Tatarstan but in other regions of Russia. 60% of investment will be for our Republic, the remaining is planned to be invested in projects of other regions of Russia.

Helping people help themselves:

• In the Halal Industrial Park the facilities for successful completion of the cycle are provided in order to solve this problem – from the farmer to the consumer. HIP will unite the whole circulation of production flow: from the small and medium-sized businesses’ employers, engaging in manufacturing, to the consumer. Linova-Trade, the special company promoting the production of HIP, has been setted up yet. It will start the activity from the next year.

The main point:

• Moreover, exactly the slant to the speculative instruments in the traditional finance sphere led to the grave crisis. On that score Islamic finance and banking, or ethical banks, how they started to be called nowadays, don’t allow to produce speculation and are turned out to be a sort of  anti-crisis instrument. We don’t say that Islamic finances are the panacea, but they could be the revitalizing factor for the whole economy. If this objective implements, we will be very pleased.

Sharing of risk is a core aspect within Islamic finance from International Shari’ah Research Academy for Islamic Finance (ISRA).

The nature of contracts, which requires that risk be shared by the contracting parties, exemplifies the principle of fairness and justice in Islamic Finance. For instance the partnership contract (musharakah) specifies that all the parties that share the capital in a particular venture will share the profit in proportion to their capital contributions. On the other hand, if there is any loss, all have to share the loss according to the portion of the capital contributed. This equity-based contract will also help to generate greater economic activities through the principle of profit-and-loss sharing; and the clearly defined risk-and-profit-sharing characteristic serves as an additional built-in mechanism to avoid any disputes and economic uncertainties.

Relevance to Bankwatch:

We are in changeable economic times, and everyone expects that to last for many years to come.  Today on Fareed Zakaria his topic was ideas as he seeks to understand what it will take to operate and thrive in this new world.  He interviews Robert Kaplan, Clay Shirky and Richard Florida.  (It is an hour that knocks it out of the park if the future interests you)

What struck me about the methodology espoused by Islamic Finance is not the adoption of Islam or Halal.  Rather it is the adoption of sound principles that avoid the bad and focus on the good (Umair would like that).  It is not a rhetoric argument to argue that gaming and alcohol business will not generate the innovation required to move us through these times.  Rather what struck me is the focus on non-speculative core business which in the case of Tatarstan happens to he Halal but there is no reason these finance principles cannot be applied to core businesses that operate in western economies. 

A core aspect of product redesign that banks can learn from Islamic finance is shared risk.  What if mortgages made during the period 2003 – 2007 had a proportion based on shared risk and benefit.  This would have limited the home ATM phenomenon, speculation would have been reduced, and frankly less risks would have been taken.  A product designed this way where the bank shared in the appreciation on homes would have had no interest in 2006, but what of such a product in the 2010 – 2020 timeframe?

Back in 2008 I noted the proposal by Niall Ferguson for a Jubilee as the only solution because he believes the deleveraging necessary is too large to absorb.  Jubilee means (amongst other things) debt forgiveness and Niall noted the many times this has been used in history to get past a bubble.  Islamic finance uses shared risk as a method of producing a softer landing than absolute debt forgiveness but achieves similar results.

It just strikes me that there are serious lessons to be learned from the world of Islamic Finance that can be applied to genuine innovation of western financial products that would work not just for Muslims for for western consumers, business and economies. 

Here is one set of regulation that seems to have worked. The article recounts one broker who is down from 85 on staff to 3.

What is intriguing is that the bankrate article seems to suggest this is a bad thing. The reasons provided in the quote below just sound like back to basics banking process that provides lenders and customers protection.

In fact it suggests brokers can only operate in a loose credit/ no diligence environment. I do not believe that and surely there is a model for brokers that involves lending discipline.

http://www.usatoday.com/money/economy/housing/2010-08-28-mortgage-brokers_N.htm

Credit histories must be dutifully compiled for all borrowers. And any number of new criteria can lead to a refusal to lend. One new practice closes the door on loans to anyone who’s done a short sale — a way of selling a house when the sale proceeds fall below the balance on the mortgage — in the past three years.

