There’s been so much in the news that a UK-based economist could be forgiven for fretting over what to write about this weekend. Inflation rose by 2.7pc in May, we learnt last Tuesday, up from 2.4pc the month before. Then there were the recommendations from the G8 summit in Fermanagh.
We’ve also seen policy fireworks across the Atlantic, too. Just a hint from Federal Reserve Chairman Ben Bernanke that the US could soon “taper” its turbo-charged money printing was enough to throw global stock markets into a rout.
Then, on the Continent, Eurozone finance minsters agreed that a Cypriot-style “bail-in”, with bank deposits being lost above a certain level, could now be imposed elsewhere. That raised contagion fears, doing nothing to calm Europe’s jittery bond markets.
Oh, and then there was a manufacturing slump in China, amid growing concern the second-largest economy on earth, lately substituting for America as the world’s growth locomotive, could itself soon slow down.
So the economic news has been flowing thick and fast. Yet I’ve had no hesitation in opting to write about the UK banking sector. When it comes to mounting a genuine domestic recovery, nothing is more important than “fixing” our banks. When it comes to preparing the UK for the next “systemic moment” on global markets – for there will be one, of that we can be sure – then, once again, our banks are centre-stage.
Last week saw the publication of an exhaustive final report by the Parliamentary Commission on Banking Standards. Under the leadership of Treasury Select Committee Chairman Andrew Tyrie, the Commission boasts some pretty heavyweight members – including Former Chancellor Lord Lawson and a previous Treasury Select Committee Chairman, Labour’s Lord McFall.
These are people of massive experience and for whom I have enormous respect. Yet having been through all 571 pages, I’ve sadly concluded this report will change very little. That’s because it fails to promote the one reform, above all others, that really must happen if we’re to defuse the “too big to fail” time-bomb and prevent the UK’s banking sector, once again, from doing serious damage to its host economy.
A major strength of this report is its account of the extent to which existing bank practices work against consumers. Going through it makes the reader angry and, when it comes to description, the Commission has pulled no punches.
“Given the misalignment of incentives in banking, it should be no surprise that deep lapses in standards have been commonplace,” the report booms. While that’s obvious, for a high-powered Parliamentary body to say so still represents progress.
Many of the Commission’s 80 recommendations make sense. A new “Senior Persons Regime” could make it harder for boss-class bankers to avoid punishment by claiming responsibilities were delegated and bad decisions collectively taken. Requiring senior managers to sign up to a code of conduct may also help focus minds.
The most powerful recommendation, in my view, concerns the all-important leverage ratio. For years, banks have juiced-up returns on equity by borrowing money to “leverage” the size of their investments. But that magnifies losses when markets collapse, so leading to astronomical bail-outs. So far, the government has failed to grab hold of this important issue, not least because the banks have lobbied extremely hard for them not to do so.
It is to be welcomed, then, that the Commission called for politicians to “relinquish control over decisions over the leverage ratio” arguing that “such matters are for regulators”. Having already recommended this in its first report back in December, the Commission didn’t flinch.
Last week’s tome said members were “not persuaded” by Treasury claims that high leverage ratios would harm the banks. The Commission also still sees “no good reason” why the government has delayed even a review of who sets leverage ratios until 2017. Quite.
The recommendation that top bankers found guilty of “reckless conduct” should be jailed was the most eye-catching, of course. Yet existing laws on financial fraud are perfectly adequate when it comes to imposing custodial sentences.
What’s needed is political will – and for the regulators to be sure the political classes will back them if they turn the screw on high-finance white-collar crime. Such will has been thin on the ground. A Parliamentary Commission’s proposal for a new offence, even if eventually enshrined in law (a big if), will do nothing to change that.
Measures to delay bonuses by “up to” 10 years are also likely to be ineffectual – as the bankers will just bump-up basic pay. And the idea of “clawing-back” salary if fines are later levied on a bank, while appealing, will be problematic too. The result could be a lawyers’ bonanza, ultimately paid for by the taxpayer if the firm in question has already failed.
So while the Commission’s report is a descriptive tour de force, and is good in parts in policy terms, I don’t believe it will live up to its title and succeed in “Changing Banking For Good”. I don’t necessarily blame its members for that. They’re working in shark-infested political waters, after all. And radical reforms, while relatively easy for a newspaper columnist to advocate, can unsettle financial markets if proposed by a weighty Parliamentary Commission.
Having said all that, I still think the Commission has backed down too easily when it comes to the reform without which we have absolutely no hope of creating a relatively stable banking system – that is a genuine “Glass Steagall” separation of investment and commercial banking.
Sir John Vickers’ proposed “ring-fence”, a Chinese wall within the existing universal banks, is a political compromise with not a chance of reining in London’s rapacious investment banking culture. The Vickers measures won’t stop traders from continuing to leverage and then gamble with the deposits of ordinary firms and households, safe in the knowledge they’ll be bailed-out when their bets go wrong. Relying on the ring-fence is to all but guarantee another crisis a few years down the line – not least because, under pressure from the bankers, ministers have agreed not to implement this extremely weak measure until 2019.
Back in December, the Commission’s first report stated that the “ring-fence” would be “tested and challenged by the banks”. It recommended “electrification” – the passing of reserve powers to implement a full-split if banks game the system. “All history tells us they will do this unless incentivized not to,” the Commission boomed six months ago.
In this latest report, though, the language on the “ring-fence” is far softer, “electrification” has been downplayed and the Commission appears to have simply accepted a 6-year delay even of this most inadequate safeguard. This is a very big mistake indeed. A proper institutional split between investment banking and ordinary deposits is a pre-requisite of a stable banking system – and it’s a measure that, by curtailing the danger of yet another crippling bail-out, would actually make the City of London stronger.
In his final speech as Bank of England Governor last week, Mervyn King said “it is vital, as memories of the 2008 crisis fade, that the audacity of pessimism is not lost”. That’s entirely correct. So I don’t apologize for being downbeat about our economic prospects as long as our banking sector remains moribund and fundamentally unreformed. And I don’t apologize for refusing to pretend that this Parliamentary Commission’s proposals amount, as has been billed, to a “radical overhaul” of our banking sector – when that is so clearly far from the truth.