Insider Reveals the 2 Biggest Problems With Modern Banks

By Markets Fool.com

In a 2011 interview with The New York Times, M&T Bank CEO Robert Wilmers described today's mega banks as "virtual casinos." Pressed further, and in light of all the reforms since the financial crisis, Wilmers calmly stated, "[the mega banks]are still doing things that I don't think are very good."

Continue Reading Below

What kind of things? In last year's annual report, Wilmers broke down the two most significant problems he sees in the industry: the trading business and executive compensation.

The problem with today's mega bank trading units
The idea of banks as a market maker and trader came out of a need in the real economy. Farmers, manufacturers, and other non-financial businesses have a genuine need to trade on the commodities and capital markets. These businesses seek to lower costs, stabilize processes, and generally operate more efficiently. That's where derivative contracts first appeared -- as a way for farmers or manufacturers to lock in the prices of their products ahead of time as a risk-management tool.

Banks were the natural fit to provide these services. There was nothing speculative about it. Real commerce had a need, and banks were there to provide the service. In this light, derivatives, hedging, and trading are actually good businesses.

But as Wilmers points out, today's trading units operate far beyond these humble beginnings. According to Wilmers, the trading volume of natural rubber was 156 times the volume of the industry's annual consumption. This volume, largely driven by banks, far exceeds any level that could be reasonably attributed to commerce. This is pure speculation.

He provides another example, best told in his own words:

Continue Reading Below

Last year, a consumer beverage company -- a user of aluminum -- provided testimony to the Senate Committee on Banking, FinancialInstitutions and Consumer Protection about bottlenecks artificially limitingsupply. Of the 37 Detroit-based storage sites that control 70% of the availablealuminum in North America, 29 are owned by a large U.S. bank. A mediainvestigation pointed out that delivery times out of the warehouses haveincreased from six weeks to 16 months since the bank bought the warehousesin 2010, coincident with the fact that the institution earns 48 cents per ton,per day, for storing the metal. It is little wonder that industrial users are outraged by bank ownership of parts of the supply chain for commodities.When put in this light, it seems directly at odds with the interests of producers and, in turn, consumers.

Today's operations are a "virtual casino" indeed, including a bottom-dealing dealer.

The fundamental problem is that these activities don't support commerce. They are pure speculative plays that benefit no one other than the bank, and unnecessarily put taxpayers, depositors, and investors at risk.

Executive compensation
Wilmers' criticism of executive compensation is not limited to banks alone. It's much broader, afflicting the entire swath of large public companies.

He points to a few trends that do an amazing job summarizing the current problem. In 1983, the average chief executive of the six largest U.S. banks earned 40 times the average pay of all U.S. workers. Today, that multiple is an incredible 208 times. The average for non-bank CEO pay is even greater at 244 times.

From the public perspective, the outrage is clearly understandable. These executives earn salaries that are unfathomable to everyday Americans, and they do so by running companies that required billions of dollars in taxpayer bailouts just a few short years ago.

Summing it all up, these executives earn unfathomable sums by putting public money at risk, and taking on no personal risk of their own. It's not difficult to grasp both the public outrage and the reputational harm being done to the industry.

Challenges remain for the U.S. banking industry
The last eight years have been tough for U.S. banks. The financial crisis brought to light many of the excesses and inappropriate behaviors common at the nation's largest banks.

Much has changed since then, but work remains to be done. As a bank analyst here at the Motley Fool, I sincerely hope that the industry will follow the lead of Robert Wilmers and M&T Bank. Investors, depositors, and taxpayers all deserve better.

The article Insider Reveals the 2 Biggest Problems With Modern Banks originally appeared on Fool.com.

Jay Jenkins has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.