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Banking is Complex Because the World has Become More Complex

Frances Coppola has a good post over on her site explaining her view on why banking really shouldn’t be boring.  But I want to expand on her thinking because this is an important operational debate to understand when we think about modern “banking”, public policy and ideas like “too big to fail”.

There was a time when banking was truly boring. That is, banks were basically just lenders who operated a physical payments system (literally taking in physical checks and clearing them). This was a very simple process because the economy used to be a fairly simple machine. That world is long gone and hyperglobalization and technological changes have completely altered the landscape. Banks have grown into massively complex international technology firms who operate a highly sophisticated network of financial markets, credit markets and payment systems. They aren’t just traditional old boring “banks” because our financial system is now much more than just a simple lending and payments system.

This system grew into this complex interconnected entity because there was great demand for it. The financial services industry is not something that just grew out of thin air because banks decided they would start trading funny derivatives. For instance, 100 years ago a farmer might have had an entire crop of corn that was exposed to the uncertainty of midwestern weather. But the commodities futures markets grew largely out of demand to establish certainty in the farming business. This market in commodities futures allowed farmers to hedge their risks in certain commodity markets and create a more stable business model. And the natural market makers of this insurance were often times banks and institutions who were specialists in managing risks.  As the economy grew and became more complex the banking system and the financial services industry became more complex as it grew to meet the expanding demands for various types of risk management.

The key point is, the financial services industry is not becoming less complex. In fact, technology is likely to make it increasingly opaque, automated and sophisticated. When we combine that with the reality that we reside in a monetary world that services an increasingly complex and interconnected global financial system there is a strong likelihood that finance will only become more and more complex. There is simply no going back to “banking should be boring” because banking has evolved to adapt to an increasingly complex global financial system.

So no, banking can’t and shouldn’t be boring because the traditional banking business model cannot properly service the complex world we have today. And as long as we have privately managed profit seeking institutions managing this financial system we will have inevitable booms and busts at times as these institutions (inevitably) mismanage risks at times. We can constrain the limits of such risk taking (and we should in my view), but we cannot make financial services any less complex than the inevitable increasingly complexity of all of the other technologies we use on a daily basis.