Frightened bankers and the skill of shrinking

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IT IS not easy to defend the high street banks, but it is possible to explain their plight, and - for the really charitable - to pity them.

They are, of course, everyone's Aunt Sally. Hardly a day passes without someone taking a shy at them. The most recent attack has been generated by reports that they are to charge customers who have become used to 'free' banking. But that is just one, relatively minor challenge. The more serious charge is that the banks are chiefly to blame for the depth and duration of the recession: by irresponsibly encouraging companies and individuals to over-borrow at the height of the boom, they laid the foundations for the present pile of bad debts. Now, by pulling the plug on viable businesses and upping their charges to cover the cost of their dud loans, they are making recovery impossible. The banks, the argument runs, are not just greedy and stupid, they are also destructive.

This is a grave charge and there is a deal of truth in it. The banks' appalling public relations, allowing the idea to develop that they operate as a cartel, has made matters worse. But anyone who is angered by the service from their bank should be aware that they are dealing with not just a lumbering and unresponsive animal, but a frightened one, too.

For the banks are facing something that is quite outside their experience. They are used to duff loans and cross customers, but they are quite unused to a sustained fall in demand for their services. For their entire history, 150 years or more, the banks have been accustomed to growth. Now they must learn to shrink.

The banks are, in this respect, like the steel industry of a decade ago. They provide a basic product which everyone continues to need. But just as there has been falling demand for crude steel, and hence little profit in making it, so there is falling demand (and little profit) in the banks' service of taking deposits and making loans. Why should people leave their spare cash in a bank when National Savings offers a better return? And who can afford to borrow from a bank that charges 20 per cent or more for a loan? Better to wait and pay cash. Companies and individuals alike will continue to use the banks as a money transfer mechanism, but that is a clerical function with little profit in it.

The steel industry has responded by slashing its costs and its workforce; and by producing more sophisticated steel products - covered with zinc for cars, ready- painted for washing-machines - for which it can charge more. Banks are in the early stages of a similar revolution.

The potential job losses at the banks will not be as large, proportionately, as those of the steel industry, which has lost two-thirds of its workers in a decade; but in absolute terms they will be larger. Bifu, the banking union, fears that 30,000 jobs will be lost this year and yesterday the union was urging delegates at the TUC to write to NatWest in protest at that bank's redundancy plans.

One solution to falling demand promoted by the banks - cutting costs by building up telephone banking - will make the redundancy problem worse. Both Midland's FirstDirect and Girobank have developed telephone services which provide basic banking much more cheaply than a high street branch. But the more people switch their accounts to telephone banks, the less business there is for branch banks to share. Result: more branch closures; more redundancies.

A decline in the number of branches is inevitable. The extent to which banks can slow this process will in part turn on their ability to develop and sell new financial products. These could be the services that small businesses say they need and claim they are not getting: access to high-quality accounting, tax, and management advice. They could be ethical life assurance policies and pension plans. The Nineties will see the cleverer banks getting away from the emphasis on selling people loans, and instead thinking of more imaginative ways of collecting savings.

The banks must also tackle their unpopularity. There is nothing much that can be done now about their duff loans to Peru or Canary Wharf, but a lot can be done to improve relations with their customers. For many corporate customers it is a question of nursing them through the rest of the recession. There are already plenty of companies that might have gone under but which, after a period of intensive care, have found new capital and are trading successfully. But some have been shut down unnecessarily. If the banks are not to damage both themselves and the country they must cope more sensitively with customers who are in trouble.

The relationship with companies may matter more for the economy as a whole, but the greater challenge comes in the relationship with personal customers. Businesses have to go to the banks; people do not, for they have an alternative in the building societies.

The Eighties saw radical improvements in the quality of service of several big British nationalised industries. But the banks have not lifted their game, and perhaps do not fully realise the peril they are in. Their advertisements assert, like the slogans of the old East European governments, how wonderful they are. But it is as though the adverts are a substitute for change, rather than a part of it. The banks' problems do not stem so much from external pressures such as the sluggish economy; they come from within.