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Vince Cable: banks need reform, but what form must it take?

Vince Cable

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 Independent Commission on Banking (ICB) under Sir John Vickers was asked to look at the issue of structural reform in detail.

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.

Comments
Guest
Sophie Gilbert says:
27 July 2011

I also don’t want the fat cats who FAIL to be rewarded by bonuses people would be chuffed to win in the lottery and by a pension that pays more in a single year than what an average salary brings in a whole career.

Guest

Shouldn’t we ask News International what they would like to do about the banking crisis instead? 😉

Guest
Russ says:
27 July 2011

Firstly I am not a banker Nor am I a financial expert so I am not about to give a biased answer.
The personal side of banking is subsidised by the business side of banking which would mean if there there was a split we would all have to pay to have a bank account, not every body will want to pay and can afford to pay for an account, this will mean financial hardship because if you dont have an account then you cant have a job and in most cases any form of tax credit that goes with it so we need to think hard about it.
Secondly before and when we all left school we had the chance to assist ourselves in a career path, some chose to do nothing and let the tax payer pay them for sitting on their backsides, by the way the bankers pay tax on their bonuses, once we all chose our careers in which ever field it is get paid the going rate for doing that job as do bankers, I run my own kitchen studio I am not a banker I would love to earn what bankers earn but I don’t because I chose this career. We have to be objective not jealous. Yes the financial crisis is partly down to banks but mostly down to government because they are the ones that turned a blind eye and cosied upto the banks just like they have to News International.

Guest
Bill says:
28 July 2011

Russ you dont have to bank with one of the big five. Pay your salary into a building society you get cards for ATM withdrawal + credit cards and cheque books,Morgage / consumer loans if you require them ect The mutuals are not involved in casino banking the 3 ex mutuals who turned themselves into banks Alliance & Leicester,Bradford & Bingley & Northern Rock all went belly up.

Guest

If you witnessed a mugging, would you blame yourself for not having a go or the police and the government for not anticipating it? The mugger should not be blamed since he is just following his chosen career path.

Guest
Grabbler says:
28 July 2011

What rubbish! We don’t ‘choose’ our careers when we leave school. Most of us have no idea what opportunities are out there at that stage in their lives and for some people they never do. We are guided into our occupations by our parents or extended families or inspirational teachers or other influential people in our lives. If our grandparents were made unemployed due to economic recession and our parents were unable to find work when they left school there is every likelihood that the only options available appear to be to muddle along on benefits and maybe making a bit on the side by whatever means become available. Education has been no use to people in this situation; teachers have little idea about the world outside academia and the subjects taught in schools appear to have little or no relevance to children in this situation. They become the scapegoats for governments to look as if they are cleaning up the economy when in fact it is thoroughly corrupt. The people who make the most ‘succesful career choices’ when they leave school are those with ‘successful’ role models, usually in their families, and particularly those who have benefitted from a private education at places like Eton, where they join the priviledged network, the elite that manage the country in which we live – be them investment bankers, politicians, top civil servants, corporations etc. The few exceptions that join that strata from less priviledged backgrounds are merely the exeptions that prove the rule and allow the corupt bunch including their media henchmen to blackmail the majority of people to accept their status in society.

Guest
Adam says:
29 July 2011

Reading the comments and the views to this post is actually quite scary.

If you want to make something of your life, get off your backside and do something. Don’t just be jealous of others. You (and your parents/upbringing) dictate your career path, nobody else.

Guest
pickle says:
27 July 2011

I agree with Vince Cable – ringfencing the retail part would be much safer although the banks would make this the excuse to put up charges. It might be worth it…..

Guest

I would obviously like my savings to make me money but the main issues for me are first security. I cannot afford to lose it. It would be desirable to keep up with inflation (real inflation not false government figures) if possible but I am not prepared to gamble with it.

Guest

If ring-fencing is done right, it would work the same as if there are two separate companies. In which case, what are the arguments for NOT going for two separate companies? If there are any arguments, does that mean the ring fence will have to have a hole in it?

Guest
pfel says:
28 July 2011

I admire Vince immensely, he is a breath of fresh air for a politician. He speaks a lot of sense considering the murky arena he has to work within and the skulduggery of financial institutions.
For too long now, some industries have become too powerful where they know that they can get away with outrageous things, knowing politicians are too scared to act. He is right about banks and he is right about the Murdoch empire.

