We Must Call the Bluff of the Big, Bad Banks

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Friday 08 April 2011

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Jeff Randall

We must call the bluff of the big, bad banks It would be insane not to change the structure of banking, because it’s doomed to fail again, writes Jeff Randall. The Independent Commission on Banking and its impact on banks has been the subject of feverish speculation.   By Jeff Randall 7:02PM BST 07 Apr 2011

Comments

When asked by a judge why he persisted in robbing banks, the serial offender replied: “Because that’s where the money is.”

For us taxpayers, this observation is now doubly true. The banks have captured our money twice over: as cash in their vaults and investments in their shares. We own all of Northern Rock, most of Royal Bank of Scotland and nearly half of Lloyds Banking Group. We rescued them – and in so doing became their prisoners.

The scale of our discomfort will be set out on Monday when the Independent Commission on Banking, chaired by Sir John Vickers, delivers an interim report. It will be embroidered with arcane references to “functional subsidiarisation” and “macro-prudential regulation”. But cut through the gobbledegook and there is a simple question: can our banking system be reformed to make customers’ deposits more secure, without destroying the value of the state’s enormous shareholdings?

Would new rules to separate the racier aspects of banking – so-called casino operations – from traditional savings-and-loans business result in a diminution of banks’ profitability and, as a result, prompt a flight of institutions from these shores?

Top bankers want us to believe the answer is yes. The global economy cannot function without big banks, they say: gigantism provides synergies, efficiencies and benefits of scale. What a hoot. Tell that to the shareholders of Citigroup, a banking behemoth, which all but disappeared up its own balance sheet in 2008, having had a wild (losing) punt on sub-prime mortgages.

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Big banks’ claims of indispensability are “preposterous”, says Nouriel Roubini, professor of economics at New York University. The financial hypermarket is doomed to fail because “the complexity of these firms, never mind the exotic financial instruments they handle, makes it mission impossible for CEOs – much less shareholders or boards of directors – to keep tabs on what’s going on across every division at every trader’s desk”.

Even if financial conglomerates could provide services a bit more efficiently than smaller banks – which they can’t – are the marginal advantages worth holding the whole system hostage to a few super-sized players whose failures would be catastrophic? Go down this road and you end up in a toxic dump with the capacity to wipe out entire economies – as Ireland has discovered. Irish banks weren’t too big to fail, they were too costly to save.

Applying the logic that bigger is always more beautiful, says Roubini, “one might build a gigantic nuclear power plant that’s a hundred times the size of Chernobyl, simply to gain some minor economies of scale. That’s nice – until there’s meltdown.”

The real reason big banks want to take in small depositors’ money has nothing to do with the effectiveness of a one-stop shop. It’s simply that Mr Littlechap’s account is a cheap source of funding, backed, as it is, with a guarantee from government that is obliged to protect small savers.

Terry Smith, a former top-rated banking analyst, who now runs his own fund management company, explains: “I’d never invest in big banks as they are. Their managements have demonstrated they’re completely incapable of running businesses that combine high-risk trading with conventional high-street operations. There is not a shred of evidence to demonstrate that attempting to do both improves customer service.”

Insanity is repeating one’s mistakes but expecting different results. We’ve tried madness and it doesn’t work. We need a new settlement with our banks. But in what form?

There is a general perception that we don’t want banks to fail, not even bad ones. This is a mistake. We should be perfectly happy to see poorly run businesses disappear – as long as they don’t take customers’ deposits and the wider financial system with them. The obvious conclusion is that we need to split up the banks, or at least make sure that their gung-ho trading departments are hermetically sealed from ordinary people’s savings.

It is widely perceived that Mervyn King, the Bank of England’s governor, shares such a view. He invited us to infer this in an address to Scottish business organisations in 2009: “Anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities, would be thought rather unworldly.”

I have re-read the governor’s Edinburgh speech. He did not declare unambiguously that the banks should be split up, but neither Dr King nor his press team chose to correct the ubiquitous impression that this is what he had meant. The headlines went unchallenged.

In recent days, however, with the Vickers report looming, I’m picking up a markedly different scent wafting through the corridors of Threadneedle Street. The governor, it seems, will not go toe-to-toe with Vickers if the commission’s conclusion, as many think likely, is that the big banks should remain largely intact. Having strayed perilously close to interfering in fiscal policy, perhaps the governor does not want to embarrass the Chancellor by being openly at odds with a government-commissioned study.

If this is the case, then I fear that the upshot of much hand-wringing, head-banging and horse-trading will be a ghastly fudge, a limp compromise. The big banks are threatening to remove their bat and ball if they cannot set the game’s rules. They point out that the playing fields are more attractive elsewhere. Let’s find out. We should call their bluff.

