̽��ֱ�� of Cambridge - banking

Could cryptocurrency help the ‘bottom billion’?

lw355 — Mon, 17 Oct 2016 12:02:53 +0000

‘Cryptocurrency’ is a form of finance that exists only online. Unlike national currencies like the British pound, it isn’t forged as coins or printed as notes and no central authority governs it.

Most often it’s associated with an eclectic mix of individuals: gamers, hackers and the tech-savvy; anti-authority libertarians who believe in a global currency; gamblers happy to speculate on ‘digital gold’; shady dealers, money launderers, users of adult content services and the dark web; forward-thinking members of the financial sector.

But it has also been looked at as one possible solution to help a very different demographic – the world’s poorest poor, the so-called bottom billion. Many in this demographic lack bank accounts, have difficulty in proving they own their own land or business, and frequently depend on sending or receiving money across borders to poorer relatives.

In fact only one in five adults living on less than $2 per day has a bank account, and nearly 80% of poor adults, or two billion people, are excluded from the formal financial system. Meanwhile, the World Bank estimates that 75% of the $581.6 billion global remittances in 2015 were sent to developing countries.

But how can cryptocurrencies help? Since its launch in 2009, bitcoin, the most well known of digital currencies, has had a chequered history. Issues with market volatility, security and regulation, together with its association with online black markets like the now defunct Silk Road, have created suspicion among citizens and policymakers alike.

And yet, a recent headline in Wired stated: “Thought bitcoin was dead? 2016 is the year it goes big”; the reason, they explained, is it can “provide a much cheaper and simpler way of moving money from place to place, particularly when you’re a consumer or business moving it across international borders or a retailer accepting payments from online buyers.”

Dr Garrick Hileman, who researches the impact of cryptocurrency on world finance at the Cambridge Centre for Alternative Finance, adds: “And it’s not just transfer fees. Conventional financial systems can suffer from slow transfer times, inconvenient hours for completion of transfers, limited access to transfers, and the failure of approximately 2% of all international transfers to be successfully completed. These all negatively impact remittances.”

He and colleagues have been looking at which markets and countries are the most likely to adopt cryptocurrencies based on 40 different factors, ranging from degree of technology penetration to cross-border transactions fees to history of financial crises and inflation. ̽��ֱ��results indicate that Sub-Saharan Africa, Latin America and former-Soviet Union countries have the greatest potential for adopting cryptocurrency.

“Cryptocurrency is an immature technology and is not without flaws. However, as with any new technology, it’s the applications that have ignited interest – it’s raised important questions about how cross-border payments can be improved and, wider still, whether the very special type of ledger system that underpins cryptocurrency can be used for any number of other areas.”

At the heart of bitcoin is the ‘blockchain’, a database that records all transactions chronologically through a unique series of numbers arranged in ‘blocks’, which are then ‘chained’ to the next block cryptographically, so as to be both secure and accurate. This linking of information makes them like a financial ledger, but unlike centralised banking systems, the blockchain is a database that can be stored and shared worldwide by anyone with a computing device and internet connection – hence its description as a distributed ledger technology (DLT).

Part of the promise of cryptocurrency lies in the absence of a gatekeeper in its set-up, as Hileman explains: “Transactions occur person to person, or machine to machine, without the need for third party institutions – and that means lower or no transaction fees.”

“For the seven years bitcoin has been operating, there hasn’t been a single minute of downtime, unlike traditional IT networks employed by banks and other institutions. This resiliency has people’s attention,” says Hileman. “And currency is not the only thing that DLT can be used for. It can be used to exchange anything that has value – stocks, houses, airline miles, notarisations, votes.”

This year, the Government Office of Science published a report in which Chief Scientific Advisor Professor Sir Mark Walport described distributed ledgers as “powerful, disruptive innovations that could transform the delivery of public and private services” and “provide new ways of assuring ownership and provenance for goods and intellectual property.”

One of the recommendations was for the UK research community to ensure that distributed ledgers are scalable and secure. ̽��ֱ��report added that the Alan Turing Institute – a joint venture by the universities of Cambridge, Edinburgh, Oxford, ̽��ֱ�� College London, Warwick and the Engineering and Physical Sciences Research Council – would help to support these endeavours.