Guest
Grabbler says:
28 July 2011

Forgive my typo’s (corrupt has two ‘r’s of course) and the use of the word ‘blackmail’ , when I meant to type ‘brainwash’ !

Guest
Tony Jones says:
28 July 2011

Dear Mr Cable
You are on a hiding to nothing here. The banks are international global institutions that have acquired so much power they are able to totally ignore national regulations. And if any government gives them too much hassle they simply threaten to up sticks to another country – which is usually enough to force capitulation.

These people are truly the greedy, immoral masters of the earth – if not the universe – and in the absence of a global government there is nothing anyone can do to control or influence them. Only fear of popular action will lead to a change of behavior. But the British are so apathetic servile that even those such as Fred Goodwin are able to go about their everyday lives openly and in complete confidence. Which is hasn’t been found at the bottom of the Clyde wearing concrete welllies – which is what he deserves.

Guest

The original objective of having a bank account was that it was a more secure place to put any money that you did not have immediate need of in a safer place than your own property. The secondary objective was for the value of the money in your account did not depreciate whilst it was in the hands of the bankers. To achieve this bankers lent money to aspiring businesses with sound prospects of making a profit and hence a return for the bank. The system worked because most banks were run by people with whose propiety and honesty was accepted by the community. Now that banks are so large this link with the customer has been lost and in the rush to make large profits fast the discipline of investing in sound, relatively low risk ventures in a trusting society has been usurped by investment bankers gambling on high risk ‘investments’ hoping to boost their already inflated rewards without regard to the true odds on success. The practice of selling debts from one investor to another is an abhorrent way of defrauding us and a method of passing on their errors of judgement to another mug. This practice alone demonstrates the corruption of the system.

Guest

Following the banking crisis of 1929, the US passed the 1933 Glass-Steagall Act, separating investment from retail banking .

There were no banking crises over the following 70 years.

In 1999, thinking the danger was passed, the US repealed Glass-Steagall. Within 8 years, the Lehman Brothers bankruptcy triggered the banking crisis we are now clearing up.

Point taken?

Guest

Excellent idea.

Retail banking should be separated from investment banking particularly when the latter are grossly irresponsible in loaning exorbitant sums of money to those who are not likely to repay the loans.

If individual banks disagree, then depositors should consider moving their deposits to another bank such as the Co-operative Bank (to date, I have never used the Co-op). The prospect of such action might just cause a run on the bank concerned, change the minds of its directors and shake the rest of the banking sector. If the major newspapers’s financial journalists were to support such moves, it might be possible to bring our banks back form the precipice.

If separation of the retail and investment banking sectors leads to bank charges for personal accounts – so be it. This will be far cheaper than the current situation where governments have unerpinned banking to the tune of Billions of pounds of our money.

Guest
Denis Fairmaner says:
28 July 2011

Giles (above) makes a very telling point. I am deeply sceptical about the firewall approach, which seems illogical. Either the firewall will provide effctive separation, in which case there is no logic in keeping the two parts in the same company or it is not effective which is the main reason for keeping the two types of banking in one organisation. Judging from the markets’ reaction to Vicker’s interim report, the conclusion is that the banks will find a way of by-passing the firewall, just as they have around all the existing regulatuions.

Guest
allanisniceok says:
28 July 2011

we will lose whatever happens with the banks there greed is universal
they will increase charges like they have been doing since the crisis altho vince and others condem the banks they are still afraid to go to war on them, money talks the old saying and it still does yes vince and others hve a go at the banks but words not action
the banks are still s******g us while the politicians look on afraid to take on the might of the banks let them go to other countries blackmail does not go doen well with the british public

Guest
Emm says:
28 July 2011

Grabbler and Tony Jones make excellent points. This exercise in ‘listening’ is mostly useless – it will result in something like putting a partial fence around a chicken coop to stop the foxes from running off with all the chickens.
The problem is that it used to be that “whoever you vote for, you always get a politician”. Now, whoever you vote for, you get the politicians’ masters – the financiers. Politicians are mostly cowardly nonentities, scrambling to do whatever will advance the cause of the already obscenely privileged minority. Worshipping ‘the markets’, embracing and not taxing foreign billionnaire kleptocrats, conniving with the Murdochs of this world, etc., etc.
Vince Cable and his worthies are going nowhere, because even if they have the will, they don’t have the power. It will take much bigger and better men and women than them to make any real difference. So from my perspective, his is a largely cosmetic and hence pointless exercise.

