Alternative Banking: Competitive Advantage and Social Inclusion Kurt von Mettenheim & Olivier Butzbach Paper presented at the Society for the Advancement of Social Economics 23rd Annual Conference Universidad Autónoma de Madrid, June 23-5, 2011 1 Abstract There is ample empirical evidence to suggest that not for profit financial institutions (savings banks, cooperative banks and development banks – what we call here alternative banks) have outperformed their joint-stock competitors in the past few decades – especially since the largest overhaul of banking regulations after the 1930s and prior to the 2007-08 crisis. This presents us with two puzzles. The first puzzle is empirical: the regulatory reforms of the 1990s led to banking markets de-segmentation, liberalization, an increase in competition and banks’ reliance on capital markets for funding and investment. Such changes seem to run contrary to many of the fundamental characteristics of the business model embodied by alternative banks (non profit-maximizing, social mandates, stakeholder model of corporate governance). How is it then that alternative banks thrived in such a hostile environment? The second puzzle is theoretical: vast sways of the literature on banking have explored market failures of various kinds (in particular information asymmetries, constitutive of the banking system) – but not much seems to have been written yet on the theory of alternative banking, and how alternative banks might increase a country’s welfare through increased social inclusion. Similarly, modernization theories within the comparative political economy literature ignore to a large extent the contribution made by alternative banks. The aim of this paper, therefore, is twofold – one, to discuss and analyze the sources of alternative banks’ competitive advantage over for-profit, jointstock banks; secondly, to review the features that make up the specific business model of alternative banks, with a particular attention to their role enhancing social inclusion in advanced and developing countries. The ultimate goal of this paper is to contribute to lay the ground for a theory of alternative banking. 2 Introduction The great banking crisis of 2008 has led to deep soul-searching on the part of bank regulators and academics alike. No account of the crisis can avoid laying at least part of the blame on bankers, and in particular “dramatic failures of corporate governance and risk management at many systematically important financial institutions” and “a combination of excessive borrowing, risky investment and lack of transparency” (FCIC, 2011). In other words, the business model put in place by most large banks, in the United States and in Europe, was fatally flawed. And its flaws had much to do with an inadequate incentive system. To quote, again, the report published by the Financial Crisis Inquiry Commission (set up by the US Congress in the immediate aftermath of the crisis in 2009), “executive and employee compensation systems at [large banks] disproportionally rewarded short-term risk taking” (FCIC, 2011: 243). As a consequence of the crisis, far-reaching reforms of the banking sector have been announced. In the United States, the Dodd-Frank Act, passed in 20101, creates new regulatory authorities and incorporates a watered-down version of the so-called “Volcker rule” (i.e. a rule limiting banks’ exposure to risky investment through ownership of shares in hedge funds and private equity firms2); in the United Kingdom, the government recently gave its seal of approval on proposals made by the Independent Commission on Banking (set up in 2010), in its 2011 Interim Report – in particular, the proposal to “ring-fence” retail banking by having retail banking activities carried out by a separate subsidiary in bank holding companies. These post-crisis reforms fall in line with calls for a return to “narrow banking” coming from various parts of the academic world3. There are, De Grauwe argues, two alternative approaches to reform banking regulation to avoid future crises (De Grauwe, 2009). One is the “Basle approach”, based on scientific advances in risk analysis – which justified the move from Basle I to Basle II and, since 2010, Basle III. This approach is doomed, De Grauwe argues, because it is based on a flawed hypothesis: the efficiency of capital markets, and because it fosters potential conflicts of interest. The only workable alternative is then, De Grauwe suggests, the “GlassSteagall approach”, i.e. a return to narrow banking, where banking activities are “narrowly circumscribed” (De Grauwe, 2009). Indeed, as De Grauwe argues, the problems with banks in the 1990s-2000s is not only that commercial banks, through diversification, started behaving like investment banks; it is also that investment banks started behaving like commercial banks, creating credit (to hedge funds for instance). 1 The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law by President Obama on July 21, 2010. 2 In the Dodd-Frank Act that limit was set to 3% of a bank’s Tier 1 capital. 3 Of course, soul-searching has not stopped at the borders of banking theory, but has invested the whole discipline of economics and finance. While many post-crisis contributions are critical of the key assumptions of mainstream economics theory (see, for instance, Akerlof & Shiller, 2009, on challenges to the efficient markets theory; or Stiglitz, 2010, for a broad-brush attack on mainstream economics), others have remained faithful to the core hypotheses of individual rationality and market self-regulation. Richard Posner, for instance, argues in his book about the crisis that “the profit-maximizing businessman rationally ignores small probabilities that his conduct in conjunction with that of his competitors may bring down the entire economy." (Posner, 2009) 3 Gorton, too, advocates a return to old banking regulations restricting bank entry into various markets (Gorton, 2010). Such restriction, Gorton argues, create “charter value”, i.e. incentives for bank managers / owners to avoid risk that would jeopardize future monopoly profits. Entry into banking by nonbanks causes charter values to fall (Gorton, 2010: 166). Gorton thus pleads for a re-enactement of old regulations except that they would bear on activities and not on institutions themselves. More generally, economists have had to address the deep flaws in mainstream theories that, it is argued, played an indirect role in the financial collapse of 2007-2008 – through, in particular, its encouragement of financial innovation, competition and liberalization without enough regard for their impact on systemic stability (see footnote 3). It is remarkable, however, that such sweeping questioning and rethinking has not paid much attention yet to those banks that, for a large part, have withered the most extreme aspects of the crisis (bankruptcies, wiped-out equity, liquidity and solvency crises, bank bailouts, forced mergers): savings banks, cooperative banks and development banks. These “alternative banks” (or ABs), as we call them in this paper, not only fared better than their joint-stock counterparts during the crisis and its aftermath4; they have been constantly over-performing them for some time – whether we compare cost efficiency, riskiness or even, in some respect, profitability - a paradox as ABs are in principle not profit-maximizing entities. After the crisis alternative banks have, in other words, retained competitive advantages over private commercial and investment banks – in a context characterized (pre-crisis) by the regulatory reforms of the 1990s, which led to banking markets de-segmentation, liberalization, an increase in competition and banks’ reliance on capital markets for funding and investment. These changes seem appear to run contrary to many of the fundamental characteristics of the business model embodied by alternative banks (non profit-maximizing goals, social mandates, stakeholder model of corporate governance), which creates our first puzzle. As Canning et al. (2003) put it, “a central issue is why notfor-profit banks arise and survive in a world dominated by investor-owned banks, run for profit”. In other words, what are the foundations for alternative banks’ competitive advantage? A first (empirical) answer would be that alternative banks retain competitive advantages because of greater client confidence, broad retail networks and relational banking deeply embedded in local, regional, national and international social and political economy networks. But a deeper discussion of contemporary banking and political economy theories is required. The other issue of interest here is that of the key role played by alternative banks with regard to social inclusion. Cooperative banks and savings banks, often owned and run by local governments, have 4 We do not argue here that alternative banks are entirely immune from speculative or risky behavior. Indeed, the troubled fate of the German Landesbanken (local government-owned) over the past few years, as well as the difficulties experienced by many Spanish savings banks, the Cajas. One of our hypotheses, however (which will be discussed in later sections), is that alternative banks, overall, are less incline to undertake risky behavior, for a variety of reasons. 4 served local communities across Europe, some for centuries. Drawing on banking theory5, we argue here that alternative banks’ unique position within the banking sector is likely to help them provide counter-cyclical lending, thus contributing to avert the formation of asset bubbles, soften the impact of downturns, shorten economic recessions. Furthermore, we argue that alternative banks can be instrumental in reaching broader policy goals – economic development and social inclusion. Alternative banks’ broader retail networks help avert capital drain and improve access to public goods, especially banking products and related services such as insurance for citizens and small and medium enterprises. Alternative banks provide more patient capital than equity markets to help firms and households through hard times. Alternative banks are able to monitor firms, debts and the economy better, especially when markets fail to provide accurate information and efficient pricing. The social mandates, core management principles of sustainable profitability and stakeholder governance makes alternative banks averse to the excesses of profit maximization and able to invest longer-term for infrastructure and social policy. Alternative banks thereby contribute to development by investing where private banks or fund managers remain unwilling to put money. Finally, alternative banks provide policy alternatives for social and political forces while dramatically reducing the fiscal cost of government and increasing control over public policy. Special (development) banks may help implement reforms such as privatizations, public sector modernization and provide long-term finance for green policies, industrial renovation and lead consortia for social and human investments. Government banks provide a powerful fiscal advantage: they produce more public policy for less cash. The slim central offices, low cost/income ratios and principles of profit sustainability at special purpose banks and development banks provide powerful competitive advantages over private banks and help lower the costs of public policy. Staff at cooperative and savings banks can manage complex information about local needs, costs, benefits and risks to improve policy formulation and, thereafter, assert contractual control to correct public policies before they run astray. Alternative banks also tend to retain greater client confidence and trust. This reduces liquidity risk and enables alternative banks to increase price competition without incurring excesses of unscrupulous marketing and unethical sales driven by imperatives of profit maximization at private banks. The long histories and institutional networks of alternative banks embedded in social networks and political institutions provide powerful competitive advantages in banking and shape markets. Alternative banks also embody traditions of social economy and solidarity that resonate with the dominant political parties in European Welfare States and democracies abroad. Finally, we suggest that we ought to take another look at the theory of change applied to banking and banking systems. In the past decades, alternative banks have retained profound competitive advantages while providing policy alternatives and supporting social economies – in both advanced and emerging economies. For instance, liberalization of banking in Latin America has led to the internationalization of the industry but also the modernization of alternative banks and pursuit of 5 Such as Berger et al., 2010 and Bhattacharya & Thakor (1993) or much earlier works such as Macloed (1856). 5 new policies to accelerate social inclusion. Liberalization and new information technologies have thus produced a “back to the future” modernization of public savings banks rather than their substitution by private commercial and investment banks through privatizations or competitive pressures. The following sections explore these arguments by drawing from theories of political economy and banking. Section 1 offers a brief discussion of the nature and origins of alternative banks, showing how ABs emerged from the bottom up as depositories for popular savings – thereby securing broader retail networks, more secure liability bases and larger capital reserves compared to the riskier liability profiles and leverage strategies of private, commercial banks. A closer look at the history of ABs also clarifies the transition from wholesale to retail alternative banking. Once significant capital reserves were accumulated and demand for broader wholesale banking services emerged, savings banks and cooperative banks formed giro associations and wholesale banking divisions to serve their broader retail networks and client/member/customer base that reinforced local institutions and branch offices. Mature alternative banks can therefore build on solid capital reserves and savings deposits by providing wholesale banking and financial services while branching out into insurance, leasing, factoring and a variety of related products and services. By building on these competitive advantages, alternative banks have remained at the center of new banking landscapes after liberalization of the industry and while information technologies revolutionize banking. Section 2 explores the more recent period in the history of ABs, and draws on recent empirical studies comparing their performance to that of joint-stock, commercial banks. Section 2 also introduces the question of the foundations of ABs’ competitive advantage. Section 3 then turns to contemporary banking theory for understanding the foundations of ABs’ competitive advantage. Section 4 focuses on the role of Abs for public policy and social inclusion. As we will see, the role and impact of alternative banks shed new light on discussions about the validity of state and non-market intervention in finance, the importance of banking for sustainable development and proper relations between politics, public policy and markets. In section 5 we look at the processes of change in banking, as highlighted above, before offering our conclusions. 1. Alternative banks: nature and origins 1.1. The nature and origins of alternative banks: some definitions Banking is commonly defined as the activity of accepting deposits and making loans. This is a minimal definition6 that captures the core characteristics of banks and, therefore, does not seem very controversial. However, besides what is often seen as their core business, banks do many other things as well. As a modern textbook on banking puts it, a bank now is a “multifaceted financial institution, staffed by multi-skilled personnel, conducting multitask operations” (Matthews and Thompson, 2008). Modern banks offer a broad range of financial products to firms and households, 6 On minimal definitions, see Gerring, 2010. 