“We probably have yet to see the full extent of future uses of distributed ledgers,” adds Hileman. “However, our research has shown that cross-border transactions are viewed as one of the most promising applications of distributed ledger tech, due to the high transaction fees, technical interoperability issues, complex and conflicting regulatory frameworks, and legacy equipment and processes associated with existing systems.”

To realise this potential, he says, there are problems that need to be solved for customers in developing countries: “people know they are being stung by transaction fees but are still reluctant to switch for a wide range of reasons.”

“It could even be that banks themselves adopt the technology, and yet still enable its distributed peer-to-peer set-up, offering it as a separate service to their traditional monetary services. In other words, customers may never know their transactions are happening on a blockchain,” he adds.

Bitcoin has had a volatile exchange rate and Hileman concedes that it’s too early to know whether regulatory measures will help shield customers from this and other risks, or reduce money laundering and financial crimes committed with bitcoin. In the meantime, the Centre’s work on benchmarking cryptocurrency and blockchain activity will provide useful data for policymakers and other stakeholders keeping an eye on the technology.

“More than $430 billion was sent in remittances to developing countries in 2015, mostly to India, but also China, Mexico and Nigeria,” says Hileman. “ ̽��ֱ��costs of these transactions – which can average as high as 12% in Sub-Saharan Africa – hit the poor the hardest. Technological advances like cryptocurrency and distributed ledgers may offer a solution.

“It would be surprising to me if in 30 years from now we aren’t looking back and saying yes this was a watershed moment for financial inclusion, and that cryptocurrency and distributed ledgers played a significant role in opening up access to the financial system in developing economies.”

Many of the world’s poorest poor don’t have access to a bank account and yet depend on being able to transfer money across borders. Could digital currency help, ask researchers at the Cambridge Centre for Alternative Finance.

More than $430 billion was sent in remittances to developing countries in 2015, mostly to India, but also China, Mexico and Nigeria. ̽��ֱ��costs of these transactions hit the poor the hardest

Garrick Hileman

FamZoo Staff

From cash to digital

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Opinion: Forget Super Thursday, the Bank of England can only offer Mildly Useful Thursday

Anonymous — Wed, 03 Aug 2016 11:18:06 +0000

̽��ֱ��Bank of England is expected to announce on Thursday measures to stimulate the UK economy following signs that there will be a significant economic downturn following the vote for Brexit. ̽��ֱ��Bank may cut interest rates, inject another dose of quantitative easing or conjure up something new to give the economy a monetary boost.

Although some have dubbed this “Super Thursday”, it cannot hope to be anything of the sort. ̽��ֱ��Bank only has tools to help ameliorate the immediate damaging impact of the Brexit vote. It can do little to address the underlying structural problems of the UK economy; structural problems that are likely to deepen unless the government makes a U-turn and uses fiscal policy as a means to stimulate long-term economic growth.

̽��ֱ��impact of the Brexit vote will be revealed over many years. ̽��ֱ��immediate evidence is patchy but the initial signs are that the economy is slowing down. ̽��ֱ��Purchasing Managers’ Index, which is a lead indicator of GDP, shows that the UK economy suffered a significant deterioration following the Brexit vote.

Sterling totters. J D Mack/Flickr, CC BY-ND

Sterling has weakened and this was expected to stimulate manufacturing exports. But the immediate evidence suggests that even manufacturing activity is slowing down. ̽��ֱ��Bank is also expected to revise downwards its growth forecast for the UK economy – not simply because of its macroeconomic model but also, as the Financial Times has reported, because some of its economists have been talking to businesses and finding out the story from the horse’s mouth.

Stimulating

̽��ֱ��Bank, assuming the mantle of the “muscular” interventionist, is expected to introduce further monetary stimulus to help business confidence and encourage spending. This should help to reduce the depth of the emerging downturn and it will assuage markets that at least there has been some response to deal with the impact of the Brexit vote.

But there is little evidence that monetary stimulus alone will address the long-term weaknesses of the UK economy. There are two major limitations of excessive reliance on monetary policy to manage the economy.

First, it does little to expand the capacity of the economy by stimulating new investment. Second, it increases the inequality of wealth: the big gainers are those who own assets which are propped up by the monetary stimulus such as housing, bonds and shares. Very low interest rates have increased demand, but this demand has served to increase the prices of existing assets – such as the cost of housing. It has had little impact on the creation of new assets, such as house building and corporate investment and expansion.

