Comment: Neither a borrower nor a lender be

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Borrowers are going on strike. Consumers do not want to borrow more, witness the fact that in June they paid back more debt than they took on. Businesses do not want to borrow if they can help it: some forecasts suggest that they may be back in financial surplus by the end of the year. Home owners are either deeply resistant to increasing their debts, or cannot borrow because of the fall in the value of their houses. What will happen to the lenders?

Up to now most of the debate about the new caution of would-be borrowers has been in terms of its impact on the economy: the extent to which peoples' desire to increase their savings will check any rise in consumer spending, or the determination of companies not to increase their debts have stifled investment. What has attracted less attention is the plight of the financial services industry. Banks and building societies need people to borrow money. (They also need them to pay the money back, but that is a different issue, though at present a delicate one.)

However, though people may not want to borrow, they will still want to save. If the return of thrift is a lasting phenomenon, and not just some fad, then the institutions that have collected savings and parcelled these into loans will have to find something else to do with the money they attract. Economic theory holds that savings will always equal investment, and that interest rates will simply fall to balance the two. Eventually that may happen, but meanwhile in the real world, our banks and building societies must find something else to do.

Essentially, they have a choice. They can shrink their business; or they can find new products to sell; or they can do some combination of both of these.

ADVISORY SERVICES

In one sense there is nothing new in this. For the best part of 10 years the banks have been trying to increase their non-interest, or fee, income. For their corporate customers this has involved developing and selling advisory services; for personal customers it has involved charging for services that were previously provided free: letters telling customers they were overdrawn.

More recently, the building societies have been trying to use their high street outlets as a shop for selling other financial products, life assurance in particular.

But this, not always successful, shift of business was until recently taking place against a background of rising basic business. In real terms, loans were rising, though the margins might in many areas be tighter than the lenders would like. Thanks to inflation, in money terms the loan book was rising quite quickly.

Now the financial institutions may have to face a long period, perhaps five years, when the real value of their lending hardly rises and may even shrink. If inflation falls to 2 per cent, as some forecasters are now expecting by the end of 1993, it is quite possible that the nominal size of banks' and building societies' loan books may shrink too.

This is new territory. Financial institutions have not had to face anything like this in the memory of the people running them. The idea that a bank might have to shrink in a radical way, as opposed to closing a few branches, is a new one that is very difficult for people who have only known expansion to grasp. It is as difficult as it was for the people who ran industrial companies, like the British Motor Corporation, in the 1960s.

It is, however, an easier shift for bank management to make than it is for building society management. Banks have been through the fire in a way that building societies have not. Most of their errors during the 1980s were lending decisions, but they have also made management errors, for example delaying the cost-control measures that are now being put in place, or in not costing properly the services they offer. (A firm of consultants recently found in one of the big four that it only made a decent profit on 20 per cent of its medium-sized corporate clients; on the rest it either broke even, or made a loss.) The banks are not yet wonderfully managed, but at least most of them understand what they have to do.

Building societies have no similar experience. If the fall in nominal house prices is a new phenomenon for the people who bought them at the height of the boom, it is also a new one for the lenders. Nor have they even experienced the rapid decline in housing turnover that has occurred, a near-halving from the 1988 peak. The desperation with which they have started to call for government measures to rescue the housing market reflects the shock they feel.

NEW ATTITUDES

Some of the implications for the management of financial institutions have been set out a new report, Saving Housing, from PA Consulting. It assumes that housing values worldwide (yes, worldwide) will decline, and that the attitudes towards housing of the high-inflation economies like Britain will come close to those of the low inflation economies.

As a result, it suggests that financial groups will have to do three things; they will have to have as low an operating base as possible; they will have to distribute their services cost effectively; and they will have to understand better what their (increasingly sophisticated) customers want and deliver it to them.

That brings the argument full circle. If the theme of the thrifty 1990s is right, then people will tend to want savings vehicles rather than loans. Of course some people and some companies will need to borrow; but the growth will be in finding ingenious things to do with savings.

For companies that are cash-rich this may include finding candidates to be taken over, the game of the 1980s. But it will also include financial products that give a better return than the deposit markets. For people, the services will include tax-efficient savings schemes linked with pensions; or accounts that 'sweep' spare funds automatically and put them into, for example, PEPs or Tessas.

In a way, a low-inflation world of thrift is a wonderful opportunity. If people are to hold a smaller proportion of their total assets in the form of property and more in the form of financial instruments, there will be a new and largely untapped market for any organisation that can create, or simply package, those instruments. But it is tough to tell a building society that its customers will not want more home loans, when home loans have been its principal product.

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