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Jeff Randall

Comments

When asked by a judge why he persisted in robbing banks, the serial offender replied: “Because that’s where the money is.”

For us taxpayers, this observation is now doubly true. The banks have captured our money twice over: as cash in their vaults and investments in their shares. We own all of Northern Rock, most of Royal Bank of Scotland and nearly half of Lloyds Banking Group. We rescued them – and in so doing became their prisoners.

The scale of our discomfort will be set out on Monday when the Independent Commission on Banking, chaired by Sir John Vickers, delivers an interim report. It will be embroidered with arcane references to “functional subsidiarisation” and “macro-prudential regulation”. But cut through the gobbledegook and there is a simple question: can our banking system be reformed to make customers’ deposits more secure, without destroying the value of the state’s enormous shareholdings?

Would new rules to separate the racier aspects of banking – so-called casino operations – from traditional savings-and-loans business result in a diminution of banks’ profitability and, as a result, prompt a flight of institutions from these shores?

Top bankers want us to believe the answer is yes. The global economy cannot function without big banks, they say: gigantism provides synergies, efficiencies and benefits of scale. What a hoot. Tell that to the shareholders of Citigroup, a banking behemoth, which all but disappeared up its own balance sheet in 2008, having had a wild (losing) punt on sub-prime mortgages.

Banking Commission risk rating for Britain's top five banks

The banks have offered an olive branch

A return to a client-centric culture will ensure City’s future

UK banking needs more competition, so what's the solution?

RBS sale a 'missed opportunity', key report warns

MPs' report on retail banking – in quotes

Big banks’ claims of indispensability are “preposterous”, says Nouriel Roubini, professor of economics at New York University. The financial hypermarket is doomed to fail because “the complexity of these firms, never mind the exotic financial instruments they handle, makes it mission impossible for CEOs – much less shareholders or boards of directors – to keep tabs on what’s going on across every division at every trader’s desk”.

Even if financial conglomerates could provide services a bit more efficiently than smaller banks – which they can’t – are the marginal advantages worth holding the whole system hostage to a few super-sized players whose failures would be catastrophic? Go down this road and you end up in a toxic dump with the capacity to wipe out entire economies – as Ireland has discovered. Irish banks weren’t too big to fail, they were too costly to save.

Applying the logic that bigger is always more beautiful, says Roubini, “one might build a gigantic nuclear power plant that’s a hundred times the size of Chernobyl, simply to gain some minor economies of scale. That’s nice – until there’s meltdown.”

The real reason big banks want to take in small depositors’ money has nothing to do with the effectiveness of a one-stop shop. It’s simply that Mr Littlechap’s account is a cheap source of funding, backed, as it is, with a guarantee from government that is obliged to protect small savers.

Terry Smith, a former top-rated banking analyst, who now runs his own fund management company, explains: “I’d never invest in big banks as they are. Their managements have demonstrated they’re completely incapable of running businesses that combine high-risk trading with conventional high-street operations. There is not a shred of evidence to demonstrate that attempting to do both improves customer service.”

Insanity is repeating one’s mistakes but expecting different results. We’ve tried madness and it doesn’t work. We need a new settlement with our banks. But in what form?

There is a general perception that we don’t want banks to fail, not even bad ones. This is a mistake. We should be perfectly happy to see poorly run businesses disappear – as long as they don’t take customers’ deposits and the wider financial system with them. The obvious conclusion is that we need to split up the banks, or at least make sure that their gung-ho trading departments are hermetically sealed from ordinary people’s savings.

It is widely perceived that Mervyn King, the Bank of England’s governor, shares such a view. He invited us to infer this in an address to Scottish business organisations in 2009: “Anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities, would be thought rather unworldly.”

I have re-read the governor’s Edinburgh speech. He did not declare unambiguously that the banks should be split up, but neither Dr King nor his press team chose to correct the ubiquitous impression that this is what he had meant. The headlines went unchallenged.

In recent days, however, with the Vickers report looming, I’m picking up a markedly different scent wafting through the corridors of Threadneedle Street. The governor, it seems, will not go toe-to-toe with Vickers if the commission’s conclusion, as many think likely, is that the big banks should remain largely intact. Having strayed perilously close to interfering in fiscal policy, perhaps the governor does not want to embarrass the Chancellor by being openly at odds with a government-commissioned study.

If this is the case, then I fear that the upshot of much hand-wringing, head-banging and horse-trading will be a ghastly fudge, a limp compromise. The big banks are threatening to remove their bat and ball if they cannot set the game’s rules. They point out that the playing fields are more attractive elsewhere. Let’s find out. We should call their bluff.

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