6 distribute insurance products, provide financial advice, manage assets and liabilities, underwrite securities, trade securities and derivatives on markets, invest in hedge funds, are important actors in the corporate governance of large corporations and small firms alike. And even if one wants to subsume those multifold activities within a narrow set of economic functions (such as the twin functions of consolidating and transforming risk on the one hand, and acting as dealers or brokers on credit markets on the other hand, as Gurley and Shaw (1960) first, and then Baltensperger (1980) suggested), one cannot but notice that banks are institutions that are deeply embedded in their social context and political economy. Banks make donations to political parties and candidates. They seek to influence agendas and government policies through industry associations, interest groups and lobbying. Banks tend to be more political than other enterprises7. Large banks symbolize national presence in the global economy and are often seen as too large to fail, even by politicians normally disposed to let firms go bankrupt to avert moral hazard8. Beyond politics, banks are also tightly linked to their social context, through their ties with depositors, borrowers, firms and local governments alike. In addition to banks being “multifaceted institutions”, there are many non-banking entities that provide a very similar range of financial products and services: stock brokers, insurance companies, pension funds, mutual funds, credit mutual guarantee associations, mortgage and savings associations and a variety of other entities. Given this vast reach of phenomena, a minimal definition of banking should separate complex and contested matters from the core business of banking, defined above. This semantic choice has, of course, deep implications, as it implicitly lends support to the view, presented above, that banking regulation should “go back to basics” and make banks stick to their core identity as deposit taking and loan making institutions. But this issue of definitions will be tackled later. Once we agree on a definition of what a bank is, it is not difficult to define alternative banks. In our view, alternative banks are banks that distinguish themselves for a series of characteristics, namely their non profit-maximizing goals, their social or public mandates and their stakeholder model of corporate governance9. This definition excludes private commercial and investment banks, but includes a wide variety of banks and credit institutions such as development banks, special banks, savings banks, cooperative banks and mutual guarantee associations. Alternative banks vary widely in terms of organization, ownership and corporate governance. However, they share traditions of stakeholder governance that center on corporate boards rather than delegation of management to CEOs and top staff.10 Cooperative and savings banks’ governance thereby tends to include 7 And their links to government might seem at times inextricable. For an example, see Sorkin (2010) for an excellent account of the crisis and how the Goldman Sachs-US Treasury nexus reacted to it. 8 The bankruptcy of Lehman Brothers being a dramatic exception to that rule, while the massive bank bailouts under TARP was the proof of it. 9 That’s why our alternative banks strongly resemble the “not for profit financial institutions” in Canning et al. (2003) and “stakeholder banks” (Coco and Ferri, 2010). 10 On stakeholder governance and management structures in alternative banking, see Schmidt (2004) 7 representatives from employees, labor unions and stakeholders such as government officials and social and political personalities. Development banks, on the other hand, tend to retain centralized operations under the authority of finance ministries and responsible for government policy. Alternative banks’ stakeholder-oriented corporate governance differs from private banks’ shareholder-oriented corporate governance insofar as control and decision making in the former belongs to broadly representative boards that include participation of creditors, employees and other public and private groups associated with bank operations. Schmidt (2004) argues that stakeholder governance at alternative banks favors voice over exit, implies more stable management and longer terms in office, involves representation of local and regional banks and employees, and retains corporate control and decision making power on the board rather than upper management or shareholders. Stakeholder governance also implies coordination and cooperation outside the bank with associate institutions in industry organizations and political and social forces and government representatives. Stakeholder-oriented governance is, indeed, reinforced by another distinctive characteristic of alternative banks, which is the principle of profit sustainability over time in the service of broader institutional goals and missions such as development, environmental sustainability, social inclusion, regional policies and social and cultural investments. Alternative banks do not maximize profits, although most of them do aim to generate profits out of their business. But they have an often explicit mandate to achieve socially desirable goals or to conduct public missions. Cooperative banks, for instance, traditionally cater to needs of the lower-income earners and smaller firms, rooted in local communities. Savings banks often redistribute their profits (this is the case in Spain or France) to finance NGOs, welfare, the arts. Development banks explicitly direct their funding towards public priorities, such as social housing. Alternative banks thereby retain corporate cultures that remit to founding missions and long histories involved in social economy. A third important characteristics of savings banks, cooperative banks and most other alternative banks (but not development banks11) is their peculiar organization: they tend to be locally rooted, decentralized retail banking institutions with a second tier of wholesale banking and shared operations for giro, payment transactions, finance and other services. Most alternative banks emerged from the bottom up as local and regional associations that subsequently linked to form regional, national and international forms of cooperation to achieve economies of scale while retaining the core principles of alternative banking. Indeed, and this should be clear by now, alternative banks are very much the product of a peculiar history. And their nature as peculiar economic and social institutions has more to do with the way 11 This important difference between savings and cooperative banks, on the one hand, and development banks on the other, did not deter us from including the latter in our broader category of “alternative banks”, given their strong resemblance on the other two characteristics – stakeholder governance and not profit-maximizing goals – which are, in our view, crucial in determining alternative banks’ behaviour – and, ultimately, their impact on society. 8 they developed over time than with the characteristics that today distinguish them from private, for profit banks. Modern banking emerged in Europe in the XVIth century from the transformation of money lenders into merchant banks. However, at the same time in Italy and Spain, catholic orders and monarchies encouraged the creation of pawnshops to reduce usury and the power of urban money lenders – and to create and diffuse money. The Monti di pietà, or elaborate pawnshops, emerged during the 16th and 17th century with large capital reserves and a patrimony that became essential to finance crown and court, especially for war and to repress rebellions. The Monti soon set up their own banks. Those banks were public in nature and performed banking activities that were already quite distinct from the burgeoning merchant bank business. A peculiarity of public banks is the original nature of their founders, specifically philanthropic institutions, whose mission included aid to particularly weak social classes (orphans, abandoned children prisoners, unmarried mothers), sanitary assistance (like hospital institutes) and granting particular accessible forms of credit to the poorest people (the system of loan pledge on the Monti di Pietà is a typical example. (Giannola, 2009: 19) The “public bank” model, arguably born in Naples with the Banco di Napoli in the early XVIth century, was then exported. Neapolitan Bank representatives appear to have presented their model to Northern European monarchs as early as 1572. More than two centuries later, savings banks emerged in Northern Europe. Cooperative banks emerged in the mid-XIXth century, mostly as part of the Raiffeisen and Schultz movements. These three major types of alternative banks12 – pawn and popular savings banks, savings banks and cooperative banks – share with the earlier public model their philanthropic origins (Mura, 1996). Instead of profit maximization, early alternative banks were founded by religious orders, public concession or philanthropists with the mission of consolidating a capital base and endowment able to cover the budgets of charitable institutions. The accumulation of deposits and endowments was such that several decades after founding, alternative banks generally emerged to gain significant market share of domestic banking. This involved relations from the bottom up, but also politics from the top. As Giannola observes about Neapolitan public banks: Authorizations granted in the course of time by the Spanish Vice-royalty to the Philanthropic Institutes so that they could extend their activities usually controlled by the “money lenders” quickly made them dominant on the market. (Giannola, 2009: 20) In sum, in the origins of alternative banking we find the core principles of profit sustainability and the use of gain for prudent capitalization and support of charitable institutions. 12 Although it should be clear here that if the concept of “alternative banks” makes sense today, as private, for-profit banks seem to be the norm, it did not in the XVIIIth or XIXth century, when retail banking was dominated by savings and cooperative banks. We will come back to this point in the conclusion. 9 Nonetheless, or precisely for that reason, liberal economists, Marxists and corporatists share critical a view of alternative banks for a variety of reasons. Liberal economists believed that alternative banks may have been temporarily necessary to overcome social exclusion, but that once capital was accumulated it should be put to more efficient and effective purposes via private banks and capital markets. Marxists largely condemned alternative banking as elite philanthropy designed to dupe workers into the worst of fetishes, that of credit. Corporatists, and fascists later, also perceived the capital reserves and patrimony accumulated in alternative banks as a resource for rapid industrialization and, where they came to power, intervened and asserted single party control over local and regional savings banks and cooperative banks. In a broader perspective, it should be noted that alternative banks emerged during what Polanyi calls the “long 19th century” to form one of the pillars13 of the banking industry in many European countries. This suggests that Polanyi´s account of the three fundamental social reactions to markets during industrialization (agrarian protectionism, labor unions and central banking) may be enriched by including social and alternative banking (Polanyi, 1944). While alternative banks appear to have been more important in late developing countries, building societies and savings trusts in England and a wide variety of alternative banks in the US, many brought by European immigrants during the 19th century, suggest that alternative banking may be at the center of both early and late development. Alternative banks subsequently suffered a wide variety of disruptions and reorganization amidst revolutions, regime change, the 1920s boom followed by crisis and depression in the 1930s and two world wars. However, after 1945 alternative banks reemerged during reconstruction to become a critical part of European social economies and Welfare States. Since the 1980s, economic liberalism and private sector biases have dominated the mindsets and epistemic communities that have driven European unification. Neo-classical paradigms and conceptions of banks as private joint-stock firms have also informed policies of liberalization for banking and finance and transition to unified rules for competition, regulation, supervision and accounting standards. However, contrary to widespread expectations of convergence toward private banking and capital market centered finance, alternative banks have modernized to maintain or expand market shares in the 21st century through a rich variety of institutional and legal reforms, governance strategies, mergers and acquisitions and new joint ventures. The following sections take a closer look at the nature and historical development of the three main types of alternative banks: savings banks, cooperative banks and development banks. 1.2. A brief history of alternative banks 13 two if we adopt German terminology (where pillar 1 is made of cooperative banks, pillar 2, savings banks, and pillar 3, private banks). 10 Savings banks The first savings banks were created in Europe in the late XVIIIth – early XIXth century. Indeed, “the savings bank concept is a European idea” (Kohler, 1996), which first took root in continental Europe. According to recent works, the world’s first savings bank was the Ersparnisklasse der Allgemeine Versorgungsanstalt (savings section of the Prudential Institute), created in Hamburg in 1778 (Wysocki, 1996). In the late XVIIIth century several similar institutions were founded in Northern Germany: the Leihekasse der Grafschaft Lippe (now Sparkasse Detmold), in Detmold; the ancestor of the Landessparkassen zu Oldenburg in the city of Oldenburg; and Kiel’s savings bank, all three created in 1786. The savings bank movement then spread throughout all German territories, reaching a number of 110 banks in 1825. Savings banks were established in Switzerland at around the same time, with a Dienstenzinskasse (employees’ cashier) founded in Bern in 1787, the Caisse d’Épargne et de Dépôt founded in Geneva in 1789, another one in Zurich in 1805 and then in other cities. But the savings banks movement took its real impulse in Great Britain, from which it then spread to the entire world. Some local savings banks were created in the late XVIIIth century by British aristocrats. However, the first real savings banks created in Great Britain were the Tottenham Benefit Bank, founded in 1804 by Priscilla Wakefield, and the Ruthwell Savings Bank, founded in Ruthwell, Scotland, by Rev. Henry Duncan in 1810. These two savings banks experimented with the practice that then came to characterize the whole savings bank movement: the freedom to save and the liquidity of deposits. From then on, indeed, savings banks were known as institutions where depositors could save whatever amount of money they could (or wanted), be paid an interest on it, and get part or all of their money back at any moment. Savings banks gained ground in England and followed a rapid expansion path during the first decades of the XIXth century: there were 289 savings banks in Great Britain in 1820. Savings banks gained official consent in 1817 with a bill that created the trustee savings banks system. In 1841, the British Isles had 555 savings banks. From Great-Britain, the savings bank movement then reached Denmark (with its first savings bank created in Holsteinborg in 1810), Ireland (Kilkenny, 1816), the Netherlands (with two savings banks established in 1817: in Workum and Haarlem), Scandinavia (Norway, Sweden, Finland) in 1820. France and Italy followed suit, respectively, with the establishment of a savings bank in Paris in 1818 and in Padua in 1822 (see next section). Savings banks were then established in Belgium (Tournai, 1825), Spain (Madrid, 1838), Portugal (Lisbon, 1844) and Luxembourg (1853). By the mid-XVIIIth century, therefore, savings banks were established and operated throughout most of Western Europe. The savings banks movement then reached other parts of the world, such as the United States (first savings bank created in 1816) and the British Dominions (Australia in 1835, New Zealand in 1847). The original intent of savings banks was to teach popular classes the habit of saving, increase the liquidity of capital and spur economic growth. Savings banks were largely disregarded by economists 11 favoring laissez faire