̽��ֱ��Big Problem

One of the major long-term problems facing the UK economy is stagnant productivity, the prime determinant of future prosperity and income growth. There are a number of drivers of productivity including investment in capacity, investment in education and the creation of new ideas. Monetary stimulus can do little to stimulate these.

Low interest rates may stimulate private sector investment in normal times, but such investment is discouraged by economic and financial uncertainty. An active fiscal policy is required to address the productivity problem, including state investment in infrastructure, housing and education.

And the productivity problem is likely to get worse in the long-term as the UK wrestles with its post-Brexit legacy. First, the UK will find it more difficult to trade with both Europe and the rest of the world. This will lead to a widening of the UK’s trade deficit or a permanently lower exchange rate – or possibly a combination of both. Second, the level of foreign direct investment into the UK economy is likely to fall as foreign firms remain in, or move into countries within the EU single market.

Third, there will be serious disruptions to the UK’s innovation system. Universities are one of the strong aspects of the UK system, but their ability to attract funding and world-class researchers will be hindered when (or if) the UK leaves the single market. Furthermore, much business research and development in the UK is carried out by overseas firms, which may fall if such firms move or expand abroad.

A New Industrial Policy?

̽��ֱ��Brexit vote has led to a new government and a new opportunity to recast economic policy. ̽��ֱ��new Prime Minister has indicated her support for industrial policy and she has established a new Department for Business, Energy and Industrial Strategy. But we have been here before and the rhetoric and rebranding has often not been followed by action.

̽��ֱ��decisions of the Bank of England that will be announced on Thursday may be mildly useful, but they can’t hope to be much more than that. They can do little to alter the long-term direction of the economy. ̽��ֱ��key issue is whether the new government acknowledges the important role for the state in driving long-term growth and re-orientates fiscal policy towards increasing public investment in infrastructure, education and innovation.

Michael Kitson, ̽��ֱ�� Senior Lecturer in International Macroeconomics at Cambridge Judge Business School, ̽��ֱ�� of Cambridge

This article was originally published on ̽��ֱ��Conversation. Read the original article.

̽��ֱ��opinions expressed in this article are those of the individual author(s) and do not represent the views of the ̽��ֱ�� of Cambridge.

Michael Kitson (Cambridge Judge Business School) discusses how the Bank of England may try to give the economy a boost.

Captain Roger Fenton

̽��ֱ��Bank of England & ̽��ֱ��Duke of Wellington.

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Spending for smiles: money can buy happiness after all

Anonymous — Thu, 07 Apr 2016 15:00:00 +0000

People who spent more money on purchases which matched their personality were happier, found the study, published in the journal Psychological Science. According to the researchers, matching spending with personality was more important for individuals’ happiness than the effect of individuals’ total income or their total spending.

̽��ֱ��study, by researchers from the ̽��ֱ�� of Cambridge, was conducted in collaboration with a UK-based multinational bank. Customers were asked whether they would complete a standard personality and happiness questionnaire, and to consent to their responses being matched anonymously for research purposes with their bank transaction data.

̽��ֱ��final study was based on 76,863 transactions of 625 participants. ̽��ֱ��study whittled down 112 spending categories automatically grouped by the bank into 59 categories that had at least 500 transactions over a six-month period.

̽��ֱ��study matched spending categories on the widely recognised “Big Five” personality traits – openness to experience (artistic versus traditional), conscientiousness (self-controlled vs easy-going), extraversion (outgoing vs reserved), agreeableness (compassionate vs competitive), and neuroticism (prone to stress vs stable).

For example, eating out in pubs was rated as an extroverted and low conscientiousness (impulsive) spending category, whereas charities and pets were rated as agreeable spending categories. Further examples can be found below.

̽��ֱ��researchers then compared the participants’ actual purchases to their personalities using this scale, and found that people generally spent more money on products that match their personality. For example, a highly extroverted person spent approximately £52 more each year on pub nights than an introverted person. Similarly, a highly conscientiousness person spent £124 more annually on health and fitness than a person low in conscientiousness.

̽��ֱ��study was authored by Sandra Matz, a PhD candidate in Cambridge’s Department of Psychology; Joe Gladstone, a Research Associate at Cambridge Judge Business School; and David Stillwell, ̽��ֱ�� Lecturer in Big Data Analytics & Quantitative Social Science at Cambridge Judge Business School.

