Incestuous Finance

Financial markets are enormous, but it’s mostly wasteful dealing between financial firms.

Why should we be concerned?

The private financial sector dedicates too much of its time and energy dealing with itself!

Financial firms, from banks to hedge funds, overwhelmingly provide what has been called Finance by Finance for Finance. Often non-financial firms are almost entirely missing from these markets. Financial firms deal and compete with other financial firms, chasing tiny margins from gigantic transactions in what amounts to a zero-sum-game between financial firms. These activities are risky and they don’t address society’s urgent issues.

A good example is high speed or high frequency trading, where firms often hold stocks and other financial instruments for just a few thousandths of a second. To be milliseconds faster than other financial firms, traders move closer to exchanges, lay the latest high speed cables by drilling through mountains and have even laid a new transatlantic cable just to save 6 milliseconds on the time to trade financial instruments with other financial firms!

The indicator…

Over-the-counter (OTC) derivatives markets are a major source of financial instability and of financial profits. And they are huge! One way to realize just how large they are is that the gross notional amount of outstanding OTC contracts is over $600 billion. Less well known is that this market is almost entirely made up of financial firms. Statistics from the Bank of International Settlements show that over 90% of gross notional outstanding is between financial firms. Every OTC derivative involves a bank, but less than 10% face a non-financial end user. And the statistics probably overstate the amount of truly non-financial activities: the treasuries of large multinationals often act just like financial firms (some say non-financial firms have been financialised). Across the years, this share of the market has hardly changed, despite the crisis and the regulatory changes that followed.

What should we change?

To serve society, private finance needs to start investing not betting. This should mean limits and disincentives on purely financial activities that shuffle money around the financial system.

You can find more detailed policy ideas elsewhere on the Finance Watch website and on the Change Finance website.

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