Guest
Bill says:
28 July 2011

The Americans had the same problem in 1929 with the Wall Street Crash.In 1933 they brough in the Glass- Steagall act designed to control speculation, this seperated the investment banks from the depository banks. This act was repealed in the 1999 by the Gramm-Leach-Bliley act removed the seperation that previously existed between Wall Street Investment Bank and the Depository Banks this allowed banks to gamble with their depositors money.
The banking industry had been seeking to repeal the act since at least the 1980s ( I wonder why ). Bill Clinton signed into law in Nov 1999 the Gramm- Leach-Bliley act. It’s taken 8 years of gambling with depositors saving / money for the banking crises to erupt in 2007/8.
If you want to stop another banking crises threatening depositors savings and having to be bailed out again with are tax payers money SEPERATE OUT NOW THE INVESTMENT BANKS FROM THE SAVING BANKS . We need a Glass Steagall act for this country it worked very well from 1933 untill 1999 when the act was repealed. I very mutch doubt this will happen as the banks have all the power just like the Murdoch Press.The people / savers dont matter to the the government only on election day when their desperate for your vote

Guest
Daniel says:
28 July 2011

For too long we have listened to all the reasons why it should stay as is and where has it got us? Absolutely – in one mess after another! Would you allow your neighbour to gamble with YOUR money? Time to dictate to the dictators. Issue the insruction – and – tell them they can no longer rely on our genorosity. We re not a charity.

Guest
Tony says:
28 July 2011

We should split retail banks from the investment banks for the reasons given already. Why should the profits from banks be privatised leaving the vast losses from gambling by the investment banks to be picked up by the taxpayers?

Also mentioned was that the mutual’s provide an alternative to the major banks. However it’s a real pain when it comes to switching you account to another bank as I have found from recent experience of moving between banks so this option is not as effective as it could be. What we need is for customers to have a bank customer number rather like a mobile phone number which identifies us individually. This customer number would be linked by the banks to our bank account. If we wanted to move to another bank all we would have to do is to tell the new bank what our individual customer number was and it would arrange for all the credits and debits associated with our unique customer number to be forwarded to the new account. This would make moving between banks much easier and with this approach in place there would be more competition between the banks which would be better for the customer.

While personal customers find it a pain to move between banks it must be an even bigger problem for businesses. If businesses also had an individual customer number in the same way ar personal customers it would make it easier for them to move further stimulation competition between the banks.

Guest
Grabbler says:
28 July 2011

Tony, I have a problem with your suggestion. To my mind it gives all the banks too much information about us. I have managed my family’s financial affairs over the last 20 years by holding more than one bank account at a time. To begin with opening an account with a different bank in which to pay our self-employed income and pass over set sums each month to the original bank that held the loan which they were threatening to foreclose on. It meant they didn’t have access to all our money. As things improved we were able to build strong relations with both banks. When we subsequently went into employment we opened accounts at two new banks into which we paid our separate salaries. That gave us four different banks to deal with and ‘rob Peter to pay Paul’. It has so far worked for us as we pay charges at only one of them and never need to run up an overdraft. If we just had one account number that followed us from bank to bank it would reduce that flexibility considerably.
The rich and powerful pay enormous fees to advisors to minimise their taxes and maximise their profits. We simple folk have to just be as ingenious as we can to prevent being ground down. We make our own insurance in our own ways with what is available. I don’t think your idea would help us much.

Guest
John Gifford says:
28 July 2011

I believe there should be a ring-fencing with rules making it abundantly clear that there is no contamination with the investment banking environment – it must be totally financially based as standalone. Regarding costs for banking to the customer, then these banks will be competing with the likes of the buiding societies. I’m with Nationwide for my current account, which does not charge me for the day to day running of my account nor any annual/monthly fee for my debit & credit card.
Also let’s learn from Sweden in the 1990’s and when the banks are re-privatised that the Government of the day sells the stock at a price that will fully compensate for the total cost of nationalisation of these banks and not at a “give away” price.