“Historically, studies had found a weak relationship between money and overall wellbeing,” said Gladstone. “Our study breaks new ground by mining actual bank transaction data and demonstrating that spending can increase our happiness when it is spent on goods and services that fit our personalities and so meet our psychological needs.”

̽��ֱ��researchers believe the findings hold widespread implications, including for Internet businesses using search-based recommendation engines. Companies can use this information to recommend products and services that don’t just increase clicks, but will actually improve the wellbeing of their customers – allowing companies to forge better relationships with customers based on what makes them happier.

̽��ֱ��researchers also backed up their findings by running a second experiment, where they gave people a voucher to spend either in a bookshop or at a bar. Extroverts who were forced to spend at a bar were happier than introverts forced to spend at a bar, while introverts forced to spend at a bookshop were happier than extroverts forced to spend at a bookshop. This follow-up experiment overcomes the limitations of correlational data by demonstrating that spending money on things that match a person’s personality can cause an increase in happiness.

“Our findings suggest that spending money on products that help us express who we are as individuals could turn out to be as important to our well-being as finding the right job, the right neighbourhood or even the right friends and partners,” said Matz. “By developing a more nuanced understanding of the links between spending and happiness, we hope to be able to provide more personalised advice on how to find happiness through the little consumption choices we make every day.”

Categories with the lowest and highest scores on each of the Big Five personality traits:

Big 5 Trait	Low	High
Openness	Traffic fines, residential mortgages	Entertainment, hair and beauty
Conscientiousness	Gambling, toys and hobbies	Home insurance, health, fitness
Extraversion	Home insurance, accountant fees	Entertainment, travel
Agreeableness	Traffic fines, gambling	Charities, pets
Neuroticism	Stationery, hotels	Traffic fines, gambling

Reference:
Sandra C. Matz, Joe J. Gladstone, and David Stillwell. ‘Money Buys Happiness When Spending Fits Our Personality.’ Psychological Science (2016). DOI: 10.1177/0956797616635200

Adapted from a Cambridge Judge Business School press release.

Money really can buy happiness when spending fits our personality, finds a study based on 77,000 UK bank transactions.

Spending can increase our happiness when it is spent on goods and services that fit our personalities and so meet our psychological needs.

Joe Gladstone

Glen Scott

Shopping

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Alternative finance market set to double in 2015

sc604 — Fri, 07 Nov 2014 09:10:33 +0000

A total of £1.74 billion will have been raised through alternative finance intermediaries – including crowdfunding, peer-to-peer lending and invoice trading – by the end of 2014, according to new research published today by the ̽��ֱ�� of Cambridge and Nesta, the UK’s innovation foundation.

Alternative finance covers a variety of new financing models which connect people seeking funds directly with funders, often through online platforms. ̽��ֱ��majority of these providers have been founded in the last five years. Regulation of parts of the industry was introduced by the Financial Conduct Authority (FCA) in April this year, and in October the Treasury launched a consultation on a proposal for an ISA for peer-to-peer lending.

In the first three quarters of 2014, alternative finance platforms facilitated loans, investments and donations worth £1.2 billion, with the amount predicted to reach £1.74 billion by the end of the year. ̽��ֱ��researchers predict the amount will reach £4.4 billion in 2015.

̽��ֱ��report shows:

Peer-to-peer business and consumer lending continued to dominate the market with £749 million and £547 million being lent through the models respectively in 2014.
Equity-based crowdfunding reached £84 million, up 201 per cent year on year.
̽��ֱ��alternative finance market has more than doubled in size year on year from £267 million in 2012 and £666 million in 2013, to £1.74 billion in 2014.

By the end of the year it is expected that the UK alternative finance market will have provided more than £1 billion in business finance to over 7,000 small and medium enterprises in the UK, the equivalent to 2.4 per cent of all bank lending to SMEs. In the last quarter, bank lending to small and medium-sized enterprises was down by £400 million, according to the Bank of England’s latest Trends in Lending report.

44 per cent of SMEs surveyed were familiar with at least one type of alternative finance, but just nine per cent had approached an alternative platform for finance.

Over half (58 per cent) of UK consumers surveyed were aware of a type of alternative finance, with more than one in seven (14 per cent) saying they had used an alternative finance platform to seek, lend or donate funds.

