Dr Eamonn Butler is director of the Adam Smith Institute. The briefing paper BankReform: Getting the Policy Right and the full report Bank Reform: Can we Trust theVickers Commission are available here.
A short while ago, George Osborne set up the Independent Commission on Banking (ICB), telling it to look for ways to improve the strength of the banking system.
What he didn’t say publicly, but everybody knew, was that he was looking for ways to spare the government having to bail out banks in the future. And so the Commission came up with two recommendations aiming at just that. One would be to restrict government bailouts to high-street banks, which would be ‘ring fenced’ from the banks’ other, international investment, business. And the second was to impose higher capital requirements – forcing the banks to hold more ‘safe’ assets as a cushion against future crises.
These recommendations are wrong and will damage Britain’s banks, raise the cost of borrowing for small firms, and cause our economic stagnation to drag on – right up to the next election, which cannot be a welcome prospect for Mr Osborne and his colleagues.
The ICB came up with the wrong answers because it completely misdiagnosed the problem. It wasn’t ‘risky’ investment banks that sparked the UK crisis. It was the ‘retail’ banks and building societies like Northern Rock and HBOS. They lent too much to people who could not repay, bought dodgy US investments they did not understand, pursued flamboyant takeovers, and borrowed to much to pay for it all.
Nor was the crash caused by a lack of regulation. The banks were the most regulated industry in the UK. But the regulators were asleep on the job, or content to pass the buck between each other.
But the ICB says nothing about improving supervision. Nor about the huge government-led boom that caused bankers to make these dicey decisions. Nor the lack of competition (the big four banks control nearly three-quarters of our accounts) that allowed bad management to persist.
Instead it proposes to break up the banks into retail and investment arms. Being designed by politicians, that process can only end in disaster. And it wants to impose a vast new set of restrictions on how the new retail banking arms can operate – adding to the complexity and opacity of the regulatory system.
The idea of forcing the banks to keep more ‘safe’ assets at hand is equally misguided. What exactly is a ‘safe’ asset? In early 2007, most banks thought mortgages were ‘safe as houses’. But they weren’t. And every extra penny a bank puts into its reserves is a penny it won’t be lending out to small businesses. So small firms – the backbone of the economy, where jobs and growth come from – will find it even harder to get loans, and will pay even more for them. The result of that is economic stagnation and unemployment that remains stubbornly high.
The sad thing is that people do want secure banks, but current policy, and the ICB proposals, won’t deliver them. In a new Adam Smith Institute report and briefing paper today, we argue that regulation should focus where it matters – on protecting high-street customers – while savvy international investors can look after themselves. We propose a new form of bank licence, allowing ‘Trust Banks’ to operate. They would have to be solid, or they would lose this kitemark status, and their solidity would be closely supervised; but there would not be a complex new rulebook telling them what they could and could not do.
Trust Banks would have to be run separately from other banks. But rather than creating them by forcibly tearing limbs of existing banking groups, we believe lots of new, smaller banking providers would seek this new status. That would bring much needed competition into banking – and competition, after all, is by far the best regulator.