policies during the 19th century. Nonetheless, philanthropists and (usually local) governments founded savings banks to ameliorate poverty and reverse social exclusion. Almost a century after the Caisse d’Epargne was founded in France, Charles Gide argued that savings banks should remain limited, like piggy banks, to collecting small amounts of capital. Neo-liberal theories also expected government savings banks to be replaced by more efficient private commercial and investment banks. The contrary has occurred. Savings banks have modernized and integrated operations in many European countries to expand market shares and sustain social and economic policy alternatives. Government savings banks also remain central institutions in developing and emerging countries. Liberal theories of bank change underestimate the competitive advantages of savings banks and the importance of the policy alternatives these institutions provide. In Europe, savings banks varied widely, from cooperative and non-profit associations to political and civil organizations and government entities (Mura, 1996). For example, in Great Britain savings banks took the form of cooperatives and providence associations, especially after the 1832 Poor Law proscribed charity. Savings banks were designed to help workers become financially independent and reduce the fiscal cost of public services (See Price, 1773; Aclan, 1786, Eden, 1801 and Coloquoun, 1806). Gosden estimates that membership in UK friendly societies reached over 5.5 million by the 1870s (Gosden, 1961). The founding ideas, organizational form and evolution of European savings banks differed widely. However, local and regional government savings banks were founded in most countries. Some savings banks were privatized during the 1980s and 1990s, most notably in England and Italy (the latter splitting social functions to savings bank foundations). However, most savings banks were not privatized. Instead, these institutions modernized and created national networks to compete with private commercial and investment banks as European Community reforms opened the industry. Since liberalization of banking, most European savings banks have increased market shares, sought to reaffirm social mandates and provided policy alternatives. Private banking and capital markets predominate in liberal market economies such as the UK and US. However, since opening Continental European banking during the 1990s, all three ‘pillars’ of domestic banking have modernized (i.e. private banks, government savings banks and cooperative banks - an expression taken from debates about German banking). The experiences of savings banks in Europe are of special interest because liberalization of banking and monetary unification during the 1990s increased competitive pressures. Bank change across Europe is complex, varied and still underway. However, the successful modernization and integration of government savings banks is marked. The central developments of European savings banks from 1945-2000 (with select updates) is summarized in Appendix A. Cooperative banks 12 The co-operative societies which have prospered are those that have made up their own capital by the heroic setting aside of part of working men´s daily wages. Those to whom the Government made loans in 1848 have soon broken up. (Schulze, cited by Macloed, 1896) Cooperative banks are deposit taking and loan making institutions grounded on the “one member, one vote” principle of corporate governance. When they appeared, in the mid-19th century, they were designed as philanthropic self-help institutions to encourage workers to join resources and accumulate savings – such was the model offered by the Schulze and Raiffeisen movements. Cooperative banks were first created as alternatives to laissez faire theories of labor market efficiency and the policies inspired by Ferdinand Lassalle to grant credit to workers. After 1860, credit cooperatives in many German, Italian and other European states expanded rapidly in two phases. The first “retail” phase was the gradual accumulation of core liability base of savings deposits and reserve capital. The second “wholesale” phase involved the organization of another tier of shared banking serves such as cross border payment transactions, giro accounts and other products. By the late 19th century, credit cooperatives came under criticism by Marxists and liberals alike. Cooperatives nonetheless flourished during the early 20th century only to succumb to nationalism, xenophobia and mobilization for war during World War I. By the 1920s in Italy and 1930s in Germany, Spain and Portugal, fascist and phalange movements reorganized cooperative movements under single party and central government control. After 1945, cooperative banks reemerged and regained large market shares in many European countries, while remaining less important in market centered economies such as the US and UK. It also is of note that most developing countries retained centralized banking institutions instead of decentralized cooperatives. Cooperative banks can be distinguished from other banks because of their core principle of member ownership and “one member one vote” principle of corporate governance. The traditional business model of cooperative banks is domestic retail banking with a regional or local geographic focus. Membership governance traditionally involved participatory decision making and equal distribution of profits to members through dividends. These core characteristics of cooperative banking reinforce social inclusion and competitive advantage. Stakeholder-based governance and profit sustainability reinforce prudent banking, avert unethical marketing and sales and sustain firms and families through longer-term relationship banking. Another key characteristic of the historical development of the cooperative banks in the XIXth – XXth century was the constitution of integrated networks – a two-tier structure that remains in place today. Members first built local and regional cooperatives through membership expansion and the accumulation of savings, credit portfolios, assets and capital balances for members and reserves. The successive expansion of inter-bank deposits reflects the gradual expansion of cooperative banks away from core business of savings and credit for members toward other banking products and services. The next step was the emergence of the second tier of wholesale cooperative banking – which took 13 place in Germany with the founding of central cooperative agencies in 1895. Appendix B shows data reflecting this twin characteristic: the down-market focus and the importance of wholesale financial services. In sum, cooperative banks developed into two tier wholesale-retail institutions and networks based on “one member one vote” membership governance and business model valuing profit sustainability to sustain its local focus and social mission. The first stage of development was the accumulation of deposits, loans and capital in reserve in regional cooperatives to ensure viable operation of retail banking. The second stage follows in the creation of new products and services for a second tier of wholesale banking that leverages the accumulation of savings and capital reserves. The creation of Giro central transaction institutes and financial market groups shared by cooperative banks is a structure retained until today, one that maximizes scale and scope to reduce the cost of wholesale banking but retaining the decentralized relationship banking possible by the local and regional branch offices and networks of individual cooperative banks. This sequence is similar to the emergence of two tiered structure in the savings banks sector. Another similarity between savings and cooperative banks’ history is the interruption of this process by centralization under fascism in Italy and Germany. While cooperative banks emerged from the bottom up during the latter half of the 19th century and early 20th century, these institutions were consolidated under party and state control by the fascist movement. In Italy, the Banco Nazionale de Lavoro (BNL) also emerged under fascism through the forced consolidation of local and regional cooperative banks. However, here again, there are significant cross-country differences in the way cooperative banks were organized. As seen above, continental European cooperative banks emerged primarily as part of the Raiffeisen and Schulze-Delitzsch movements while UK cooperative banks were organized as banking divisions of existing cooperative wholesale societies linked to commercial groups. Development banks Development banking describes a variety of institutions that financed industrialization during late development across Continental Europe, Asia, Latin America and other developing nations (see Aghion, 1999 and Hirschman, 1961). Given that private banks were unable to measure and unwilling to bear long-term risks associated with infrastructure investments,14 Continental European governments founded industrial development banks in the early 19th century (Sylla, 1991)15. The 14 ‘The logically sound basis for the presumption against long-term commitments is that it is much more difficult to estimate a borrower’s creditworthiness 20 years ahead than 6 months ahead. The factors relevant to creditworthiness are substantially different over the longer period and the capacity and experience required in the bank manager are of an all together different order, an order it is not reasonable generally to expect unless he has specialized expert staff.’’ R. S. Sayers, Central Banking After Baghot, (Oxford: Oxford University Press, 1957) cited in Aghion, 1999, p. 3 15 Aghion notes: ‘The oldest government-sponsored institution for industrial development is the Société Générale pour Favoriser I’Industrie Nationale which was created in the Netherlands in 1822. However, it was in France that some of the most significant developments in long-term state-sponsored finance occurred. In this respect, the creation in 1848–1852 14 French government-owned Crédit Mobilier soon became both model abroad and shareholder in other European development banks as its ability to finance railroads and accelerate industrialization became widely acknowledged.16 The Crédit Mobilier also became a model for banks in Asia, such as the Industrial Bank of Japan and Industrial Bank of India (Diamon, 1957). Development banks were also founded after World War I for European governments to provide cash, subsidized loans and guarantee of bank bonds for industrial reconstruction.17 After World War II, the Kreditanstalt fur Weidaraufbau (Reconstruction Credit Agency, KfW) and Japan Development Bank were created to channel Allied government funds for reconstruction. German and Japanese development banks thereafter adopted new policies and strategies as development challenges evolved. Newly independent countries in Africa and Asia also created development banks after World War II to channel World Bank loans and foreign aid.18 Gerschenkron, Myrdhal, Lewis and other economists argued that development banks were essential to accelerate industrialization in late development. Development banks were central to the commanding heights approach. Johnson’s study of the Japanese Ministry of Technology and Industry (MITI) remains a classic account of finance, late development and government intervention (Johnson, ) Hirschman argued that economic development in Latin America required inducement mechanisms and policy coordination to channel foreign assistance as well as public and private investments (Hirschman, 1963). State development banks and agencies were also cited as critical agents for accelerated growth in developing countries of Asia (Woo, ). However, times have changed. The different character of manufacturing, information technology, financial markets and banking in the 21st century suggest that more complex tradeoffs between markets and development banking now obtain (Evans, ). Woo-Cummings summarizes three problems with development banks (Woo-Cummings, 1999). First, because development banks tend to deeply leverage large industrial groups with bank credit, state-owned and private enterprises avoid going public through issues of equities. Second, the massive scale of political and economic interests of institutions such as the Crédit Foncier, the Comptoir d’Escompte and the Crédit Mobilier, was particularly important’, Aghion, 1999, p. 3 16 On development banks in Europe, see Kindleberger, (1984) and Cameron, (1972). ‘Of even greater importance than the outcome of the operations of the Credit Mobilier were the intangible benefits such as the imitated skills of the engineers and technicians which it sent abroad, the efficiency of its administrators and the organizational banking techniques which were so widely copied.’ (E. Cameron, 1953, cited in Aghion, ‘Development Banking’, p. 86). 17 Aghion cites: Société Nationale de Crédit à I’Industrie (Belgium, 1919), Crédit National (France, 1919), 1928, National Bank, Poland, 1928), 1928, Industrial Mortgage Bank (Finland, 1928), Industrial Mortgage Institute (Hungary, 1928), 1933, Instituto Mobiliare Italiano (Italy, 1933), Instituto per la Ricostruzione Industriale (Italy, 1933). 18 Diamond notes: ‘Probably the aggregate resources provided by the development banks have been small, but the fact that there were made available at particular times for strategically important enterprises and industries gave them a significance far greater than the amounts involved suggest’, Diamond, Development Banks, pp. 38-9. 15 associated with development banks often increase moral hazard and require costly bailouts. Development banks can protect outmoded industry, impede economic innovation and sustain bad equilibrium. Large scale development projects are also notorious for their impact on the environment. Finally, Woo-Cumings argues that development banks tend to unfairly transfer the cost of risk through either inflationary finance that monetarizes industrial losses, or through government infusions of equity that hides losses in government accounts. For Woo-Cumings, the Asian financial crisis during 1997-1998 reinforced views that development banking places domestic political economies at greater risk.19 Development banks fell from favor after 1980 as policies of liberalization and privatization were adopted to free market forces. Development banks also inspire essentially contested, diametrically opposed theories and concepts about government intervention, banks and financial markets. For critics, development banks reproduce financial repression, favor rent seeking and unfairly subsidize industry. Their centralized technocratic decisions tend to remain beyond public scrutiny and may have profound environmental impacts. However, paradigmatic development banks such as the KfW and Development Bank of Japan have led in terms of transforming industrial production toward environmentally sustainable practices and processes. Special Purpose banks also suggest that governments retain the tradition of strategic investments in priority sectors such as home construction and agriculture. For example, mortgage banks and other public institutions democratized home finance and ownership and led in the securitization of mortgages and deepening of capital markets since the early 20th century. 2. Alternative banks’ performance in a hostile environment: the past twenty years As seen above, combination of prudent profit sustainability, client confidence and social mission have been the core characteristics of alternative banks for the past two hundred years. But how have alternative banks fared in the context of regulatory reforms and profound changes in financial systems in the 1980s and 1990s? The following sections offers a brief summary. 2.1. Changes in alternative banks’ environment: the 1980s and 1990s During the 1980s and 1990s, alternative banks were faced by a series of adverse shocks that arguably threatened their very identity and the roots of their success. Shifts in industrial countries’ macroeconomic regimes modified the constraints and incentives associated with monetary policy. As Forsyth and Notermans observe: “the growth regime of the 1950s and 1960s relied on monetary and fiscal policy (macro-policies) to stimulate demand and thereby promote growth and employment, while it used labor market policies and regulation of financial markets (micro-policies) to curb inflation; by contrast, the dis-inflationary regime of the 1980s and 1990s relied and still relies primarily on 19 On competing explanations of the Asian financial crisis, see Hall (2003). 