The exam question is simple: how do we deal with the problem of banks deemed too big to fail and then taking risks underwritten by an effective taxpayer guarantee? This is the problem the Banking Commission sought to resolve in its report issued last week.
Bankers are in no position to resist reform. As a local MP I daily come across examples of the human effect of spending cuts which the government argues are necessary because of the financial collapse. All across Europe, in varying degrees, this is the case.
While most people in banking don’t enjoy the telephone number salaries we read of, the rewards at the top are way out of line with what anyone in a regular job can conceive of as value for money. Put more bluntly, most people would ask if a nurse is worth £25,000 a year why do top bankers get seven figure bonuses?
But is Vickers the right reform? He proposes a ringfence between the everyday retail operations – savings, current accounts and small business lending and the more exotic end of what universal banks do – sometimes referred to as casino banking. This, he believes, will mean a government guarantee focused on what most people would regard as the right area – people’s savings – and a greater focus on the risk taking part of the bank on who should bear the consequences of the risk. Vickers also says that on the retail side of the ringfence greater levels of capital would have to be held as greater security.
The examples of failure during the financial crisis are mixed. Northern Rock was a retail bank. It borrowed from the wholesale markets to lend in the mortgage market. When it couldn’t borrow any more, the government had to nationalise it to save it from collapse. Lehman Brothers, on the other hand, was an investment bank. It too collapsed.
So what are we to make of all this? Bankers protest that the investment side creates profits which aid the retail side. Most of us enjoy free current accounts. If we keep our account in credit, there are no charges (though if people go into unauthorised overdraft it’s a very different story). The bankers hint that this free banking may have to come to an end if the investment and retail sides become divided, or at the more extreme end that this set of rules may be so onerous as to force activity out of the UK.
For all that bankers have become the people politicians love to hate, especially during conference season, we should remember that financial services is a very important employer and income earner for the UK. We may have become too reliant on it but it should still be a major part of our economy in the future and if the UK is seen to have a strong financial sector that will mean more people employed and more families able to enjoy a decent standard of living.
The real question should not be one of vengeance but of function. The UK needs a better balanced economy, less reliant on property bubbles and more reliant on making things and playing to its other strengths such as the creative economy and the provision of excellent services. For this to happen, the real economy needs to be supported by a banking system which will lend in a responsible manner and look to the medium and long term. Some businesses are lucky enough to enjoy such relationships with their bank, but not enough do. Without credit on reasonable terms business cannot invest and expand.
Government efforts like the Merlin agreement on lending are not seen to be making a difference on the ground. Sick banks have to pay more to raise money in the markets. These costs are passed on to small businesses, making a base rate of 0.5 per cent meaningless to a small business seeking a loan from these banks.
I don’t believe anyone can say with certainty what the effect of Vickers will be on the banking system but the yardstick must be the degree to which the banking system supports the real economy. We will only get the growth we want if the financial system supports the job creators, investors and exporters of the country. It’s against that test that reform should be judged.
This article is also available on the Progress Online website. Posted on 20 September 2011.