“2014 has been a phenomenal year for the industry and this record-breaking growth is set to continue into the next year and beyond,” said Bryan Zhang of the Department of Geography, one of the report’s co-authors. “By connecting people directly and offering more efficient, diverse and transparent ways to invest or raise funds, alternative finance is increasingly becoming a viable source of capital for individuals and businesses alike. Although there are challenges ahead, the future looks very promising for alternative finance.”

Liam Collins, another co-author on the report, said: “These findings shed light on a growing movement that is revolutionising banking, investing and giving by using technology to simplify the links between those who want to invest money and those who need it. With bank lending to SMEs down again this quarter, it’s no wonder that alternative finance is fast becoming an important source of funding for individuals, businesses and organisations who struggle to access finance elsewhere.

“ ̽��ֱ��UK is leading the way globally, and with significant potential for the market to expand it won’t be long before we see alternative finance moving into the mainstream.”

“ ̽��ֱ��UK alternative finance market is burgeoning and we need to develop a more nuanced understanding of its structural drivers, intrinsic characteristics, dynamics and diversity, challenges and opportunities,” said Dr Mia Gray of the Department of Geography. “This report is an important first step to promote empirical research in this increasingly significant area of our economy.”

̽��ֱ��report is the result of a collaboration between Nesta and the ̽��ֱ�� of Cambridge, with support from PwC and ACCA.

̽��ֱ��UK’s alternative finance market – which includes crowdfunding, peer-to-peer lending and invoice trading – is set to reach nearly £2 billion by the end of the year, and is expected to double in 2015, as businesses increasingly seek more efficient ways to raise funding.

By connecting people directly and offering more efficient, diverse and transparent ways to invest or raise funds, alternative finance is increasingly becoming a viable source of capital for individuals and businesses alike

Bryan Zhang

Rocío Lara via flickr

Crowdfunding

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Stress hormones in financial traders may trigger ‘risk aversion’ and contribute to market crises

fpjl2 — Tue, 18 Feb 2014 09:27:09 +0000

High levels of the stress hormone cortisol may contribute to the risk aversion and ‘irrational pessimism’ found among bankers and fund managers during financial crises, according to a new study.

̽��ֱ��study’s authors say that risk takers in the financial world exhibit risk averse behaviour during periods of extreme market volatility – just when a crashing market most needs them to take risks – and that this change in their appetite for risk may be “physiologically-driven”, specifically by the body’s response to cortisol. They suggest that stress could be an “under-appreciated” cause of market instability.

Published today in the journal Proceedings of the National Academy of Sciences, the study conducted at the Cambridge Judge Business School and the ̽��ֱ��’s Institute of Metabolic Science is the first to show that personal financial risk preferences fluctuate substantially, and these fluctuations may be linked to hormone response.

̽��ֱ��finding could fundamentally alter our understanding of risk as, up until now, almost every model in finance and economics – even those used by banks and central banks – rested on the assumption that traders’ personal risk preferences stay consistent across the market cycle, say the authors.

In a previous study conducted with real traders in the City of London, researchers observed that cortisol levels rose 68% over a two week period when market volatility increased. In the latest study they combined field work with lab work, a rare approach in economics, to test for the effects of this elevated cortisol on financial risk-taking.

̽��ֱ��researchers administered hydrocortisone – the pharmaceutical form of cortisol – to 36 volunteers, 20 men and 16 women, aged 20 to 36 years, over an eight day period, raising their cortisol levels 69%: almost exactly the levels seen in the traders.

̽��ֱ��volunteers took part in lottery-style financial risk-taking tasks with real monetary pay-offs, designed to measure the preferences for risky gambles and the judgments of probability underlying their risk taking. While initial spikes of cortisol had little effect on behaviour, chronically high and sustained levels, as seen in traders, led to a dramatic drop in participants’ willingness to take risks, with the ‘risk premium’ – the amount of extra risk someone will tolerate for the possibility of higher return – falling by 44%.

“Any trader knows that their body is taken on a rollercoaster ride by the markets. What we haven’t known until this study was that these physiological changes - the sub-clinical levels of stress of which we are only dimly aware - are actually altering our ability to take risk,” said Dr John Coates, co-lead of the study from the Cambridge Judge Business School, and a former Wall Street derivatives trader himself.

