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Sir John Vickers' ICB report is a start. But its failure to address issues such as size caps on banks makes more crises inevitable
The process of reforming the banking system has begun. The Independent Commission on Banking's report is welcome official recognition that the banking system is broken and needs mending. The New Economics Foundation (Nef) still believes that full separation of the banks is a cleaner, more efficient option than ringfencing. And the commission was never even tasked with two of the most important questions: to investigate what went wrong to cause the crisis; and to picture what a good banking system would look like. But it is a start.
The commission's proposal to ringfence retail banking away from investment banking will undoubtedly help reduce the extent to which banks can borrow cheaply as a result of their implicit government guarantee (the so-called "too-big-to-fail" subsidy, which Nef estimated to be worth approximately £46bn to the largest five UK banks in 2010). However, we are kidding ourselves if we believe that these reforms will mean that taxpayers will never again be called upon to bail out troubled banks.
It is worth noting that Lehman Brothers was an investment bank that had no retail banking component; yet its collapse sent shockwaves around the globe. In the UK we have individual banks with assets greater than UK GDP and, given this reality, even outright separation between retail and investment banking – which is not what we are getting – would still leave lingering too-big-to-fail problems. We have to acknowledge the fact that we quite simply have banks that are too big for our economy.
Some argue that banks have to be as large as they are in order to provide good services at decent prices, but this argument does not fit with history. From the late 19th century until the 1970s, banks' assets as a percentage of UK GDP remained steady at approximately 50%. However, at the end of the 20th century, we allowed banks to balloon in size, and by 2006, banks' assets as a percentage of UK GDP were over 500%.
The UK's exposure to the banking sector is also exceptionally high by international standards. For example, financial sector assets in relation to GDP are higher in the UK than in most other countries, including the US, Japan, France, Germany, Australia, Canada, Italy and Spain. Further evidence of our exceptionally bloated banking system can be found in IMF calculations that revealed that the UK had to pledge more support to its financial services industry, as a percentage of GDP, than the majority of other advanced economies. In 2009, the UK pledged 101% of UK GDP in support of the banking sector, in comparison to the US's 42% of GDP, Germany's 27% of GDP, and Japan's 21% of GDP.
Given the above, it is disappointing that the commission did not seriously explore imposing size caps on our banks; it instead gave only very brief consideration to this proposal. This is perhaps the commission's greatest failure. While some may disagree with the idea of size caps, surely few can deny that they should at least have been fully discussed.
Lately we have heard many arguments that reforming our banks would reduce their ability to compete internationally, and encourage them to relocate overseas. However, we shouldn't be fooled into thinking that economic growth stemming from a fundamentally unstable system will generate long-term value for the UK. It is this type of thinking that led us into the current mess, where we find ourselves being blackmailed by what was supposedly our golden goose. In the commission's own words: "The fact that some other countries may implicitly subsidise their wholesale/investment banks does not make it sensible for the UK to do so."
The discussion over the appropriate timing for the reforms also illustrates an interesting double standard: when it comes to cutting government spending, a key driver of economic growth, the government gave short shrift to any suggestions that this economic shock should be implemented slowly over time, to prevent derailing the recovery. In contrast, amid cries that reform will impair our anaemic economic growth, the banks are being given eight years to adjust to the new reality.
We should also be conscious of the fact that a crisis brings a once-in-a-lifetime opportunity to implement real reform. By the time the economy has recovered, we may not have the political or public will to tackle this hugely influential interest group. The banks have enormous sway with politicians; for example, over half of the donations made to the Conservative party in 2009 and 2010 stemmed from the City. So we may be dealing with a case of "it's now or never".
The executive director of financial stability at the Bank of England, Andrew Haldane, once said: "There is one key difference between the situation today and that in the Middle Ages. Then, the biggest risk to the banks was from the sovereign. Today, perhaps the biggest risk to the sovereign comes from the banks."
This statement remains true, and we must not be distracted by comments that the commission's proposals are the most radical reforms the banking sector has seen in the past century. This is only a reflection of the excessive freedoms we have granted banks in the past; it does not mean that our problems are now solved.
We need real reform of our megabanks, which almost certainly should involve cutting them down to size. Otherwise, history will, at some point, repeat itself.
- Banking reform
- Financial crisis
- Bank of England
- Banking
- Financial sector
- George Osborne
- Recession
- Banks and building societies
- Consumer affairs
- Conservatives
Lydia Prieg
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