This coming Wednesday, the House of Lords debates the second reading of the government’s banking reform bill. Now we’re in the holiday season, and the sun is shining, the prospect of an ermined discussion about bank regulation may strike you as deadly dull. But you’d be wrong.
This draft legislation forms the centre-piece of the UK’s response to the sub-prime collapse, the related banking meltdown and the resulting economic damage meted-out to millions of British workers. It’s unfortunate that such vital measures are being considered by the Upper House only at the fag-end of the Parliamentary year, when the Commons has already risen and media scrutiny of Westminster is on go-slow.
Perhaps Parliamentary business has been arranged this way because that’s what the government wants. For whatever reason, pivotal legislative debate, relating to a powerful and controversial industry, has been shunted into the “silly season”.
The UK remains in the economic doldrums. Having suffered the deepest slump since the Great Depression, we’re staging the slowest recovery in our recorded history. On top of that, and despite the “austerity” rhetoric, our national debt has doubled since 2008 and, on official estimates, will have more than tripled over eight years by 2016.
On all counts, our “world-class” banking sector is in the dock. British banks were central to the sparking of this crisis and, by cynically restricting credit, have stymied any UK upswing. Through a combination of triple-digit-billion bail-outs and weak GDP growth, they’ve done serious damage to our national accounts for decades to come.
Now, as a result of ferocious lobbying, the big banks are successfully resisting even the most feeble reforms designed to ensure that the next meltdown, when it comes, is less cataclysmic in economic, fiscal and human terms. So it is, to say the least, regrettable that contentious banking measures aren’t being debated in political primetime.
“The structure of the UK banking sector needs fundamental change,” proclaims the Treasury in a recent press statement, “to make banks more resilient to shocks and easier to fix when they get into difficulties, and to reduce the severity of future financial crises”. That sounds all well and good. But if ministers truly believes these words issued in their name, why have entirely reasonable proposals made by the Parliamentary Commission on Banking Standards (PCBS) been systematically watered-down? That question should be at the heart of the Lords’ debate on Wednesday.
The PCBS is an authoritative cross-party body. Set up in the aftermath of the Libor scandal, which has seen criminal charges laid at the door of several mainstream banks, it boasts members such as Former Chancellor Lord Lawson and Labour’s Lord McFall, together with Chairman Andrew Tyrie, with genuine financial expertise. The PCBS has heard from numerous witnesses and issued an exhaustive 571-page report. This document and the government’s response to it represent, as Tyrie says, “a unique opportunity for banking reform that must be seized”.
Having followed this debate closely in recent months, it is clear to me that the government is being far too dismissive of the PCBS and its conclusions. Mindful that ministers wouldn’t countenance a full institutional separation of investment and commercial banking along “Glass-Steagall” lines, the Commission cleverly proposed an “electrified ring-fence” instead.
In other words, if the big banks abused the incoming reforms proposed by Sir John Vickers, requiring them to keep the deposits of ordinary firms and households away from risky investments, the PCBS suggested regulators could publicly request that the government rapidly reconsiders the question of full separation.
Both politically and technically, this was a smart idea. While keeping the final decision in the hands of the Treasury, it gave regulators scope to blow the whistle if the banks try to “game” the Vickers measures – which, on previous experience, they will. Regulators would have genuine independence, helping them to keep in check banks that were taking liberties and placing bets using ordinary deposits backed by a taxpayer guarantee – a strategy which boosts bank profits but obviously raises the danger of more mega bail-outs. Yet the government dismissed the “electrified ring-fence” almost as soon as the PCBS proposed it.
It was the same story when it came to the Commission’s recommendations to limit proprietary trading – when banks make trades with their own funds that have nothing to do with customer activity. Such practices can also be deeply destabilizing, which is why the US is introducing laws to rein-in “prop trading”.
Again, the PCBS came up with an innovative solution, arguing that legislation should be amended so regulators – in the form of the new Prudential Regulation Authority – have powers to inspect bank trading books and ban prop trading when they see it. Taking this route would have avoided definitional problems which have seen America’s “Volcker rule” run to thousand of pages. Once again, though, ministers vetoed the Commission’s proposal, no doubt to the delight of the banks.
Tyrie is an intelligent and reasonable man, who has worked hard to square the needs of finance on the one hand and broader society on the other. No wonder he labels this rejection “very regrettable”, while dubbing “inexplicable” the government’s broader determination to dismiss the Commission’s warnings and pander to the banks. No wonder, also, that someone of Lord Lawson’s massive experience and financial nous now says the government’s “banking bill, as it stands, remains defective in many key areas”.
Such consummate political insiders, locked in negotiation with the highest powers in the land, don’t speak out unless they feel something is very wrong. They clearly feel that the opportunity is slipping away to implement the reforms we so desperately need. They are neither grand-standing nor seeking publicity. On the contrary, they’re deeply concerned about further damage that will ensue if our banking system, once again, is allowed to spiral out of control.
Last month, Sir Mervyn King told the Treasury Select Committee, also under Tyrie’s Chairmanship, that bank lobbying has become “unacceptable” in recent years, with pressures being brought on regulators “from within government” after senior City executives had made “phone calls to Number 11 and, in some cases, Number 10”. Why would an out-going Bank of England Governor make such claims without good reason?
For years, banks have juiced-up returns on equity by borrowing money to “leverage” their investments. That’s financed bumper bonuses, but magnified losses when markets collapse, leading to massive bail-outs. The PCBS called for ministers to “relinquish control over decisions over the leverage ratio” arguing that “such matters are for regulators” – yet another proposal the government has seen cause to reject.
“Banks argue that, on grounds of competition, that they ought to be allowed to have very high leverage,” King said in a recent newspaper interview. “But of course, that’s just another way of saying that taxpayers should be required to subsidize [them]”.
“Leverage is the one issue that matters above all others,” King continued. “Of course, it’s precisely for that reason that the banks will resist most strongly the regulation of leverage and the politicians will compromise on precisely that”.
Asked why such compromise would happen, King said: “Well, there’s always been a willingness to be overly impressed by people who appear to be extraordinarily successful financially. That was true with the great entrepreneurs of the past. Politicians wanted to be befriended by them and be supported by them. So they had influence beyond what we’d think of as rational”.
Their Lordships should remember that when, on Wednesday, they debate the government’s bill on banking reform.