16 monetary policy (macro-policy) to fight inflation and maintain external balance, and on supply-side policies, including selective tax cuts and other investment incentives (micro-policies) to promote growth and employment” (Forsyth and Notermans, 1997). Such changes in macro and micro economic regimes echoed and reinforced the opening of financial markets (to capital flows and foreign investment) and led to increased competition within them – which deepened financial globalization, as mentioned above. Indeed, the lift of capital controls and the abandonment of deficit monetization policies, both increased the depth (and therefore the attractiveness) of financial markets and gave them, in return, greater leverage on macroeconomic policies pursued. Shifts in industrial countries’ macroeconomic regimes led to, or accompanied profound changes in financial regulation. Three broad trends can be identified: privatization, de-segmentation (of financial activities), and a shift from “structural” to “prudential” regulation. This new wave of “de-regulation” (following that of the 1960s) profoundly affected the organization and functioning of the banking industry in most industrialized (and developing) economies, along the lines of market opening (or desegmentation) and expansion. As Gardener argues, a deregulated banking environment is “predicated to a large extent on the economic desirability of a strong market orientation, a demand-determined emphasis, in banking strategies.” (Gardener, 1994: 59.) In addition to these changes in macro and micro regulation, since the 1970s, a series of technological innovations took place that radically transformed the business of finance over successive years. Powerful, high-speed electronic networking has allowed real-time information flows across markets and between institutions – interconnectivity becoming the cornerstone of financial markets’ interdependence. Technological innovation has streamlined banking and financial business organization, and has changed clients’ relationships with their banks: automatic teller machines (ATMs) first allowed multiplying the territorial rooting of banks; e-banking later allowed clients to perform many operations at home. Changes in customers’ behaviour put further pressure on banks and financial institutions to adjust. Large firms were the first to change their financing behaviour. With rising interest rates and the emergence of stock markets in the 1970s, many large firms throughout Europe started resorting to the market (through commercial notes and bonds) to finance their investment needs, thus leaving their traditional banking lenders in search for a new strategy. With the rapid growth of the stock market in the 1980s and 1990s and the availability of new instruments (as well as new services geared towards helping firms access market finance), many medium-sized firms were also tempted to shift from bank loans to bonds issued on the market. Changes in clients’ behaviour were not circumscribed to banks’ liability side. More recently, households too have been modifying their financial behaviour. First, they have been offered the 17 possibility of diversifying their portfolio and starting to earn real interest20 on some of their savings. Secondly, households have been switching their funds from short-term savings to protect themselves against the risk of becoming unemployed, to longer-term investment destined to complement their pensions. Overall, “banks’ twofold dependence on money markets and credit ratings today plays a similar role to the last-century’s fear of a depositor’s run on the bank.” (Verdier, 2002). The vast transformations in their regulatory, technological and competitive environment in the 1980s could not leave banks unaffected. In fact, even while the transformation of banks’ environment was under way, many observers made conjectures on what changes banking would undergo (see, for European banking, European Commission 1990; and PriceWaterhouseCoopers 1988). In particular, four trends were identified: (i) growing competition; (ii) banking disintermediation – that is, the crowding out of bank intermediation by market actors and activities; (iii) the marketization of banking – that is, the increased reliance of banks on financial markets for their revenues, and the transformation of banking strategies to better suit market incentives and constraints; (iv) the “rationalization” of banking structures – that is, the restructuring of the banking system through mergers and acquisitions. In other words, the profound transformation banks’ environment were entirely geared towards more market-oriented structures and behaviour – evidently polar opposites to the traditional business model evoked above. Yet alternative banks have held their ground. 2.2. Recent developments in alternative banking Since liberalization of banking across Europe, domestic regulators and alternative bank managers have pursued a wide variety of policies and strategies. Some traditional public savings banks were privatized, notably in Sweden. Some public savings banks opted for conversion into cooperatives, notably in France. Italian savings banks were privatized, but with shares delegated to newly created Foundations designed to reaffirm the traditional social role of savings banks while assuring the separation of banking from charity and social programs and policies. German savings and cooperative banks retained their legal forms (mostly local government firms) to consolidate and deepen wholesale networks and associations to compete with private and foreign banks. This wide variety of reforms and management strategies still requires further research. Its outcome, however, seems to have been the re-affirmation of alternative banks’ business model, behaviour and values. Savings banks Unlike the fiasco of savings and loan bankruptcies in the US in the 1980s and 1990s, local, regional and national savings bank groups still remain at the center of domestic banking systems across 20 For instance, from the mid-1970s until the mid-1980s, the real interest rate earned on administered savings (“Livret A”) in France was negative, given a fixed interest rate and high inflation. 18 Europe – which has led some observers to claim that savings banks represent a ‘European Advantage’ over the US and other countries without such institutions (Carnevali, 2005). In fact, far from being destined to failure under growing competitive pressures from private and foreign banks, savings banks have instead reformed, modernized, consolidated and adopted new strategies to compete in more open European banking, credit and finance markets. They have also largely avoided the perils of financial market bubbles and crises, especially in comparison to private commercial and investment banks. Considered individually, local and regional credit institutions are often very small. However, as a whole they sum to a large part of political economy in most advanced economies. And since opening banking to competition during the 1990s, local and regional government banks and decentralized cooperative banks have maintained or increased market shares across Europe. Savings banks also remain important institutions in developing and emerging countries. Savings banks were an invention of European enlightenment; they are also a legacy of European colonization. Savings banks were critical for state formation after independence throughout Asia, Africa and the Middle East.21 They remain so in the 21st century. Given the modernization of banking through the adoption of information technology, electronic and mobile banking, the recognition of microcredit and finance in development and the importance of access to finance and banking services to alleviate poverty and promote social inclusion, it follows that large savings banks may provide important policy alternatives for developing countries. In many developing and emerging countries, very large public savings banks (often postal savings banks) have realized competitive advantages and provided policy alternatives even - and perhaps most importantly - in weak and failed states for public management, social inclusion and reconstruction after war and natural disasters. Cooperative banks Since liberalization of banking in Europe, cooperative banks have modernized as well. They have restructured, merged local and or regional cooperatives to reap economies of scale22 and broadened “second tier” wholesale divisions and operational networks to better offer banking, insurance and financial products and services to members and clients. Cooperative banks have thereby retained or expanded market shares while seeking to sustain their business models of membership governance, profit sustainability and social missions. Many cooperative banks have pursued a variety of new business strategies such as focus on non-retail banking, geographic expansion (even abroad), sale of shares on capital markets to capitalize new business lines, active pursuit of non-member clients, adoption of profit incentives beyond traditional membership dividends, relaxation of membership rights and responsibilities, more strategic staff training, and education programs and corporate communication strategies taken from private 21 On postal savings banks in Asia, see: M. Sher and N. Yoshino (2004). In Germany, for instance, the total number of cooperative banks dropped from more than 3,000 in 1980 to less than 900 in 2010. 22 19 banking while converging toward private bank accounting and reporting requirements and standards. These experiments may weaken traditional cooperative banking principles and operations. Further research is needed on how modernization has affected the traditional structures and missions of cooperative banks. However, in comparison to private banks, cooperative banks tend to offer standardized products, services and interest rates consistent with their socially oriented business model. They also seek to manage portfolios, investments and local business operations consistent with their social mandate. Our review of data suggests that cooperative banks have also retained or expanded market shares since the liberalization of industry and transition toward Basel Accord capital risk guidelines and International Financial Reporting Standards. A look at how cooperative banks emerged clarifies their two-tier structure, alternative corporate governance and competitive business model. We argue that cooperative banks have realized competitive advantages since liberalization of domestic banking systems in Germany, Italy and France. Indeed, for many cooperative banks the 2000 downturn in financial markets was a first turning point as clients returned to more secure deposit and savings accounts. For example, the number of members in the Netherlands Rabobank had declined from peak of one million in 1980 by half to near 500,000 by 2000. However, from 2000-10 Rabobank membership increased to over 1.6 million. Although booming capital markets during the mid-2000s pressured cooperative banks by attracting members and clients away to more lucrative accounts and investment funds in commercial and investment banks, the financial crisis and economic downturn beginning in 2007 in the US reversed this trend. Once again, members and clients preferred the security of traditional large scale cooperative bank networks and the social model and mission in the face of private bank and market abuses and losses. Overview of the structure and market share of cooperative banking provided by the European Association of Cooperative Banks suggests that these institutions remain one of three pillars in many European banking systems. Although further research will be needed to construct time series and understand the variety of modernization strategies, cooperative banks appear to have retained between one-third and half of domestic banking markets in many European countries. The accumulation of branch office networks, data bases, soft information among staff about clients, regions and legal, political and social context has placed cooperative banks in a favorable position as the industry adapts to the revolution of information technology and new products and services for banking, payments, insurance and finance. The corporate governance principles of one member one vote and the participation of members in strategy, control, supervision and decision making also provide an advantage for cooperative banks in terms of self-regulation and the maintenance of banking prudence. These characteristics of cooperative banks led the Oliver Wyman consulting group, in a study commissioned by the European Association of Cooperative Banks, to describe these institutions as “customer champions” able to compete with private and foreign banks since liberalization of European banking. 20 The Oliver Wyman study also identifies a series of current concerns, challenges and institutional foundations of competitive advantage for the sector. For this consultancy, the boundaries between cooperative banks and commercial competitors are blurring because of reduced local autonomy, decreased reliance on members and customers for capital and increased organizational complexity. Moreover, the fundamental differences of the cooperative bank business model remain “prone to attack” from media, regulators and competitors that share a bias toward private joint stock bank model. For this consultancy, the one member one vote principle of governance, the business model of profit sustainability based on cautious capital reserves and lower return, risk-averse business strategies, and the vast retail branch office networks of cooperative banks remain anomalies subject to criticism and competitive pressures. Finally, the EACB commissioned report suggests that the three tier organizational model, profound information advantages of cooperative banks amidst local networks, sustainable dividend policies and profoundly positive image of cooperative banks among members, clients and citizens at large suggest that modernization and reform of cooperative banks may overcome the competitive disadvantages that lower profit margins, heavy capital base and anomaly status during convergence toward international banking standards and European Commission regulations that have freed cross border banking and increased market pressures. These conclusions support our empirical observations and theoretical explorations below. 