Imagine that you’re kicking off your first day working for an investment bank in the City of London. You’ve just finished a Masters in Finance and are confident that you know all there is about discounted cash flow (DCF) models, RoE and any technical issue that could come up. But, you ask yourself, why am I here? What purpose am I serving in the broader scheme of things? What am I bringing to society’s table?
If this seems like an existential question, bear in mind these are the issues that banks are addressing internally. Battered and bruised from the financial crisis, financial services organisations are in a crisis of conscience, desperately trying to prove their value to a society blinded by big pay packets and misconstrued stereotypes.
Questioning what, exactly, the financial sector should be doing is fundamental to understanding how it should move forward.
“Imagine you’re graduating from medical school and all you have is a very in-depth knowledge of anatomy,” says David Pitt-Watson, a former fund manager and executive fellow at London Business School (LBS). “That’s important, but it doesn’t equip you with all the skills to practice medicine.”
The purpose of finance
Pitt-Watson, together with Chris Higson, is teaching a new module in LBS’s Masters in Finance course on the purpose of finance. Most Masters in Finance courses are now addressing softer topic like ethics – often at the behest of employers – but none are questioning why the industry exists in the first place, and thus how it best can be improved.
“If you distil it down, there are essentially four functions of the financial sector – keeping our money safe, allowing us to transact, allowing us to share risk and intermediation; that is taking our savings and giving them to someone to invest” he says.
How successful has the sector been? Not very, is the short answer. Thomas Philippon, a professor of finance at the Stern School of Business looked at how the U.S finance industry had helped the ‘real economy’ over the course of the past 130 years. He found no real improvement over the course of this period – the “unit cost of intermediation” remained at close to 2%.
“We’re not teaching ethics, and we’re not trying to convert people,” says Pitt-Watson. “What we’re trying to make students understand is the broader context within which the financial sector sits, and what purpose it performs.”
There are various ways that students discuss this. For example, they learn about the first pension fund, created in Scotland in 1740 to cater for the widows and orphans of Scottish ministers. Universities in the country had statisticians who were way ahead of their time, but it’s unlikely that the widows and orphans would have entrusted their money into a scheme they had little understanding of were it not for the fact that they believed that the Scottish ministers overseeing it would not allow their money to be lost or abused.
“We also run a game that allows students to make decisions without full information—that happens all the time in the real world. Of course students discover they have made all sorts of bad decisions.” say Pitt-Watson.
The course is accompanied by a book, What They Do With Your Money. It has piqued the interest of Barclays chairman David Walker and former Vanguard Group chairman, Jack Bogle. Legendary investor, David Swensen, who heads the Yale endowment fund reckons these ideas should be learned by anyone who cares about the role of finance in today’s economy.
“It’s the first year that we’ve done this, but we’ve already had LBS alumni come to us saying they wish learned this ten years’ ago before they started working in finance,” says Pitt-Watson.
“Ultimately, there’s no single definitive answer to what the best financial system would look like, just as there is no blue print for the perfect medical system , but addressing these questions is essential to ensuring that the financial sector becomes more efficient and more effective,” says Pitt-Watson.