“It is frightening to realise that no one in the financial world – not the traders, not the risk managers, not the central bankers – knows that these subterranean shifts in risk appetite are taking place.”

Cortisol is a hormone secreted by the adrenal glands in response to moments of high physical stress, such as ‘fight or flight’. Importantly, cortisol also rises powerfully in situations of uncertainty, such as volatility in the financial markets. Cortisol prepares us for possible action by releasing glucose and free fatty acids into the blood. It also suppresses any bodily functions not needed during a crisis - such as the digestive, reproductive, and immune systems.

However, should this stress become chronic, as it might during a prolonged financial crisis, the elevated cortisol can contribute to impaired learning, heightened anxiety, and eventually depression. ̽��ֱ��current study has now shown that in addition to these known pathologies, chronic stress can also lead to a substantial decrease in the willingness to take financial risks, say the researchers.

They also suggest that an unsuspected side effect of anti-inflammatory treatments such as prednisone may be financial risk aversion.

̽��ֱ��study’s authors also looked for differences between men and women. While other researchers have argued that women are more risk averse than men, the current study found no differences between the sexes under normal circumstances. However, the study did find that, when exposed to chronically-raised levels of cortisol, men placed too much importance on smaller risks, while women did not.

̽��ֱ��authors point out that during the Credit Crisis of 2007 to 2009 volatility in US equities spiked from 12% to over 70%. They argue that it is reasonable to assume that such historically high levels of uncertainty would have caused stress hormones to rise far higher and longer than the team had been able to observe in their study.

Chronic stress may therefore have decreased risk taking just when the economy needed it most – when markets were crashing and needed traders and investors to buy distressed assets, they say.

Physiologically-driven shifts in risk preferences may be a source of financial market instability that hasn’t been considered by economists, risk managers and central bankers alike.

Added Coates: “Traders, risk managers, and central banks cannot hope to manage risk if they do not understand that the drivers of risk taking lurk deep in our bodies. Risk managers who fail to understand this will have as little success as fire fighters spraying water at the tips of flames.”

New study’s findings overturn theory of personal risk preference as a ‘stable trait’, and show that real source of instability in risk behaviour “lurks deep in the physiology of traders and investors”.

It is frightening to realise that no one in the financial world – not the traders, not the risk managers, not the central bankers – knows that these subterranean shifts in risk appetite are taking place

John Coates

Rafael Matsunaga via Flickr

That was supposed to be going up, wasn't it?

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Fraud claims and board games: What now for regulation and governance?

bjb42 — Thu, 02 Aug 2012 07:57:04 +0000

Sir Adrian Cadbury is one of a number of distinguished experts who will be speaking at the 4th Cambridge International Regulation and Governance Conference on 6 September. Booking details can be found at www.anglia.ac.uk/reggovconference

Under the banner, "More regulation, or better stewardship?" the conference will ask how far the global financial crisis has posed a challenge to existing systems of governance and regulation and where they should go from here.

Current reviews, both in the UK and Europe, have suggested that poor governance of major companies was one of the reasons behind the economic failure which began in 2008. Some reforms to the way in which these companies are controlled and regulated have already taken place, but as the Libor-fixing scandal suggests, big questions about governance remain.

̽��ֱ��aim of the conference, which is being jointly hosted by the ̽��ֱ�� of Cambridge and Anglia Ruskin ̽��ֱ��, is to encourage the exchange of ideas about these issues between practitioners specialising in governance and regulation, policy-makers and academics.

"As we examine the mistakes of the past and look to the future we need to think carefully about how our companies and banks should be governed," Dr Paul Sanderson, a specialist in regulation at the ̽��ֱ�� of Cambridge and one of the conference organisers, said. "Essentially the question is do we want more rules, which could potentially stifle innovation and growth, or better stewarding of what are, after all, our assets?"

Sir Adrian Cadbury, who is also a ̽��ֱ�� of Cambridge alumnus, will address the conference on the 20th anniversary of his landmark contribution to the field, the "Report of the Committee on the Financial Aspects of Corporate Governance." ̽��ֱ��publication of this report led to the first code of corporate governance being established as a requirement for a listing on the London Stock Exchange and ultimately to the current UK Corporate Governance Code and numerous such codes around the world.

