This is the right time to relaunch financial services

27 October 2008

Financial Times, Andrew Hill, 25 October 2008

The FTSE 100 has lost a quarter of its value in the past four weeks. Two British banks have been nationalised. Three more are preparing for the state to take direct stakes. The UK stands on the edge of recession. It hardly seems like the best time to encourage private citizens to entrust their savings to financial institutions.

Yet it may be just the right moment. As the financial crisis has bled from the business pages onto the front pages, faith in the whole structure of financial services has taken a beating. Sophisticated investors are used to suffering through volatile markets. The difference this time is that the crisis has rocked ordinary savers and bank depositors. These are exactly the customers that banks, insurers and fund managers would like to encourage to buy more sophisticated investment products.

The crisis also broke just as the biggest UK companies were starting to edge out of the shadow of the scandals of the past decade: the Equitable Life affair, split capital investment trusts, endowment mortgages and pensions mis-selling.

The banks' bosses have the hardest job in restoring trust. But they have two advantages over the rest of the sector. First, short of stashing cash under the proverbial mattress, risk-averse savers have little alternative except to put money on deposit with a bank. Second, the government's implicit 100 per cent guarantee should help bridge most of the gap between customers' suspicions and bankers' promises to do better next time.

It sounds odd, but history suggest the prospect of imminent recession should also help revive a savings culture. The household savings ratio, which turned negative in the first quarter for the first time since the 1950s, rises when house prices are falling, the economic barometer is dropping and unemployment is rising. Galloping inflation, negative real interest rates, or a deep depression that forced everybody to draw on their nest-eggs would curb that effect. But recent commodity price falls seem to be reining in inflation. Action to ease interest rates should see off the risk of a deeper and more damaging downturn.

Still, it is hard to imagine shaken depositors taking the next step towards more risky investment when the industry's biggest names are being attacked publicly.

The biggest risk is that aversion turns to revulsion in vulnerable younger adults, raised to believe it is normal to accumulate high debts (starting with student loans) and neglect savings.

An impressive new report by Reform, the think-tank, for the Chartered Insurance Institute, lays this out starkly. In the worst case, it suggests a regulatory clampdown could stifle product innovation, increase the cost of offering advice and turn 18- to 35-year-olds into "a generation of victims", whose mistrust of financial services will blight the whole system for years.

In the best case, government, regulators and companies manage to harness the under-35s' latent urge, natural capacity and strong demand for the tools to take charge of their financial affairs. New products are developed (or allowed to develop), sold in new ways and backed by more professional, better-trained advisers.

Innovation, professionalism, confidence. Seen from today's low-point, many feel the first has been discredited, the second has been abandoned and the third has evaporated. It will take an immense collective effort to realise the rosy vision of the younger generation as the saviours of the financial system. But, if recent events cannot kick-start radical new thinking across the financial services industry, it is hard to imagine what can.