So the economics of banking do not suggest that bigger need be better. Indeed, if largescale processing of loans risks economising on the collection of information, there might even be diseconomies of scale in banking. The present crisis provides a case study. The desire to make loans a tradable commodity led to a loss of information, as transactions replaced relationships and quantity trumped quality. Within the space of a decade, banks went from monogamy to speed-dating. Evidence from a range of countries paints a revealing picture. There is not a scrap of evidence of economies of scale or scope in banking – of bigger or broader being better – beyond a low size threshold.12 At least during this crisis, big banks have if anything been found to be less stable than their smaller counterparts, requiring on average larger-scale support.13 It could be argued that big business needs big banks to supply their needs. But this is not an argument that big businesses themselves endorse, at least according to a recent survey by the Association of Corporate Treasurers.14 Take Grameen Bank – not a household name in the UK, I realise. This grew out of a microfinance project in Bangladesh which began in 1976.15 Grameen operates as a set of local credit cooperatives, often comprising as few as five members. The bank’s relationship with its borrowers is bound not by legal contract but by trust.
As the banking system has since stabilised, people’s bearings have returned and with them confidence. Trust is an altogether different animal. It is based on beliefs, not observable proofs. It is grounded in perceptions rather than evidence. It is as much a psychological state as a financial one.10 A clean balance sheet might instil confidence, but it need not repair trust. Because it is a moral judgement, repairing trust can be a slow and painstaking business. Moral compasses take rather longer to self-correct than magnetic ones. This has implications for the path of recovery in the period ahead. Historically, credit has tended to lag the recovery in output in the majority of recessions, especially financial recessions. During the previous three major recessions in the UK – in the 1970s, 1980s and 1990s – credit to business recovered slowly and in some cases only several years after the recovery in activity (Charts 8, 9 and 10). This is consistent with trust between financial institutions and their customers being slower to recover than confidence more generally. Moreover, unlike the situation today, earlier recessions in the UK were not primarily the result of financial factors. International evidence suggests that financial recessions have tended on average to be both costlier and lengthier.11 Normal recessions have been associated with a recovery in output to its previous peak after around 3 ½ quarters. Recovery to peak output following financial recessions has on average taken around 5 ½ quarters (Chart 11). Like its predecessors, lack of confidence may have “caused” this time’s recession.