How can finance best serve society?
The growth of the financial sector and its profitability has far outpaced wider economic growth. This is partly because governments have deregulated financial systems and removed obstacles to cross-border movements of capital. In the UK this process has developed to such an extent that some argue finance is outsized and divorced from the needs of the non-financial, or real, economy.
The pandemic has tested the weaknesses of the financial system. In the short term governments and central banks will attempt to prevent a wave of crippling defaults. This must be done without creating undue moral hazard, encouraging reckless or otherwise unwise lending or borrowing. The need remains to ensure the financial system is made more resilient to crises in the long term, and that it is a core part of a sustainable and more equal economy.
Some proposed reforms focus on reducing financial activity that has little social or economic value. This could be through the imposition of transaction taxes on high frequency trading or foreign exchange dealing. There are calls for credit guidance policies to steer bank lending towards productive sectors of the economy.
Other proposals concentrate on challenging the dominance of the country’s big four clearing banks – Barclays, HSBC, Lloyds and NatWest – on lending to SMEs. There have been calls for a radical decentralisation of the banking sector through the establishment of regional stakeholder banks or for the creation of state investment banks and publicly banked venture capital funds to provide patient capital to firms.
The high level of financialisation and financial sector profitability in the UK is partly enabled by the state. This includes the implicit government guarantee it will not allow banks to go bust, as seen during the 2008 financial crisis.
There are growing concerns over the financial sector’s ability to supply the funding needed to meet the economic challenges we face. This has focused attention on the ownership and accountability of the UK’s unusually concentrated financial sector.
According to the Bank of England, the proportion of UK bank credit flowing to non-financial firms has fallen to just 15%, with just a third going to SMEs. There are calls for credit guidance policies to steer this lending towards productive sectors and away from less desirable options, such as mortgage credit. This could be done, for example, by the Bank of England capping the amount banks can offer to various parts of the economy. Other proposals include changing ownership within the finance sector.
Creating a net zero economy by 2050 will cost between £39bn and £78bn (1-2% of GDP) a year. There is a crucial role for the government in establishing a credible commitment to decarbonisation, including ending carbon subsidies and increasing public investment, but the target will only be met if private financial institutions direct funds in ways that can reduce emissions.
Central banks have so far focused on the risks to financial stability from climate change instead of steering capital into green investment. They could take into account the carbon intensity of assets when conducting monetary policy by reducing the cost of capital for low-carbon sectors.
There are also calls to stress-test financial institutions for their resilience to climate risks and to impose higher leverage requirements on banks with exposure to assets – for example, fossil fuels investments – that could become worthless as a result of climate change.