RBI Governor - Boring Banking

"A very striking feature of the financial crisis was its global scope with no country escaping unscathed. This should not surprise us. The progressive globalisation of financial institutions and services over the last two decades has led to a complex web of interconnected markets, institutions, services and products. Institutions transcended borders; markets became accessible in real time and financial services were available from everywhere. In short financial markets and institutions declared 'death of distance' and 'conquest of location'. And when the crisis came, it showed that globalization meant that no country can really be an island."

"The narrow banking of the 1950s and 1960s was presumably safe and boring. But that was in a far simpler world when economies were largely national, competition was sparse, pressure for innovation was low, and reward for it even lower. Bankers of the time, it is said, worked on a 3 - 6 - 3 formula: pay depositors 3 per cent interest, lend money at 6 per cent and head off to the golf course at 3 pm. From the 24/7/365 perspective of today, that may appear romantic but is hardly practical."

"utility and a casino; "

"17. The boring banking concept does not appear persuasive even going by more recent evidence and on several counts. First, recall that during the crisis, we saw the failure of not only complex and risky financial institutions like Lehman Brothers but also of traditional banks like Northern Rock. What this demonstrates is that a business model distinction cannot be drawn between a utility and a casino; and if it can, it does not coincide with the distinction between what has to be safe and what need not be. Second, in an interconnected financial sector, how can a 'boring' bank realistically ring-fence itself from what is happening all around? Let us say a large investment bank, a casino if you will, fails. Because of the inevitable interconnectedness, that will cause a break down of trust not just in that particular bank but in the entire financial sector. So utilities cannot expect to insulate themselves against the risks being taken by the casinos. Third, the co-existence of utilities and casinos can also open up arbitrage opportunities. During 'tranquil' periods, financial institutions with higher risk and reward business models will wean away deposits from narrow banks. But when problems surface and stresses develop in the financial sector, the position will reverse with the deposits flowing back into the so called 'boring banks' triggering procyclicality. Finally and most importantly, what will be the cost of boring banking in economic terms? Does restraining banking to its core function just to keep it safe not mean forgoing opportunities for growth and development?"

http://www.rbi.org.in/scripts/BS_SpeechesView.aspx?Id=447