These lay down basic principles on matters such as the separation of the roles of Chairmen and CEOs, the appointment of non-executive directors to boards, the responsibilities of board members and indeed shareholders, and how decisions should be made about senior executives' pay.

But, constructing a universal template - a set of rules that can be applied to all types and sizes of companies on all occasions - is almost impossible. Cadbury cleverly incorporated into the code the comply-or-explain principle to deal with this. It allows companies to explain to their stakeholders when they have not fully conformed to the rules. It is then a matter primarily for shareholders to consider whether such action is justified and react accordingly.

Some explanations may be considered unacceptable, where a powerful figure fails to convince shareholders of the need to combine the roles of Chairman and CEO. In other cases non-compliance may be unavoidable, such as the inability of a director to attend the requisite number of board or committee meetings through illness, or even death.

In addition, while in theory the rules reflect best practice, best practice is also something which evolves. So non-compliance by a company may simply mean, in some cases, that the company has followed best practice and the code itself needs revising.

̽��ֱ��difficulties in determining the extent to which rules should be operated flexibly in codes of corporate governance is mirrored in the regulation of many other sectors, such as financial services, health and safety, hospitals, railways and so on. Failure inevitably and rightly leads to calls for better regulation, which often means that the rules become less flexible and enforcement measures become stronger.

Yet this action, while it may prevent some future failures, may also prevent innovation - the development of new products and services that would benefit us all. Getting the balance right is difficult - but clearly something has gone wrong, or we would not be suffering an economic downturn, with banks needing bailouts and GDP in many countries more or less stagnant.

This suggests that, as the Leveson Inquiry in the UK has hinted, we need to examine the culture of organisations. Most public companies are, as the name suggests, owned by the public one way or another, through pensions, insurance or savings plans. It is possible that greater emphasis is needed on protecting our assets, by implementing measures which ensure companies in whom we and large institutional shareholders invest adopt the practices and ethos of the very best.

These complex issues will be the subject of more than 40 papers which will be presented by experts from around the world at the conference on 6 September.

̽��ֱ��10 plenary and parallel sessions focus on topics such as corporate governance, regulation and ownership, board composition, executive pay and regulating the financial sector. In addition, the directors of two companies founded more than 400 years ago will speak on how to manage companies in the long run. To set the scene, Philip Augar, author of “ ̽��ֱ��Death of Gentlemanly Capitalism” will speak at the pre-conference dinner at Queens College, on 5 September.

Further information about the conference can be found here

̽��ֱ��author of the report which laid the basis for British and international corporate governance codes will be the guest speaker at a conference which asks what the future of such measures should be.

As we examine the mistakes of the past and look to the future we need to think carefully about how our companies and banks should be governed.

Paul Sanderson

SEIU.

Banking Protest.

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̽��ֱ��crisis of shareholder primacy

bjb42 — Mon, 19 Mar 2012 15:44:21 +0000

How do we prevent another financial crisis? Since the devastation that began with the collapse of the U.S. subprime mortgage market in 2007, a great deal of ink has been spilled trying to answer this question.

Unfortunately, most official accounts of the crisis, and how to avoid the next one, have missed the mark. They have overlooked the fundamental problem: a corporate governance model that the puts the private interest ahead of the public interest.

Financial institutions in most countries today are governed based on the theory of shareholder primacy. According this model, the institution’s management has one overriding duty: to maximize shareholder returns. True to its name, shareholder primacy puts shareholders in the driver’s seat; they get to choose the people who will run the financial institution for their benefit alone.

There are good reasons for supporting shareholder primacy. It is based on a healthy distrust of managers, who may be tempted to use the firm’s resources to pursue their own interests, rather than those of shareholders. Asking managers to balance the concerns of a number of different constituencies is just a license for them to abuse their power.

As a result, shareholder primacy tries to remove any ambiguity by making managers beholden to a single group – the firm’s shareholders. In addition to imposing legal obligations on directors and officers, today’s dominant corporate governance regime ties executive compensation to the share price. All of this is designed to align the interests of shareholders and managers.

In theory, this makes sense, but in practice it’s a recipe for crisis, specifically in the context of financial institutions. ̽��ֱ��business model of financial institutions is very different from that of an ordinary firm.

Basically, financial institutions profit from the “spread” between short- and long-term interest rates. In other words, they make money by lending at higher rates than they borrow. Thus, the best way for a bank to increase its profits is by increasing its “leverage” – that is, by making as many loans as possible.

