The Changing Role of Banks

Last week, I drove across the US with my husband and dog. The 40 hours of driving corresponded nicely to the audio version of ‘The House of Morgan’, Ron Chernow’s 1989 history of the Morgan banking family through the preceding 135 years.

While the core function of a bank, providing financing services to institutions and individuals, has remained intact for hundreds of years, the relationship of banks to their clients has changed dramatically. The most interesting difference I noted through the years covered by the book was a departure from the so-called “Gentleman Banker’s Code”, where relationships were sealed with a handshake and partnerships were forged over books of business. Since banks historically had a role as the intermediaries between the users and providers of (scarce) capital, clients would look to them for financing activities but also as long-term advisors. A banking relationship was a signal and a partnership.

Though some form of trusted advisory service is still alive in banking, it’s much less common to think of banking relationships as a seal of quality on an actor. I don’t buy an equity based on its underwriter, for example, though that was not an uncommon pretense in the early 20th century. As education and regulation created more access to financial information, and alternative vehicles for financial services created competition, companies and individuals have looked less to banks as financial advisors. 

Part of the value proposition of “blockchain” technology is the ability to automate some of the procedures central to financing and trading activities. The promise of more automation in an age of cheap computing power threatens all route processes, from driving on roads to flipping hamburgers, but it also creates opportunities for differentiation. Migration to software-driven paradigms strip activities down to reveal the subtleties of our social and political ecosystem. 

One example of this in financial services is the practice of margining, where the holder of a financial instrument posts collateral with a counterparty. Though margins can be computed by an algorithm and arguably enforced on a blockchain, it’s not obvious that it ought to be. Margining can act as a tool. In a long term relationship, it can solidify trust between two actors that they are willing to forgo enforcement of a particular change in margin - understanding that their counterparty will be “good for it” later.

Judgement, integrity, and trust will always be at the foundation of commercial relationships. It’s worth remembering the Gentleman Banker’s Code and the value of a handshake as we try to think of ways to lower transaction costs.