The IBM Institute For Business Value recently published a study on the global financial services industry. The report, “Toward transparency and sustainability: building a new financial order” makes a number of interesting points about how the financial markets industry will need to change in the future in order to remain profitable. It also reveals something many consumers have suspected all along.
Among the report’s conclusions is the fact that financial firms will need to work with greater transparency in the future. After a decade of making big profits by creating increasingly complex financial instruments, such a development will require a major change in the thinking of financial services providers.
Perhaps the most interesting finding in the study, which was conducted by surveying individual and institutional investors, government officials, and industry executives, was the level of agreement given to this statement:
Financial services firms are likely to offer products and services that serve their own interests [rather than the interests of their clients].
More than 60% of the retail and institutional investors and financial intermediaries responding to the survey agreed with this statement. Remarkably, almost half of American financial industry executives surveyed also agreed, as did 40% of industry executives based in Europe, the Middle East, Africa and Asia-Pacific.
It’s not surprising that financial services clients might feel that major investment firms don’t have their best interests at heart; I suppose it’s a good thing that a significant number of industry executives have not been deceived by their own marketing campaigns. For example, the report quotes an executive at a large US bank as saying, “We have lost sight of the client in our own striving for outsized returns. We must get back to basics and focus to a far greater extent on our clients.” As Congress considers increased regulation of banks and financial institutions, including greater scrutiny of systemic risk-taking, the financial services industry will be forced to make adjustments.
It will always be the case, to some degree, that the financial services industry will be driven by its profit motive. This may not always lead financial companies to create financial products that are in the best interests of their clients. In order to do so, they need not be deliberately deceitful; they only have to be careless.
Risk-taking behavior has abated for a while, but once the financial system starts to heal, investor appetites for yields in excess of ultra-safe Treasury bonds will increase. Regulators will need to be extremely nimble to stay on top of the wizards of Wall Street. Past experience has not shown regulators to be given to nimbleness, so only time will tell if that can change. I wouldn’t bet against the wizards, though.
What this study points up is the fact that consumers of financial products must do their homework when a new item is offered. Financial firms create new products because they believe that people will buy them. In the best of circumstances, the products fill a need, the provider makes a reasonable profit, and everyone is happy. Historically, regulatory activity goes in cycles, increasing and decreasing in response to all sorts of factors. What usually happens after a crisis is that the regulatory screws are tightened down to prevent future problems, but eventually the regulators, the companies, and the consumers all relax and become less watchful. New products that conform to the rules develop, but new difficulties, unanticipated by the regulations, get baked into the newest financial confections. Markets go up and everyone is happy until the next blow-up, when the cycle repeats. Wise consumers will make a point of knowing what they’re buying so that they don’t take risks that they can’t afford.