2.3. The comparative performance of alternative banks The previous section has showed how, defying expectations, alternative banks resisted the potentially devastating impact of the wave of regulatory reform in the 1980s-1990s. Not only did alternative banks hold their ground; they actually outperformed their for-profit counterparts on many counts. Alternative banks have maintained or gained market shares in retail banking (deposits, savings accounts and lending to firms and households). In 2009 in Italy, France, Germany and the Netherlands, cooperative banks’ market share in small business lending ranged between 25% and 45%23. Market shares for ATMs reached more than 50% in France and Austria and more than 35% in Germany and the Netherlands24. European savings banks hold sizeable market shares as well: in 2009, in Austria, savings banks held 17% of assets, deposits and loans in the domestic banking market. In Germany, collectively, the Sparkasse system (including Landesbanken) totaled in 2009 2,364 billion euro (35.5% of the German banking sector’s total assets), making it the third largest banking group in the world (behind the French BNP and UK’s RBS) - while holding a 38.7% market share in bank deposits and 28.1% of the lending market. The Spanish savings banks, Cajas de Ahorro, in the late 2000s held 39% of domestic bank assets, 50% of deposits and 46.9 % of loans in the country. But alternative banks have also outperformed private, for-profit banks on the grounds of profitability and efficiency. Several recent studies have showed the existence of at least slightly higher cost 23 24 Source: European Association of Cooperative Banks. Ibid. 21 efficiencies with savings and cooperative banks. This is, for instance, the findings of Altunbaş et al. (2003), who undertook a study for a sample of banks in 15 European countries and in the US between the years 1990 and 2000. Their results show that savings and cooperative banks are more cost efficient than their commercial peers in all but three countries. More limited studies in scope find the same result; for instance, Giordano & Lopes (2008) on Italian cooperative banks. Iannotta et al (2007), in a study of a sample of European banks find opposite results – namely, government-owned banks and cooperative banks perform worse than private, commercial banks (in terms of profitability and riskiness, but not, interestingly, in terms of costs). This result, however, might be biased by the sampling method – the authors rely on a sample of 181 large banks, automatically overlooking smaller-size savings and cooperative banks. Iannotta et al., though, reach a conclusion in line with what contradictory empirical studies find as well: namely, that alternative banks have a different financial intermediation model than for-profit, joint-stock banks. Alternative banks’ record in terms of profitability is mixed, which is probably not surprising given their non profit-maximizing goals. Still, savings and cooperative banks managed to post higher ROA and ROE in many countries over the past decades. Millon Cornett et al. (2010) present somehow mixed evidence on the comparative performance of government banks. Studying a sample of East Asian banks from 1989 to 2004, the authors find that state-owned banks were less profitable, held less core capital, and had greater credit risk than privately-owned banks prior to the 1997 crisis – but they somehow caught up in the years after the crisis. Another area where alternative banks seem to outperform their commercial peers is risk. Here the evidence is more abundant. Carbò Valverde et al. (2008) show that the presence of savings banks decreases overall risk. La Porta et al. (2002) find that government-owned banks are less stable, Iannotta et al. (2007) find European government-owned banks to be less stable, but cooperative banks more stable than private ones. Salas & Saunders (2007) and Garcia and Fernandez (2008) find that Spanish savings banks are more stable than commercial banks. Hesse and Cihak (2007) also find cooperative banks to be more stable than private banks. Laeven and Levine (2008) find that banks with large, dominant shareholders take more risks than banks with dispersed shareholders. Thus alternative banks seem to hold a clear competitive advantage over their commercial peers. How can we explain sense of such advantage? This is the goal of the next section. 3. The theoretical foundations of alternative banks’ competitive advantage 3.1. Alternative banks in traditional banking theory Banking theory provides many of the concepts and theories used herein. However, we start with a warning. In a broader sense, economists such as Modigliani, Miller, Gurley, Shaw and Fama argue that banks do not play an independent causal role in growth and development. Gurley and Shaw described 22 banks as intermediating institutions that respond to policies of monetary authorities on the one hand and non-financial agents on the other hand (Gurley and Shaw, 1955, 1960). Fama argued that banks simply provide payment services and allocate resources according to the Modigliani-Miller theorem (that describes financial decisions as neutral or irrelevant to economic equilibrium) (Fama, 1980; Klein, 1971). Neo-Classical theories of banking provide a more dynamic view of banks. Tobin argued that ‘old views’ of banks failed to consider the impact of loan practices and interest rates on the economy (Tobin, 1987). For Tobin, bank assets and liabilities are also determined by the behavior of banks. Banks thus seek to maximize returns from lending and interest rates on deposits (Tobin, 1982). Klein extends this organizational conception of banks, suggesting that lending is determined by the marginal returns of assets over the cost of liabilities. This tradition has developed complex microeconomic models of how banks manage reserves, calculate liquidity risk and lend. Santomero models how banks attempt to maximize returns, an approach used to analyze how banks manage both the asset and liability sides of balance sheets (Santomero, 1984). O’Hara describes how banks perform further functions (O’Hara, 1983). For O’Hara, banks are complex organizations that provide brokerage and transform risk, while responding to shareholders and regulatory agencies in the context of uncertainty. This combines views of how banks diversify and value assets with research that emphasizes the function of banks as delegated monitors for the evaluation of risk. O’Hara also emphasizes the importance of liability management and reviews the long line of research on money deposits with banks. Recent banking theory has tended to focus on banks as intermediaries in financial theory, leading to a wide variety of insights about asymmetric information, liability management and credit rationing.25 These concepts and theories from contemporary banking theory help explain the realization of competitive advantage by alternative banks and their policy capacities for social economy. Scholars such as Minsky, Davidson, Chick, Dow, Dymski and Carvalho have also explored the behavior of banks in the context of a still wider range of economic phenomena (Dymski, 1988). Post-Keynesian approaches suggest that banks are an independent causal factor capable of braking or accelerating economic growth, employment, inflation and other economic indicators. For Studart, “The supply of finance is causally determined by banks: it is banks and not savers, who hold a key position in the process of growth.” (Studart, 1995) These scholars emphasize two insights from Keynes, that perceptions of uncertainty are not probabilistic and that banks, and other economic agents, therefore favor liquidity. This is consistent with our claim that alternative banks provide counter-cyclical lending to avert crisis and ease adjustment (in contrast to the liquidity preference of private banks that exacerbates downturns). Banking theory also focuses on liquidity in another sense - the liquidity of liabilities that can produce runs on deposits during banking crises (Diamond and Rajan, 2000). Diamond and Rajan provide a dynamic theory of bank capital based on relations between assets and liabilities, the importance of 25 See overview in Bhattacharya & Thakor, 1993 23 bank safety and access to refinancing at low cost, and the ability of banks to enforce repayment or liquidate bad loans. They pursue further modeling of strategic positioning by banks and creditors during refinancing (Diamond and Rajan, 2001). This is the basis for our claim that greater client confidence and trust in alternative banks provide a competitive advantage over private banks. While clients tend to withdraw deposits from private banks during banking crises, deposits often increase at alternative banks during crises. This is another competitive advantage that reinforces the capacity of alternative banks to provide counter-cyclical lending. It has proven critical during banking crises since the 19th century. In the 21st century, private banks and policymakers have already twice sought to stem a run on deposits (in 2000 and again in 2008) that threatened to escalate into banking crisis. Meanwhile, many alternative banks experienced inflows of deposits during these periods of doubt. Again, these matters are critical because revolutions in information and communication technologies are profoundly changing the banking industry. Alternative banks can also do more today than in the past because new technologies have reduced the cost of bank transactions an estimated one hundred fold (Claessens et al., 2002). In the past, bank transactions involved expensive, fully-equipped branch offices and large numbers of white collar staff. Estimates suggest that face-to-face bank transactions at a teller cost one hundred times an internet transaction, fifteen times an electronic transfer and ten times an ATM transaction. The supply curve for banking is shifting to the right. This helps explain ou anomaly for liberal theory. Instead of being replaced by more efficient private and foreign banks, alternative banks use their scale, brand name, reputation and accumulated trust of clients, members and citizens to reposition their operations and realize competitive advantages as the industry adjusts, consolidates and modernizes. In sum, contemporary banking theory views banks as firms that allocate assets, monitor firms and consumers, and balance costs, benefits, risks and returns in the context of depositors, debtors, government regulators and business cycles. Concepts and categories drawn from banking theory help explain the competitive advantages of alternative banks. However, the theory of institutional foundations of competitive advantage implies that alternative banks are fundamentally different than profit maximizing firms - because of their social missions, core principles of profit sustainability and stakeholder governance. 3.2. From banking theory to alternative banking theory? Most of empirical studies explain alternative banks’ superior performance with the characteristics of those banks, and in particular their governance structure (Bongini and Ferri, 2007), lower revenue diversification (Giordano and Lopes, 2009) and the importance of networks (Desrochers and Fischer, 2005). The argument runs as follows: alternative banks’ shareholder-oriented governance, non-profit mission, social mandate and nature as institutions deeply embedded into local comuntities created a specific set of incentives and constraints that (i) shape alternative banks’ behavior, and in particular 24 allow them to not focus on short-term profit maximization, which, in turn, helps explain better longtem performance; and (ii) allow alternative banks to reap significant advantages in terms of economies of scale and relationship banking. Giannola (2009) argues that the greater capital reserves accumulated by alternative banks provide a “patrimonial advantage” during transition to Basel II and III accords. The relative weight of governance variables itself is debated: Bongini and Ferri (2007) distinguish between a “mission” variable (low revenue diversification) and a “governance” variable (stability of board) to explain lower riskiness at alternative banks. They find that board stability is the key variable. Hesse and Cihak (2007), by contrast, find that cooperative banks are more stable because of their lower revenue diversification, “which more than offsets their lower profitability and capitalization”. The issue of income diversification is crucial to explain alternative banks’ alternative behavior – and, ultimately, superior performance in terms of risk. Indeed, in the past few decades, banks have diversified away from banks’ “traditional” business model (collecting deposits and making loans) on both sides of the balance sheet. On the liability side, decades-long trends of diversification and expansion of the banking business have made banks much more reliant on other funding sources. It is not clear, however, whether traditional deposit financing used in alternative banks is more sound. Indeed, mainstream banking theory argues that “deposit financing makes banks vulnerable to runs” (Bhattacharya & Thakor, 1993). But wholesale funding (financing banks on capital markets), as showed by the 2007-08 crisis, might create further instability (Huang and Ratnovski, 2011). On the assets side, mainstream banking theory used to tell a similar story: “both theory and evidence support the expectation that risks should be reduced rather than increased should banks be permitted to engage in securities, insurance and other services” (Benston, 1994). Of course, this view has lost much credibility with the 2007-08 banking crisis. As De Jonghe shows in a recent study of a sample of European banks, “the shift to non-traditional banking activities increases banks’ tail betas and thus reduces banking system stability because interest income is less risky than all other revenue streams” (De Jonghe, 2010). There is plenty of evidence that increased reliance on fee-based income leads to higher revenue volatility – so that income diversification actually increases, rather than decreases risk (DeYoung and Roland, 2001; Stiroh, 2004; De Jonghe, 2010). DeYoung and Roland, in particular, show that for US commercial banks, an increase in product mix (i.e. banks’ move towards non-interest bearing activities) has led to higher revenue volatility, compensated for by a higher level of revenues (as a risk premium). More recent empirical evidence for European small banks show similar results, i.e. income diversification increases risk (Mercieca et al., 2007); De Jonghe shows that for European listed banks, income diversification increases systemic bank risk measured as “tail beta”, that is the likelihood that extreme negative swings in bank stock will be linked to negative swings in bank indexes. By contrast, Chiorazzo et al. (2008) find a positive relationship between increased reliance on non-interest income 25 and risk-adjusted returns for small Italian banks. Stiroh (2004) finds that diversification to noninterest income is related to lower profits and higher risks in the U.S. banking industry. So it can be argued that one of the reasons for alternative banks’ greater stability and better overall performance is their lower revenue diversification, which is the direct outcome of their specific governance and business model – and, maybe, their smaller average size (except for development banks). This also explains why alternative banks shied away from the “originate-to-distribute” model as opposed to the traditional “originate-to-hold” model. The originate-to-distribute model creates serious pitfalls. Banks selling loans on the secondary market face issues of adverse selection and moral hazard (Berndt and Gupta, 2009). Berndt and Gupta also show that banks actively engaged in loan selling on secondary markets underperform their peers by about 9% per year in terms of riskadjusted abnormal returns. Berndt and Gupta conclude that the OTD model might not be “socially desirable”. This result is hard to reconcile with standard theory, which suggests that “in equilibrium, banks with private information cannot systematically take advantage of outside investors” (Duffee, 2009). The fact that alternative banks stick to the originate-to-hold model suggests that these banks do not only do things differently. They also do different things. First, they address the specific needs of markets and clienteles otherwise untapped by commercial banking. That can be explained, again, by alternative banks’ specific business model. In one of the rare works dedicated to the subject, McGregor (2005) proposes a specific behavioural model for low-income credit unions. In this model, low-income credit unions are institutions with a particular contract that are designed to operate in a region that commercial banks exclude themselves from because of the impact of informational asymmetries on their contract. Hart and Moore (1998) argue that institutions maximizing consumer surplus (and not profit), such as cooperatives, will distribute this surplus to customers through price subsidies (interest rate subsidies in the case of cooperative financial institutions), which will distort decisions and lead to inefficient outcomes. Canning et al., however, suggest that credit rationing might be a more optimal solution to the issue of the distribution of the consumer surplus (Canning et al., 2003). For instance, Canning et al. (2003), who focus on the optimizing decisions of not-for-profit financial institutions (which fall under our alternative banks definition), mention en passant the possibility that ABs might have an advantage in “achieving economically efficient outcomes” (Canning et al., 2003) – however, they attribute that advantage to market failures and monopoly power in general. Alternative banks are also good at doing relationship banking. A vast literature emerged in the past two decades has shown the multiple advantages of relationship banking (see Boot, 2000, for a review of the literature). – in particular in helping overcome problems created by information asymmetries . In particular, relationship banking might help to enhance the availability of credit (Petersen & Rajan, 1994), reduce the requirement for collateral, and reduce the costs of financial distress (Hoshi et al., 1990). 