Canada continues to be held in high regard throughout the ongoing crisis but the devil lies in the details.  Ontario which represents about 40% of Canadian GDP is beginning to look like Nero … fiddling while Rome burns. 

Even at the Canada level the savings rate is going in the opposite direction of western economies, and adding to debt, ie not saving.  This perplexing environment is hard for Canadian Banks to formulate a credible strategy around.

The Boeckh Investment Letter

While Canada has deservedly had a good ride in recent years particularly through the global recession, due to strong Federal Government finances and a strong balance sheet, all is not quite as rosy as meets the eye. Chart 16 shows that, while the U.S. savings rate has gone from 2% to 6.5% since 2007, the Canadian savings rate, after a brief rally, has collapsed to about 2 1/2%.

Canadian households have continued to add to their debt, oblivious to the changed world environment. House prices rose to new highs during the recovery, while U.S. house prices are down over 30% from their peak.  Moreover, while federal debt levels and trends are good by world standards, provincial debts are disastrous. There is even some talk of Ontario going the way of California. Its per capita public debt is ten times that of California whose bonds are rated slightly less risky than Croatia’s.

An interesting stat that reflects a new normal when people are consolidating and de-levering.  However the percentage decrease of 18.9% since July 2009 is not so dramatic as the headline in the Telegraph suggests.

Banks approve just 1,000 mortgages a day | Daily Telegraph

It is down from 34,575 mortgages the previous month and the situation has got significantly worse compared with last year, with levels down from 41,353 mortgages in July 2009.  The latest figure is half the amount of mortgages approved before the credit crisis hit.

A very smart interactive ad from ING Direct Canada that ran in Toronto metro hall.  Those are coins which are removed to bring out the full ad.  I would speculate the coins add up to $185.00 which is the theme of www.your185.ca

http://www.youtube.com/watch?v=62GKD-seO0g#sf484248

Exciting news from ING this morning.  I knew this was coming but not the details till now.  For more details go to http://www.your185.ca/ which is a very cool URL relative to this product.

I have been preaching for some time that bank product design since 2007 is not really attacking the core aspect of post crisis consumer need which I would characterise as features that support a deleveraging environment, where people saving and paying down debt is the defining average consumer strategy.  This new product from ING supports that strategy with a full featured yet cheap chequing facility.

ING Direct Canada Press release

August 18, 2010 @ 06:00AM

TORONTO – ING DIRECT today announced the upcoming launch of THRiVE Chequing, an online, no-fee daily chequing account that will enable Canadians to deposit, withdraw or transfer money for free, all while earning interest.  The first chequing account made for Savers, THRiVE Chequing stems from the frustration many Canadians feel about unfair bank fees that are on the rise.

According to a recent national poll conducted by Angus Reid Public Opinion on behalf of ING DIRECT, a quarter of Canadians are simply unaware of how much they pay in monthly bank fees, which on average is about $185 annually.

What an interesting and contradictory set of headlines.  We really are an an economic crossroads with no roadmap.  The only change I observe with Banks at least in Canada is that they have directed their advertising towards deposit accounts and Investment Certificates.  Interesting times.

Financial Times

US banks ease lending standards
Geithner calls for housing finance reform
US housing starts make modest rebound
US house mortgage arrears mount
US pressure grows to extend tax cuts for rich
US Housing
US yields
US builder slump deepens in August
Call for careful overhaul of US mortgage lending
Fed needs firepower to zap deflation monster

BofA have come out with a pure non branch checking account that has the right price, i.e. free.  Everything is done via online or ATM.  This type of account is gaining momentum.  Its not a game changer but with a no fee price tag, it will change behaviours of some customers.

Bank of America

eBanking

Ideal if you do most of your banking online and at the ATM, instead of with a teller.

Learn more about eBanking>>

Monthly fee waived when:

• Deposits and withdrawals are made electronically or at our ATMs
  AND
• You choose online paperless statements through Online Banking

Otherwise, $8.95 per month