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Traditionally, banks lent money to people and companies and kept the loans on their balance sheet. They made money through the interests paid by borrowers on the loans. This model of banking, called "originate and hold", was characterised by an ongoing relationship between the financial institution making the loan and the customer that borrowed the money. In addition, the bank had a direct financial interest in ensuring that the customer would repay the loan.



However, over the years a new model of banking has emerged whereby loans made by one financial institution were sold on to other institutions. The new "originate and distribute" model meant that banks could lend more money to other borrowers since the previous loans had been bought by another financial institution and therefore did not appear anymore on their balance sheet. By doing this, some banks were able to grow their business much faster than their depositor base or shareholder investments would have allowed. This model is further characterised by the fact that the institution originating the loan has no direct interest in ensuring that its customers are able to repay it, since it does not retain the associated credit risk (which was passed on to the bank that bought the loan).



This is the mechanism that Will Hutton criticises in his comment in The Banker. According to Hutton, this process "actively shirked [the financial system's] responsibilities to committed ownership. Instead it vastly magnified financial transactions, much of whose purpose was to reduce commitment, but whose fees and commissions represented both an excessive tax on the real economy and ultimately a source of instability in its own right".



Hutton goes on to say that: "A bank owns a relationship with its borrowers. But banks began to think less of the "owned" relationship and more of how they could generate fees from commoditising the relationship into a tradeable transaction - securitisation."



He also thinks that this lack of ownership commitment has spread to other areas of the financial sector and gives several examples of this:

- Short selling: the practice of lending shares in exchange for a fee.

- Leverage buy out deals: private equity firms regarding companies as vehicles for leverage and mountainous returns to private equity partners.

- "Rehypothecating" assets bought with loans that a bank provided to a hedge fund in order to lend against them.



All these practices bring instability to the financial system as there is no incentive for risk takers to behave responsibly and moderate the risk they take. If a deal fails they will not be the ones bearing the consequences and will have cashed profits anyway through fees and commissions.



Hutton proposes some solutions to reintroduce ownership and therefore ethics in the financial world. He suggests that:

- Loans and shares should not be lent to third parties for fees.

- Short selling and rehypothecation should be banned.

- Short-term trading should be subject to a transaction tax.

- OECD governments should declare that the same disclosure rules and requirements are made of all tax havens.

- All bonuses in financial services should be pad on the basis of five-year performance.

- One-year bonuses should be subject to severe marginal tax rates.



Will Hutton's comment can be read in The Banker.