This year, Britain had a ‘Goldilocks moment’ – when the temperature was just right – to get to grips with its over-mighty finance industry. Two years ago, the banks were still too weak. In the immediate wake of the credit crunch, they couldn’t have survived radical restructuring. In two years’ time, the banks will be making big profits again, paying lots of corporation tax, and making big donations to political parties. The memory of the credit crunch will have faded and the political will to break them up will have evaporated. Right now, though, they’re strong enough to take some punishment. The desire to make sure the events of 2008 are never repeated is still there. As Goldilocks would put it, it is neither too hot nor too cold – but just right. Despite that fact, Sir John Vickers and his colleagues on the Independent Commission on Banking blew it.
No one can be in much doubt that Britain’s banking industry is in need of a major structural overhaul. Put simply, this country’s banks have become too big, and too risky, for the size of the economy that ultimately underpins them. The point was well illustrated in a research note published by UBS last month. Barclays now has a balance sheet worth 100% of GDP. For a comparison, JP Morgan has a balance sheet worth 24% of US GDP. In effect, Britain is host to three very large banks – Barclays, HSBC and Royal Bank of Scotland – each of which has the potential quite literally to bankrupt the country. We have already seen how Iceland and Ireland were ruined by the recklessness of their financiers. The same could easily happen to this country. It is a threat, and one the Commission had a duty to take seriously.
Yet, probably under the influence of lobbying from the banking industry, it has largely ignored it. The report singles out Lloyds for its main attention when, in fact, it’s the bank that poses the leastthreat to the stability of the financial system. Lloyds will be forced to sell off more branches, over and above the 600 the EU is making it get rid of. It is certainly true that Gordon Brown’s decision to bounce Lloyds into merging with HBOS was one of the former prime minister’s many catastrophic mistakes. It ruined a sound bank, and dramatically shrunk competition in the mortgage and savings market. If reducing its size creates some space for new players in the financial services industry, that will be a good thing.
But it’s crazy to imagine that that will make the financial system more stable. There’s simply no evidence to suggest that too little competition between banks is what led to the credit crunch. Through 2006 and 2007, there were arguably too many lenders crowding into the British market. They were throwing around self-certification, buy-to-let mortgages like confetti. More competition in a market is always a good thing. It creates more choice and better service with better prices. But anyone who thinks it will make the system safer is kidding themselves.
If the Commission was too harsh on Lloyds, it was too soft on RBS, Barclaysand HSBC. It proposes stricter capital requirements and dividing lines between the retail and investment banking units. In theory the investment bank can safely be allowed to go bust, while the retail arm will be protected. The trouble is, neither is going to fix the real issues. The banks didn’t go bust because they had too little capital. A bigger buffer against financial shocks will help, but a reckless bonus system, too many complex products, and mindless expansion into markets they didn’t understand were the underlying causes of the crisis. Would RBS have survived with a couple of per cent more capital? Unlikely. Neither would any of the other banks.
Nor is ring-fencing the banks’ retail arms going to make a great deal of difference. It is very hard to believe that any kind of structure can be created that will make it certain that a collapse of the investment banking arm won’t bring down the retail bank as well. Bankers are very good at shifting money around a balance sheet. If there is a way of making the retail unit subsidise the rest of the bank, someone will find it and exploit it. For the system to work, you have to believe that the regulators are smarter and more knowledgeable than the people working in the banks – and the chances of that are just about zero.
Vickers had a one-off chance to do something really radical. He should have proposed a complete split between retail and investment banking. The retail banks would be safe, dull institutions, and they could be fully protected by the government from failure. The investment banks could take all the risks they liked, in much the same way that the hedge funds do. If they went bust it wouldn’t matter much to anyone, apart from their staff.
Sure, under pressure, Barclays might opt to move to New York. HSBC might decide to go back to Hong Kong, or to Shanghai. But so what? It matters much less than most people suppose whether a bank is domiciled in this country. The Commission had a duty to think seriously about whether it was responsible to host massive banks in Britain. It failed completely. The moment to protect the country from another massive banking collapse has passed – it won’t come again.