But the greater the bank’s leverage, the greater its risks. This is because if the bank’s debtors begin to default, or if there’s a perception that they might, the bank’s creditors (its depositors) will come running for their money all at once; hence the expression “bank run”. During a run, the “mismatch” between the bank’s assets and liabilities leaves it strapped for cash, and can ultimately lead to insolvency and failure. This is precisely what happened to the likes of Northern Rock just a few years ago.

What does all this have to do with shareholder primacy? Since shareholders are interested in maximizing profit, they will encourage the financial institution, through its managers, to increase leverage. Given the legal obligations and financial incentives facing mangers today, they will likely oblige. If they don’t, the capital markets may see the firm as “undervalued”, making it a target for a hostile takeover bid, which, if accepted, will result in the management team being replaced by a more shareholder-friendly one.

Therefore, in a world where shareholders rule, the pressure on managers to satisfy the thirst for leverage and profit is tremendous.

We have known for decades, thanks to economists like John Maynard Keynes and Hyman Minksky, that financial institutions’ propensity for risk-taking is a key driver of economic instability. In order to maximize profit, banks look to progressively riskier assets, putting their faith in so-called “financial innovations”, which promise all the benefits of leverage without any of the risks.

For a time, rising asset prices validate bankers’ optimism, but eventually the bubble bursts, exposing it as nothing less than delusional. In the recent crisis, the innovations of choice were based on a method called securitisation, which in theory is supposed to distribute risk efficiently. In practice, however, securitisation turned out to be a “weapon of mass destruction”, as legendary American investor Warren Buffett put it.

̽��ֱ��methods were new this time, but the pattern of behaviour was anything but. In the last five decades, we have seen repeated crises of this kind, albeit not of this magnitude. So why don’t we learn from history? Why don’t we heed the warnings?

̽��ֱ��ideology of shareholder primacy has a lot to do with it. To begin with, during the boom, when shareholders are getting rich, the system makes it almost impossible for managers to buck the trend.

In addition, managers are not only expected to pursue shareholders’ economic interests, but their political ones as well. Not surprisingly, therefore, the financial industry is notorious for its lobbying activity. In the 1980s, the City of London pushed for the deregulation of the financial system. At the time, the reforms were dubbed the “Big Bang” due to the explosion in the capital markets that ensued; today the moniker is still appropriate, but for entirely different reasons…

As a result, those who would leave shareholder primacy in place and put their faith in regulation to stop the next crisis are mistaken. They do not account for the financial industry’s political influence, which has been used to weaken regulation or “capture” those who enforce it. And they are overconfident about the ability of regulators, regardless of their resources and independence, to keep up with financial innovation, especially given the unprecedented complexity and global scale of today’s financial system.

While stricter regulation – particularly with respect to capital requirements – is crucial, such reforms risk being undermined by the perverse incentives of shareholder primacy. A situation in which the regulatory system is butting heads with the corporate governance system is incoherent and unlikely to promote economic stability in the long term.

A final problem with shareholder primacy is that it results in the wrong kinds of people being appointed to serve as directors and officers of financial institutions. ̽��ֱ��skills and temperament that maximize shareholder profits conflict with those that promote economic stability. As a result, shareholders prefer dealmakers to caretakers.

True, directors and officers of financial institutions must pass the Financial Services Authority’s “fit and proper” test. But, as Lord Turner concluded in his review of financial regulation in the UK, these standards were poorly enforced in the years leading up to the crisis. This is because it was assumed – consistent with shareholder primacy – that financial institutions themselves were better placed to decide who should manage them. Not surprisingly, most bank executives didn’t understand the risks they were taking; some didn’t even have prior financial industry experience.

In order to prevent the next crisis, we need to do away with shareholder primacy for financial institutions, which are a special kind of company. We need a new corporate governance model that recognizes the essential role that financial institutions play in the wider economy and society. This means, at the very least, that their managers must have a legal duty to consider the public interest, and have the knowledge and temperament to discharge it accordingly.

If we want to prevent the next financial crisis, a new model of corporate governance is needed to replace shareholder primacy in financial institutions. Gates Scholar Mike Marin explains why.

In a world where shareholders rule, the pressure on managers to satisfy the thirst for leverage and profit is tremendous.

Mike Marin.

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