26 Finally, alternative banks benefit from their network organization. Carnevali (2005) argues that the local organizational networks and lending discretion of savings banks provide competitive advantage and help usher small and medium enterprises through economic downturns. Desrochers and Fischer (2005) further argue that integration (within a banking cooperative network) helps reduce volatility of performance among cooperatives. They use a transaction costs economics framework whereby financial cooperatives (networks) are assimilated to a “joint supply alliance”, which might be beneficial in cost terms but raises a so called “appropriability hazard” – basically a free-rider problem that can only be overcome through integration. Also, expense preferences by managers increase with size of the institution but less so in networks. Another take on alternative banking theory would insist on the systemic impact of alternative banks. This can be viewed either by highlighting the specific effects (benefits) generated by the presence of alternative banks in any banking system; or by using alternative banks as a proxy for the heterogeneity of banking institutions. In this latter vein, Wagner (2008) argues that although the homogeneization of financial institutions reduces stability (in particular by increasing the correlation of banks’ portfolios), it also reduces the degree of risk-sharing within the system and therefore brings benefits in terms of risk. This argument can be extended to include the broader impact of alternative banks on the whole economic and social fabric. The literature has identified a number of channels through which the availability of local banks has contributed to regional growth. Guiso et al. (2004) construct an index of financial development in different Italian regions and show that the historical presence of savings banks had a positive impact on the long-term regional development. Hakenes & Schnabel (2006) argue that by investing in their local economies, these banks effectively prevent a ‘capital drain’ to other regions. Hakenes, Schmidt & Xie (2009) use regional economic data for Germany to show that the presence of savings banks has a positive impact on regional economic growth, through SME lending and that this effect is significantly stronger in poorer regions. Thus we conclude that one of the elements contributing to alternative banks’ competitive advantage might be, precisely, their role for public policy and social inclusion. 4. Alternative banks’ broader role as instruments for social inclusion 4.1. The Advantage of Public Banks for Public Policy Public banks provide large levers for government. In terms of fiscal cost and government budgets, public banks can do more for less: Over ten times more if one compares the cash needed to directly implement public policy to holding cash in reserve at public banks to secure loans, credit, finance, consortia or sale of stocks or bonds. This is the core of government banking theory. Public banks can implement public policies at 10 percent the fiscal cost of cash outlays. From the broader perspectives of politics, public policy and development, a 90 percent cost advantage more than compensates for 27 the 2-10 percent higher levels of administrative costs at government banks (compared to private banks) cited, often in error, by critics. The advantage of public banking for fiscal accounts and public policy is illustrated in the following table. The first column reports hypothetical annual budget allocations of one million in (any) domestic currency eleven years out from 2000. Each year the government has one million available. The second column sums this hypothetical spending from 2000-10 (total spending = 11.0 million). The third column calculates the advantage of public banking for public policy. Given the same million allocated per year, it calculates the amount public banks are permitted to lend under Basel II Accord capital risk guidelines (i.e. ten times reserves, rounding and ignoring risk weighting for the moment). One million in reserve covers ten million in loans. Profits or losses are not counted. For governments without banks, budgets in column two sum to 10.0 million by 2010. Compare column three. For governments with public banks, loans sum to 110.0 million. Public banks cannot perform all tasks of government. However, when they can, they provide a tenfold cost advantage as well as instruments for contractual control and policy supervision. Banking theory describes banks as multipliers of money. Banks do not create money through magic. To create money they must create assets. More accurately, they must help create assets by providing credit and finance to individuals, firms and other entities public and private. This holds for public banks and alternative banks. Budget allocations to public banks become reserves against loans. These loans multiply the amount of money in the economy. It follows that concerns about banks also apply to public banks. Excessive lending may feed inflation or create credit bubbles that worsen boom and bust cycles. Without adequate supervision, crony credit, corruption and waste of resources may occur, whether the bank is private, domestic, foreign, government owned or a cooperative. However, the core and largely unappreciated difference between private and public banking is not the often slight or nonexistent efficiency advantage of private over public banks (an empirical question) but the very large levers that public banks provide government policymakers and social and political forces (see Appendix). Fourth, the corporate social responsibility policies and charitable contributions of savings banks provide social and cultural investments well above policies of private firms amidst the reduced capacities of Welfare states under fiscal pressure. For example, French savings banks reserve half of dividends to fund social responsibility programs run by bank staff and elected local or regional social and political representatives. Spanish savings banks are also mandated to contribute a share of profits to social, cultural, or community programs - on average 24.9 percent of profits during the last decades. 4.2. The Advantages of Alternative Banks for Social Inclusion Alternative banks also provide powerful advantages for policies to secure or accelerate social inclusion. Indeed, alternative banking theory and recent experiences with bank change provide new 28 perspectives on longstanding assumptions about how markets constrain social change. Since the abandonment of the electoral road to socialism in the 1970s and dismantling of Welfare States by neo-conservative politics and neo-liberal economic policies in the 1980s, social scientists have emphasized economic constraints on government social policy, limits to popular inclusion and the perverse impact of politics on markets. Przeworski summarizes this structuralist view of the state and constraints to change exemplified by the breakdown of democracy in Chile in 1973.26 Neoconservative politics and neo-liberal policies have dismantled Welfare States and worsened inequalities in many advanced and developing countries. However, advances in monetary theory and policy, the realization of competitive advantage by alternative banks, and experiments with new social policies based on old traditions of savings banks and cooperative banks suggest that alternative paths for change are now at hand. Alternative bank change implies new relations between markets, money and politics. Marxist theories of the state first captured the fiscal constraints on social policies widely emphasized since by social scientists, policy specialists, international institutions and market makers.27 Consensus still obtains that excessive social spending requires taxes that drag the economy by reducing investment and, in turn, reducing tax revenue to complete a perverse cycle. However, alternative banking and policies of social inclusion through banking, credit and basic income policies are different. Theories of fiscal constraints are based largely on economic theory before conceptions of the credit channel and interest rate channel were fully developed in monetary economics during the 1990s. These new concepts and theories for banking regulation and supervision also became widely used by monetary authorities during the 2000s. We suggest that alternative banks thereby retain a fundamentally different position in the economic cycle and provide options for social policy able to increase the pace of social inclusion in fundamentally different ways. In the past, social policies pursued by left parties and advocated by social movements such as wage increases and government spending impact aggregate demand, supply, and markets differently than income policies, free or low cost bank accounts and alternative banking that occur within credit and interest rate channels. If Dornbusch described perverse cycles of the past as the macroeconomics of populism, we suggest that the microeconomics of social inclusion describes how alternative banks may sustain or accelerate social inclusion. Instead of fiscal excess pressuring taxes and dragging growth, alternative banks include citizens through banking products and services. This brings or keeps citizens within the formal economy and within monetary channels, thereby improving the ability of monetary authorities to supervise, monitor and manage inflationary pressures and other risks associated with banking and money. 26 A. Przeworski, Social Democracy as a Historical Phenomena (Cambridge: Cambridge University Press, 1979) Gold, David A., Lo, Clarence Y. H. and Wright, Erik O. “Recent developments in Marxist theories of the capitalist State”. Monthly Review, v. 27, n. 5, p. 29-43 and “Recent developments in Marxist theories of the capitalist State. Part 2”. Monthly Review, v. 27, n. 6, p. 36-51. 27 29 This may seem unimportant or secondary in advanced economies where bank inclusion remains high. However, the stark levels of banklessness in developing and emerging economies suggest that alternative banks and new income policies may increase the pace of social inclusion. For example, an estimated eighty percent of Brazilians remained bankless (with no bank account) in 2000 (increasing to 40-45 percent in 2010). Reserve Bank of India estimates suggest that five percent of Indians have taken on credit or loans. Given the inability of private banks and market-based microcredit models to increase supply of banking products and services, alternative banks and new public policies such as universal bank card issues in the form of identity cards should be considered. Concepts of citizenship and social justice thereby provide new means to accelerate social inclusion that may avert problems incurred by wage increases and subsidies inspired by macroeconomic management toward social inclusion in the past. Cooperative banks were founded in the 19th century to overcome credit exclusion of workers and farmers excluded from private Banks and urban credit and finance markets. Given the focus of private banks on urban areas and commercial and industrial firms, workers and farmers remained excluded from banking and credit. A study commissioned by the European Association of Cooperative Banks emphasizes four factors that reinforced exclusion, problems associated with geographic distance and lack of transportation and communication, information asymmetries that led banks to avert lending to rural and urban poor, legal systems that protected creditors over lenders and high prices that kept workers away from credit. Cooperative banks were able to overcome these four barriers. 5. Theories of change Our theory of alternative bank change is based on one of four broader theories. Figure 1 (next page) represents these theories along two axes representing levels of welfare and market orientation in domestic banking and finance. The first, most widespread theory of bank change can be described as modernization through privatizations and liberalization. For theories of modernization, market orientation increases welfare and produces financial development.28 Because liberalization and privatizations increase welfare, the relation between politics and market orientation is positive sum.29 Privatization of banks and opening the industry to competition improves corporate governance, 28 W. Novaes Filho and S. Werlang, ‘Inflationary Bias and State Owned Financial Institutions’, Journal of Development Economics. 47, (1995), pp. 135-54, M. Boycko, A. Shleifer and R. W. Vishny, ‘A Theory of Privatization’, The Economic Journal,106:435 (1996), pp. 309-319, A. Schleifer and R. W. Vishney, The Grabbing Hand: Government Pathologies and their Cures (Cambridge: Harvard University Press, 1998), R. La Porta, F. Lopez-de-Silanes and A. Schleifer, ‘Government Ownership of Banks’, Journal of Finance 57:1 (2002): 265-301, S.I. Dinç, ‘Politicians and Banks: Political Influences on Government-Owned Banks in Emerging Markets’, Journal of Financial Economics. 77, (2005), pp. 453-79. 29 B. Bortolotti and D. Siniscalco (eds), The Challenges of Privatization: An International Analysis (Oxford: Oxford University Press, 2004) 30 reduces waste of resources and eliminates inflationary pressures from bad banking. Replacement of inefficient state owned banks with more efficient private banks and market forces increases welfare and improves distributive justice. The privatization of alternative banks is thus part of a broader process of modernization toward a liberal market economy, one with stock markets, shareholders and private banks at the center of the financial system. This view is still widely shared in international financial institutions and the social sciences, despite reassessments since the crisis began in the US during 2007. This view is incomplete for three reasons. First because free markets are presumed to be superior, second because correlations between government ownership and underdevelopment are spurious and third because aggregate patterns in national data tend to conceal how causal relations determine development paths.30 This is not to deny the contribution of alternative banking critics. They describe how alternative banking can go wrong - and provide several empirical measures to control for bad banking. But critics fail to consider how alternative banks may succeed, as banks, as agents of public policy and as institutions at the center political and social economies. Mismanagement of alternative banks is part of history, especially under monarchy, fascism and corporatism. But it is not the whole story. The most important developments since liberalization and during the recent crisis that severely tested banks suggest that alternative banks cannot be disregarded as corporatist agents of crony credit, fiscal excess, moral hazard, undue rents and engines of inflation. Figure 1) Four Theories of Bank Change Welfare Alternative Banks & Markets Alternative Banks or Markets Modernization Developmentalist/ Critical Market Orientation via Privatizations 30 Replication of La Porta, Lopez-de-Silanes & Schleifer’s regression of government bank ownership on GDP growth for 1995-2004 (they used average growth from 1960-1995) produced opposite regression results, i.e. government bank ownership correlated positively with higher levels of economic growth. See: K. von Mettenheim and L. Gonzalez, ‘Government Ownership of Banks Revisited.’São Paulo, FGV-EAESP, 2007 (memo) 31 Source: J. P. Krahnen & R. H. Schmidt (eds). The German Financial System. Oxford: Oxford University Press, 2004, pp. 497-516. A second theory of bank change is described as ‘alternative banks or markets.’ In this theory, welfare can be maximized in either bank-centered financial systems or market-centered financial systems. The dual peaks in the medium grey line of Figure 1 represent these incompatible financial systems. From this perspective, core functions of finance can be performed by two different, complementary structures. Either banks or financial markets can allocate household savings to firms, smooth consumption and corporate investments over time and spread the cost of covering household risk and entrepreneurial innovation. The relation between politics and market orientation from this perspective is zero-sum because of transition costs between financial systems. Given that market reforms often produce unemployment and dislocation in the short term, leaders will find it difficult to maintain political coalitions and/or office long enough for benefits to accrue.31 Comparative financial economists suggest that bank- and market-centered financial systems produce largely similar levels of welfare. If these systems are equal, why then would politicians incur the costs of transition from a bank- to market-centered financial system? Moreover, Allen and Gale suggest that banks may smooth shocks to domestic economies better than markets. Inter-temporal smoothing is a core idea in finance that, in the long term, welfare is higher when adjustment ameliorates downturns. For Allen and Gale, the oil price shock of 1973 caused the value of stock markets to decline by half from 1972 peaks in paradigmatic market-centered economies (US and UK), causing severe contraction in household incomes, especially pensions based on equities. In contrast, because neither households nor pensions then held many equities in the bank-centered systems of Japan, Germany and France, these countries were able to adjust with substantially lower costs.32 Since the 1980s, booming equity markets often shifted judgments in favor of market-centered financial systems. And downturns are often defended by advocates of free markets as part of ‘creative destruction’ necessary for modernization. However, the 2000 downturn and 2008 crisis suggest that bank-centered financial systems may have once again fared better. Allen and Gale also estimate better equilibrium across generations in an intermediated (bank centered) financial system compared to a market based system. 31 M. Pagano and P. Volpin, 'The Political Economy of Finance', Oxford Review of Economic Policy, 17:4 (2001), pp. 502-19, T. Boeri, M. Castanheira, R. Faini, V. Galasso, G. B. Navaretti, C. Stéphane, J. Haskel, G. Nicoletti, E. Perotti, C. Scarpa, L. Tsyganok and C. Wey (eds), Structural Reforms Without Prejudices (Oxford: Oxford University Press, 2006). 32 Hoshi argues: ‘Past empirical studies suggest four important benefits of … the main bank system in Japan: (1) implicit insurance, (2) alleviation of the information problem, (3) reduction in the cost of financial distress and (4) effective corporate monitoring.’ T. Hoshi, ‘Back to the Future: Universal Banking in Japan’, in: A. Saunders and I. Walter (eds.), Universal Banking: Financial System Design Reconsidered, (Chicago: Richard Irwin, 1996), p. 210. See also: T. Hoshi, Corporate Finance and Governance in Japan (Cambridge, MA: MIT Press, 2004) 32 The banks vs markets debate in comparative financial economics reinforces our core arguments. Banks are not necessarily culprits of bad equilibrium and slow growth. Banks can monitor firms, provide longer term finance and use local knowledge and information better than liquid equity markets. Bank-centered financial systems (with three pillars, two of which are alternative banks) may produce stronger, more sustainable growth than economies based exclusively on equity markets (and private banks). King and Levine also suggest that the capacity of banks to work with information (greater incentives for research and analysis, proprietary control, freedom from disclosure) may make banks better than ‘atomistic’ markets. 33 Banks may also finance innovative firms better than markets because of longer time horizons and more credible commitments and contracts to fund projects when they take off. However, the information advantage of banks may produce distortions. Hellwig and Rajan argue that banks may thereby extract rent and protect firms rather than finance innovation.34 Weinstein and Yafeh argue that banking (and regulatory requirements) can induce conservative behavior and impede innovation.35 Networks of banks on corporate boards can also lead to collusion with firm managers against outside investors and veto innovation.36 In sum, the debate about bank- vs market-centered finance systems suggests that banks can outperform markets in terms of core functions of finance. However, banking also involves risks that may undercut these advantages. Alternative banking theory informs a single peaked dark grey line to suggest that combining alternative banks and moderate market orientation maximizes welfare. From this perspective, relations between politics and market orientation are positive up to a point and negative thereafter. What point? Liberalization may improve competition. Privatizations may help political leaders shed banks that are beyond reform or bailout. However, because public banks provide policy alternatives and alternative banks retain competitive advantages over private and foreign banks, complete privatization or excessive market based regulation would, in theory, decrease welfare. Continental European banking system can be said to have approached this peak once the industry was opened to foreign competition and many state owned banks were privatized. This theory of bank change is reinforced by recent research that emphasizes market failures, the importance of legal systems and recognition of the complexity and diversity of domestic finance and banking. Combining alternative banks and financial markets may maximize welfare because public 33 R. G. King and R. Levine, ‘Finance and Growth: Schumpeter Might be Right’, The Quarterly Journal of Economics 108:3 (1993), pp. 717-37. 34 M. Hellwig, ‘On the Economics and Politics of Corporate Finance and Corporate Control’, in X. Vives (ed), Corporate Governance: Theoretical and Empirical Perspectives (Cambridge: Cambridge University Press, 2000), pp. 95-134, R. Rajan and L. Zingales, ‘Financial Dependence and Growth’, American Economic Review 88 (1998), pp. 559-87. 35 D. E. Weinstein and Y. Yafeh, ‘On the Costs of a Bank-Centreed Financial System: Evidence from the Changing Main Bank Relations in Japan’, Journal of Finance 53 (1998), pp. 635-72. 36 M. Hellwig, ‘On the Economics and Politics of Corporate Finance and Corporate Control.’ 33 banks serve as effective intermediaries to overcome information barriers and avert market failures.37 If models assuming perfect information and free markets poorly describe how banking and finance work, it follows that wholesale privatizations will fail to free market forces and increase growth. Alternative banks help overcome information barriers to efficient market pricing. Our arguments about alternative banks are thus consistent with recent research in comparative financial economics that ‘points not to markets versus banks, but to markets and banks.’38 If alternative banks perform well, provide policy alternatives and retain competitive advantages, then a combination of alternative banks and moderate market orientation, in theory, can be seen to maximize welfare. We risk including a wide variety of critical perspectives on bank change within a fourth group of theories represented by the light grey line that indicates a negative relation between market orientation and welfare. This perspective includes approaches such as the commanding heights tradition, neo-developmentalists, Post-Keynesian approaches and critical approaches to financialization and corporate governance. Although these approaches have explored a wide variety of bank change and financial market developments, our arguments about and theory of alternative banking differ from these traditions. The realization of competitive advantages by alternative banks since liberalization and during transition to Basel Accord and International Financial Reporting Standards appears to be at odds from the expectations of private bank and market dominance. In sum, alternative banking theory draws from banking theory, the varieties of capitalism approach and work in comparative financial economics to explore a positive theory of competitive advantage in alternative banking. We now turn to the advantages of public banks for public policy. Conclusions This paper suggests that stakeholder governance, social missions, profit sustainability orientations and capacity to multiply public policy are institutional foundations of competitive advantage of alternative banks. Savings banks and cooperative banks have thereby retained or increased their significant market shares since liberalization of the industry and transition to unified regulations under BIS Basel Accords, International Financial Reporting Standards and European Commission and domestic monetary authorities. Instead of convergence toward private banking, joint-stock ownership, shareholder governance and market-centered finance, public savings banks, cooperative 37 J. Stiglitz and A. Weiss, ‘Credit Rationing in Markets with Imperfect Information’, American Economic Review 71 (1981), pp. 353-76 38 A. Demirgüç-Kunt and R. Levine (eds), Financial Structure and Economic Growth: A Cross-Country Comparison of Banks, Markets and Development (Cambridge, MA: MIT Press, 2004) 34 banks and special purpose (development) banks have modernized through a rich variety of strategies to retain or expand market shares while seeking to recast their social policies and missions. This is an anomaly for neo-classical theories of bank modernization and neo-liberal policies that expected alternative banks to be replaced by private banking and capital markets. For much of contemporary banking theory and throughout epistemic communities for bank regulation, alternative banks were expected to disappear, either sooner through privatizations or later through competitive pressures led by private banks and financial markets after liberalization. To explain this apparent anomaly of alternative bank modernization since liberalization across Europe, we suggest a back to basics in banking theory and a focus on institutional foundations of competitive advantage. We have thereby defined alternative banks as deposit taking and loan making institutions and explored the governance, histories and strategies of savings banks, cooperative banks and development banks. Banking theory and comparative studies in political economy and financial economics provide further concepts and theories to explain alternative bank modernization. Factors such as greater client/customer/member confidence and trust, the value of longstanding brands that represent traditions of social economy, the embedded character of relational banking in local and regional networks, rock solid deposit bases and prudent capital reserve policies, principles of longterm profit sustainability, participatory and shareholder governance models that reduce the autonomy of top management, aversion to unethical marketing and sales strategies and ties to social and political forces sum to provide a rich variety of alternative banking models. A certain tension nonetheless exists between explanations drawn from banking theory and those drawn from the varieties of capitalism approach in comparative political economy. If concepts and theories from banking studies can explain the competitive advantage and policy capacities provided by alternative banks, then these arguments should apply to all countries. This seems to counter the idea of two varieties of advanced capitalism with different sets of institutional complementarities that sustain the competitive advantages of firms. So, a question remains whether alternative banks have realized competitive advantages because of their insertion in coordinated market economies (that predominate in Continental Europe) or if they have done so because of their competitive advantages as banks. If banking theory can explain their advantages, then alternative banks may also be capable of realizing competitive advantages in market-centered economies such as the US and UK. Further research of our anomaly for classical theory is in order. However, the evidence from recent studies and data on market share is compelling, albeit preliminary. Instead of convergence toward private commercial and investment banking and capital markets through privatizations, banking and finance in most advanced economies remain based instead on three pillars – private banks, savings banks and cooperative banks. Special purpose (development) banks also remain critical agents of public policy and industrial change in many advanced economies – years after financial market reforms and liberalization. Alternative banks remain at the center of social and political networks that shape corporate governance, reinforce competitive advantage and inform strategies of innovation 35 and private enterprise across Europe. These institutions reflect long histories that have accumulated large amounts of capital in deeply embedded local, regional, national and international markets and institutions. Far from being condemned by more liquid financial markets or risk seeking private banks, the integration of regional and local savings banks and cooperative banks have produced competitive advantage, better performance, increased market shares and renovated institutions for social and economic policy coordination. These findings also suggest that alternative banks provide alternative models to the private sector bias in developing countries that have fallen behind the pace necessary to reach the millennium goals to reduce poverty. In this context, searching for a theory to explain alternative banking might end up suggesting an alternative banking theory altogether. Toward this end, we have received support from the Rockefeller Foundation Bellagio Center to share scholarship and policy making experiences and seek endorsement of “Core Principles for Alternative Banking and Social Inclusion” for subsequent promotion and adoption by international institutions, monetary and banking authorities and alternative banks (Appendix). 36 References Acland, J. (1786), A Plan for rendering the Poor independent of public contributions, Exeter Aghion, B. (1999), “Development Banking”, Journal of Development Economics, 58 : 83–100 Akerlof, G. and R. Shiller (2009), Animal Spirits. How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism, Princeton: Princeton University Press Altunbaş, Y., S. Carbó Valverde and P. Molyneux (2003), “Ownership and performance in European and US banking – A comparison of commercial, co-operative and savings banks”, Fondacion de las Cajas de Ahorros Working Paper No. 180/2003. 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(ed, 1999), The Developmental State. Ithaca, NY: Cornell University Press Wysocki, J. (1996), “Introduction”, in Mura (ed.), History of European Savings Banks, pp.9-25. 43 APPENDIX A – Historical developments in European savings banks in the XXth century Austria 1991: Wiener Zentralsparkasse amalgamation with Landerbank to become Bank Austria 1992: Central Giro merger with joint stock bank Osterrieichisches Credit-Institut 1997: Giro-Credit amalgamation with Erste Osterrichische Spar-Casse Bank (ex-Vereinssparkasse) to become ERSTE Bank AG listed on stock market. Bank Austria acquires Creditanstalt Belgium 1942: Association of Belgian Mortgage, Savings and Capitalization 1959: Private Savings Bank Group, 1986 renamed Belgian Savings Bank Group Denmark 1960s-1970s: 486 local savings bank mergers into two national savings banks (SDS and Sparkekassen Danmark), five regional savings banks and 140 smaller savings banks (merged into 188 savings banks by 1991). France 1950 Minjoz Act frees savings bank lending 1958 583 savings banks form seven regional associations 1965 Savings for Home Act 1968 Racine Commission report on modernization of savings banks 1973 Checking services provided by savings banks 1979 Nice Conference report informs 1983 Savings Bank Reform Act defining social representation and bank status 1980s-1990s Amalgamation into regional units and closing of regional finance companies 2009 Caisse d´Epargne e Banque Populaire groups merge to create largest French banking group. Germany 1947 Union of German savings banks, giro and giro-central associations 1953 Union renamed Deutsche Sparkassen und Giroverband 1992 723 savings banks form 13 regional savings bank and giro-bank associations 2006 European Commission regulations remove Sparkasse-Landesbank interbank guarantee system 2010 Savings bank group retains 1/3 credit market share and near half of bank card market. Great Britain 1945-1976 Three groups predominate: Trustee Savings Banks (deposits 2,022 million pounds 1965, Post Office Savings Banks (deposits 1,822 million pounds, 1965), Building Societies (total assets 5,532 billion pounds, 1965) 1972-3 Report of the Committee to review National Savings (Page Committee Report) 1976 Legislation to merge savings banks into 17 regional banks with central board 1986 Trustee Savings Bank (TSB) floated as public company on London Stock Exchange Greece 1956-1990 Postal Savings Bank (PSB) accounts increase from 138,186 - 4,320,531 (over 40 percent of population), with 12,8 percent savings deposit market share, 11.4 percent credit market share and 8.7 percent total bank assets in 1990. Ireland 1923-1965 Regulations limiting savings banks to receive deposits at fixed return set by finance ministry 1964 Association of Trustee Savings Banks in Ireland lobby formed 1989 Trustee Savings Bank Act liberalizes savings bank operations to compete with commercial banks 1986-1992 Amalgamation of nine savings banks into Trustee Savings Bank, TSB 1990 Post Office Savings Banks & Trustee Savings Banks deposits = 1,167 million pounds, Building Societies = 3,929 million pounds, Government savings/financial institutions deposits = 1,407 million pounds) Italy 1953 Convergence of interest rates paid on treasury certificates at postal banks and savings banks 1960 79 savings banks with 2465 branches (up from 240 in 1940, 506 in 1950) 44 1963 bank deposit market share of 22.6 percent, increases to 28.4 percent in 1990. 