At a banking debate this morning, Which? called upon the Independent Commission on Banking to be brave with its recommendations. Vince Cable joins us to explore how we can prevent another banking crisis.
It’s 15 months since I worked with Which? on its Banking Commission, before joining the Coalition government. A group with disparate views came together to recommend unanimously a series of strong conclusions.
Its central point was that ‘banking is a structurally flawed industry that has failed its customers, its investors and the taxpayers who stand behind it.’ A year and a bit later, that verdict retains its force.
Banking needs structural reform
The Interim Report sets out carefully the argument for separation, or keeping banks’ risky investments away from your money. Traditional banking underpins a modern economy and has to be protected by the state from the risk of systemic collapse; that is not true of most wholesale and investment banking activities.
The implicit subsidy enjoyed by the banking sector effectively involves you, the UK taxpayer, underwriting bank’s high risk investment activities. When bankers have massive global exposure as they do in the UK, the public sector is taking on massive liabilities.
And since banks know that they are ‘too big to fail’ they have a big incentive to take excessive risk; and in the financial crisis some of those risks became a costly burden for the taxpayer.
We in government do not believe this is sustainable.
Will ring-fencing banks work?
The ICB recognised a trade off between the benefits of making banks safer through separation and the costs to the banks (some of which might be passed to their customers). It recommended separation through ring-fencing with retail banks having higher capital levels than now and wholesale/investment banks being sufficiently separate to allow them to fail in a crisis.
The ‘ring-fencing’ approach has been criticised for being insufficiently clear by those arguing for full separation; and by the banks themselves for going too far.
However, the ICB has made it clear that the huge advantage the UK currently has as a hub for the activities of global financial services is in no way threatened by further separation of investment and retail banking activities.
Key tests still remain
It is important to remember that this was an interim report. I have confidence in an independent commission of exceptional quality, but the ICB now has to provide convincing answers to some critical questions.
The government will still be seeking reassurance from the final report in September to demonstrate that a ring-fence can be as effective as full separation at lower cost. The keys tests will be:
- Would it stop banks using deposits underwritten by the taxpayer to cross subsidise their ‘casinos’?
- Will the ring-fence be high enough to eliminate regulatory arbitrage by the banks?
- Will the division between what is inside and outside the ring-fence ensure that nothing resembling a universal bank remains?
We, as a government, shall await the report before coming to a firm conclusion. But once we have agreed a way forward it will be essential to put the new arrangements in place as quickly as possible; we cannot wait for another banking crisis to cause even more damage.