1990 Amato Law liberalization of bank system culminating European Community legislation 1990s Planned privatizations of savings banks allocate shares to separate savings bank foundations Netherlands 1950s-1960s ‘Family’ savings banks expand to consumer credit and insurance 1960s Creation of savings bank network to compete with commercial banks 1980s Merger of Post Office Giro, Post Office Savings Bank and Nederlandische Middenstandsbank Norway 1945-1961 Savings bank deposits remain at 50 percent of market share (commercial banks decline from 48.8 percent in 1947 to 39.9 percent in 1970. 1950 Post Office Savings Bank and Post Office Giro created. 1970s-1980s Commercial banks regain market share 1987 Savings Bank Act permits capitalization through primary capital certificates (PCCs) 1996 PCCs of 15 savings banks reach NOK 10.4 billion. 1959-1996 Consolidation from 600 to 132 savings banks 1996 Savings bank market share at 29 percent of domestic credit, 45.5 percent of deposits. Spain 1947 regulation of social welfare policies of savings banks (24.65% profits 1947-1992) 1962 Bank Sector Legislation and creation of ICCA Instituto de Credito de las Cajas de Ahorros supervisory body created, transferred to central bank in 1971 1939-1962 number of savings banks declines 98-84 (29 acquired, 15 created) 1950 branches increase to 1000, reach 2000 in 1956, 3000 in 1962 and 14,414 in 1992 1985 Savings Bank Act to democratize, modernize and reform savings banks Sweden 1955 Savings Bank Act sets trustee representation (half local government appointed half elected by depositors) 1962 Limitation Committee standardizes bank regulations 1969 Savings Bank Act liberalization of savings bank policies and practices 1989-1991 Formation of single Savings Bank Group from two savings bank associations 1992-3 Banking crisis leads to creation of SwedBank (Sparbanken Sverige AB) uniting various bank units under Savings Bank Group. 1995 Savings banks retain 26.6 percent market share of deposits and 25.4 percent of private credit Switzerland 1970-1980s Adjustment to dual depressions reduces number of savings banks. 1971 Association of 248 Swiss Regional Banks formed, but market share of domestic declines from 25 percent in 1945 to 12 percent in 1975 to 5 percent in 1995. 1994 RBA Holding created to consolidate regional banks. 1990-1995 Cantonal banks maintain 35 percent of savings market. 1995 Regional banks and savings banks (n=127) retain balance sheet of 72.2 million francs, compared to 730.5 million francs at big four private banks and 262.5 million francs of cantonal banks. 45 APPENDIX B – The emergence of a two-tier structure in cooperative banking in Germany and Italy The emergence of the two-tier structure of cooperative banks was characterized in Germany by the evolution of metal reserves, foreign exchange, securities, credit and interbank credit, acceptances and capital reserves at central cooperative agencies (one in Prussia, reaching nine across German states consolidated into 6 by 1913). A similar pattern of bottom-up member based cooperative banking occurred in Italy. Data from 1876-1893 suggests a similar evolution in the number of cooperatives and members, patrimony, loans and discounts, commercial paper, loans and advances and value of public bonds and industrial securities in cooperative bank portfolios. Although we lack comparable data for the organization of central cooperative banks along the lines of the German cooperatives, the expansion of commercial paper and loans in Italian cooperative banks from 1870-1894 suggests the substantial market share and diversification into wholesale banking typical of mature two tier cooperative banking model. Data reported by Macloed also suggests the social mission and business model of cooperative Banks in Italy. The social composition of Italian cooperative bank members in 1876 and 1893 (Table B.2.) reveals the down-market focus and reality that working classes and small scale farmers made up the bulk of cooperative members. Macloed also reports profit and loss accounts from Italian cooperative banks from 1880-93 (Table B.3.), data that suggests the basic business model and principle of profit sustainability retained by these institutions. Moreover, Macloed reports the returns on paid in capital, returns on capital and reserves, dividends paid on capital and dividends paid on capital and reserves for 1880-2 and 1886 and 1893. Table B.1. Historical data on German Credit Cooperatives (million Marks) Year InterSavings Bank Member Number Members Assets Credit Deposits Deposits Balance Reserves 1860 133 31603 7 1 0 1865 498 169595 66 61 53 13 1 1870 740 314656 187 166 131 7 40 4 1875 815 418251 432 390 317 13 84 8 1880 905 460656 493 438 353 11 102 16 1885 896 458080 544 467 390 12 108 22 1890 1072 518003 620 538 438 16 117 28 46 1895 1068 525748 666 569 454 13 126 38 1900 870 511061 806 672 586 24 133 45 1905 921 539993 1109 899 836 23 166 66 1910 939 600387 1477 1202 1084 31 216 94 1915 941 601395 1754 1212 1319 23 231 121 1920 1245 746058 7158 4026 6480 na 391 164 Table B.2 - Social Composition of Italian Cooperative Bank Members, 1876 & 1893 Farmers on a large scale 6.4 6.56 Farmers on a small scale 16.8 24.12 Farm hands 3.2 4.66 Large manufacturers and merchants 4.4 4.77 Small manufacturers and merchants 32.15 25.25 Artisans 7.25 8.11 Schoolmasters and clerks 16.65 18.66 Miscellaneous 13.15 7.67 Total 100.00 100.00 Number of Members 77,340 405,341 47 Table B.3 - Profit and Loss Accounts of Italian Cooperative Banks, 1880-1893, (000 Lire) Year 1880 1881 1882 1886 1893 Gross Profits 7,320 13,416 14,487 25,090 30,744 Interest on Debits 5,225 6,264 11,159 13,908 Taxes Pers. Staff Expenses Prop. 770 770 964 997 797 846 1,131 884 997 2,314 1,866 1,648 3,357 2,815 2,397 Misc Taxes 135 195 202 178 419 Losses Charged 217 1,036 287 437 1,334 Total Expenses 3,070 9,096 9,765 17,602 24,230 Net Profit 4,250 4,320 4,722 7,488 6,514 Table B.4 - Financial Accounts of Cooperative Banks, 1880-1893 Return Cap. Return on on Dividends on Dividends on in Capital Reserve & Reserves Paid Capital 11.53 8.88 9.49 7.30 1881 11.66 9.00 9.48 7.31 1882 11.80 9.04 9.44 7.23 1886 11.32 8.81 8.26 6.40 1893 8.28 6.27 6.63 4.97 Year Paid Capital 1880 in & Source: ibid. 48 APPENDIX C – Descriptive data on cooperative banks (2008) Members / clients ratio New employees hired 2007 Expenses staff training / payroll SME loans % of total loans Österreichische Raiffeisenbanken 47% 500 n.a n.a n.a 1,569 39% Österreichischer Genossenschaftsverband 87% 371 2% n.a n.a 1,302 11% 1% 286 2% 17% n.a 3,511 14% 38% 332 3% n.a n.a 6,486 n.a Crédit Agricole 29% 4,640 6% 27% 28% 2,847 25% Crédit Mutuel 65% 1,070 6% 25% 16% 2,894 14% Banques Populaires 42% 2,700 7% 46% 8% 2,655 9% 54% -399 2% 27% 25% 2,201 34% 23% n.a. 1% 50% 4% 688 15% Assoc. Nazionale Banche Popolari 11% 2,240 1% 49% 23% 1,018 26% FEDERCASSE 17% 1,223 1% 29% 17% 1,299 10% Full Member Organizations (a) Market share of SME loans, % Nr. of clients / Nr. branches Market share of ATM's (%) Austria Bulgaria Central Bank Co-operative Finland OP-Pohjola Group France Germany BVR/DZ BANK Hungary Federation Coops of Savings Italy Luxemburg 49 Banque Raiffeisen 5% 59 0% 17% 6% 1,963 16% 99% 42 n.a. 42% n.a. 539 n.a. 18% n.a 3% 19% 38% 7,765 33% 24% 1201 n.a. 20% 13% 2,611 17% 15% 362 0.40% n.a n.a 3,011 10% n.a 34 2% 40% n.a 85,215 2% 19% 1,034 n.a n.a n.a 207 8% Co-operative Bank 50% -1,789 5% 0% 2% 28,440 4% AVERAGE (EU 27) 37% 2,124 4% 29% 25% 3,068 25% 19% n.a n.a n.a n.a 5,021 9% Lithuania Assoc. Lithuanian credit unions Netherlands Rabobank Poland Krajowy Zwiazek Banków Spóldzielczych Portugal Crédito Agrícola Slovenia Dezelna Banka Slovenije d.d. Spain Unión Nac. Coop's de Crédito United Kingdom Japan The Norichukin Bank / JA Bank Group Source: EACB? 50 APPENDIX D - Comparing Funds for Public Policy with and without Public Banks From same Year $ Budget Government Spending Value of loans via without Banks Government Banks 2000 1,000,000 1,000,000 vs 10,000,000 2001 1,000,000 2,000,000 vs 20,000,000 2002 1,000,000 3,000,000 vs 30,000,000 2003 1,000,000 4,000,000 vs 40,000,000 2004 1,000,000 5,000,000 vs 50,000,000 2005 1,000,000 6,000,000 vs 60,000,000 2006 1,000,000 7,000,000 vs 70,000,000 2007 1,000,000 8,000,000 vs 80,000,000 2008 1,000,000 9,000,000 vs 90,000,000 2009 1,000,000 10,000,000 vs 100,000,000 2010 1,000,000 11,000,000 vs 110,000,000 --------------------------------------------------------------------------------------------------------Note: Figures based on 10 percent reserve requirement. If government bank is allocated one dollar, real, or euro, the bank can lend ten times that amount keeping in reserve cash against risk of nonpayment of loans. BIS Basel II Accord capital guidelines set this figure at eight percent (risk weighted), ten percent is used for clarity of calculation. Retained profits or losses not counted. 51 APPENDIX E – Conference on “Alternative Banking and Social Inclusion” Conference to be held at the Rockefeller Foundation Bellagio Center, 5-6 July 2011 Conveners: Kurt Mettenheim & Olivier Butzbach This conference is designed to gather scholars, alternative banking executives and representatives from savings and cooperative bank associations to rethink strategies for social inclusion in the global south and launch a new policy agenda. Given the search for alternative strategies to counter the recent financial crisis, and the advances of stabilization, transparency and banking supervision in developing and emerging economies, this conference is designed to link alternative banking communities in the global north and south and help shape a new policy agenda for social inclusion. Because savings banks, credit cooperatives and other alternative banking and finance institutions have realized competitive advantages during the recent crisis, we can now think beyond. New policies may help developing and emerging nations redirect large domestic institutions such as postal and savings banks toward meeting the UN millennium goals to eliminate poverty by 2015. We hope to promote understanding of alternative banking, deepen academic and policy making networks, and provide concrete policy alternatives for bank executives and economic and social policy makers, especially in developing and emerging nations. The Bellagio Principles for Sustainable Development provide inspiration and paradigm for this conference on Core Principles for Alternative Banking and Social Inclusion. A two day conference held 5-6 July 2011 is designed to present and discuss our draft Principles with scholars, policy advocates, alternative bank executives and representatives from international organizations. The event will help sharpen strategy for promotion of a new policy agenda toward increasing the pace of social inclusion in the global south. After the conference, we plan to circulate a green paper on Core Principles for Alternative Banking and Social Inclusion, convene events to promote these principles through institutional supporters and networks, and seek adoption of these principles at policy venues such as the World Savings Bank Institute, the International Association of Cooperative Banks, the Bank for International Settlements Basel III Accord, the International Financial Reporting Standards foundation, the ISO International Standards Organization, the Charter for Responsible Business, regional development banks and the World Bank. We also plan to submit an edited volume of scholarly contributions on alternative banking and social inclusion to a major university press by year-end 2011. Institutional supporters and networks include: Institutional Supporters 52 Columbia University School of International and Public Affairs, New York; Institute for Money, Technology and Financial Inclusion, University of California, Irvine; King´s College Department of Management, London; São Paulo Business School, Getulio Vargas Foundation; Second University of Naples Networks Association of Emerging Market Business Schools, São Paulo Brazil; Community of European Management Schools, Brussels; Critical Political Economy Network; European Association of Cooperative Banks, Brussels; Global Public Policy Network, London; International Cooperative Banking Association, Brussels; Social Science Finance Network, Amsterdam; Society for Advancement of Social Economics, Philadelphia; World Savings Bank Institute, Brussels 53 APPENDIX F - Core Principles for Alternative Banking and Social Inclusion Commitment to End Capital Starvation Promote access to and use of banking and financial services by all through new technologies and distribution channels to capitalize assets among the poor. Commitment to Universalize Income, Savings, Credit and Finance Provide basic income via ATM cards and mobile banking to reach the poor and open new channels of access to income, savings, credit, finance, insurance and opportunity. Prudent Banking and Regulatory Compliance Alternative banking seeks to work within regulations, guidelines and best practices recommended by monetary authorities and international regulatory institutions such as the Bank for International Settlement Basel II Capital Risk Guidelines. Corporate Social Responsibility Leadership Integrate corporate social responsibility into down-market business strategies and institutions of representation and social forces. Transparency and Accountability Publish annual reports and balance sheets in accord with international best practices of financial, social and sustainability reporting. Leadership in Provision of New Banking Services and Products to the Poor Use competitive advantages in banking and institutional networks to channel more effectively capital, income and finance to the poor. Generate Sustainable Income and Household Asset Accumulation Use branch offices and new banking technologies to accelerate progress toward UN millennium goals to eliminate poverty. Universalize Financial Education Promote financial education to encourage responsible banking and finance and avert predatory lending and unethical practices. Adopt Cutting Edge Technology and Management Practices to Provide Competitive Alternative to Private Commercial and Investment Banks Incorporate electronic card and mobile banking services to better serve the poor. Contribute to Realization of Bellagio Principles for Sustainability Promote alternative banking and business practices that contribute to environmentally sustainable income, consumption and production as stated in Bellagio Principles for Sustainability. 54 Respect and Build on National and Regional Differences Instead of a single model, alternative banking institutions and international agents may best accelerate social inclusion by respecting different contexts, averting single models and seeking complementarities with existing social and political forces to innovate. 55