Guest

We look to Government to control the excesses and greed of the banks. If the Government seems powerless – as they appear to be in respect of bonuses – Government must understand that tghis is yet another example of disenchantment, made manifest by either fewer people exercising their vote at elections or, in a more positive, but ultimately destructive way by protesting and possibly rioting as the full impact of the cuts affect household spending power. That, together with the apparent unbridled increases in utility bills forcing more people – particularly the elderly – into fuel poverty will set the stage for confrontation with whichever party or coalition is in power. The public are aware that without the taxes paid into the Treasury by the financial sector and the utilty companies the UK would be in a poorer state, there comes a point where fairness becomes a priority rather than self interest. Have courage and be honest with the public. Ask the public to accept a reduction in living standards for a specific period in return for the banks being a great deal more regulated and utility bill increases being capped at 1 or 2%.
Regards
Dag

Guest
Grabbler says:
28 July 2011

Dag, this is surely what the present regime claims to be doing, being honest with the public in the interests of fairness and asking us all to accept huge cuts; to Education, the NHS, Charities, Local Government, Benefits etc. It is a fake – a smokescreen for a privatisation programme such as we have never seen in Britain before. The facts are, we are NOT ‘all in this together’. The powerful intend to keep their wealth and power and make the poor, who actually make up over 40% of our population, pay the bill. People don’t appear to see that those countries with the most powerful capitalists have the largest numbers of poor people. The US is an example and one which the current power elite in Britain wish to emulate. Maximum privatisation, minimum welfare state, constant pool of poor, depressed and unemployed to keep down wages and maximise profits for the rich. The only way we can develop a healthy economy that benefits the majority in this country is to reject the ideology of the Tories and the right wing; to demand a more equal Britain; to make the rich pay their taxes; to forbid the holding of vast amounts of power in the hands of few in the media, in the banks, in the corporations. We need to diversify, we need to encourage public employment that sets a benchmark for working and living standards with good wages and pensions. We need to give maximum encouragement to those private enterprises that are working for the good of the country and it’s future; develop the ‘Green’ economy, invest in production and export of green technologies. And much, much more.

Guest
Grabbler says:
28 July 2011

In the context of the corrupt political and economic system under which we are living, Vince Cable stands out as an honourable man. What he proposes might be viewed as sticking plaster but sometimes that is what is needed to heal wounds and prevent further infection. Unfortunately, we have not yet found a viable alternative to Capitalism and when, unlike in present circumstances, it does not operate to excess, it seems to be able to offer large sections of the population the opportunity for sustenance and development, which are necessary precursors to happiness. The best we can hope for is regulation to control the greed and excesses of the powerful and measures to limit the power elite. In these circumstances Vince Cable should be supported and encouraged to go further along the lines of those instituted in the US after the 1929 crash.

Guest

I agree with Giles, the investment and retail sides of all banks should be ring fenced so that whatever happens to the investment side does not impact on the retail side. Further the investment side should be required to subsidise the retail side when necessary so that there are no bank charges on normal current accounts provided they are in permenent credit by say £500 or £1000 per year.Credit and debit cards all have agreed credit limits and should be rejected at point of use once the limit is reached, until the overspend is reduced to below the limit.
Regarding the banks and other financial businesses their boards of directors should have been arrested for fraud, imprisoned and their assets seized; as it is they have all been rewarded with huge wages etc. and continue to run the businesses. In no other sphere do failures go unpunished.

Guest

The Key Tests overlook customer psychology:
Imagine Midwest has two ring-fenced divisions, Midwest Casino and Midwest Retail. When Casino starts loosing money or stops paying a dividend then I would expect Northern Rock style panic withdrawals by the customers of Retail. Especially where life savings are involved, customers will not trust any assurances from politicians, economists or accountants.

Guest

John may well have a point regarding public reaction but it is no reason not to introduce ring fencing. Nor for not holding directors personally liable for the failure of their business.

Guest
Dev says:
28 July 2011

Mr. Cable is fundamentally wrong when he speaks of casino banking in the UK. The risk capital required to support casino banking and hence the cost of this make it insignificantly profitable during normal times and adverse during times of stress. Casino banking did not cause the financial crisis, it was the over-extension of credit, especially to with poor credit profiles.

The Glass-Steagal Act was repealed because it did not work well. In the US, the investment banks adopted a holding company or partnership structure that totally negated the functioning of the Glass-Steagal Act. However, it was more the failure of the US to adopt the same risk and accounting rules that the rest of banking world were using that promoted their system to be viable for “casino banking”.

Mr. Cable idea of ring-fencing will, as someone else mentioned, result in charges for current accounts and even lower rates for deposits because the synergies of cross-fertilisation with the investment side. This is because deposits and current accounts act to lower the banks cost of capital in aggregate and this benefit is passed back onto the account holders in terms of free banking. In addition, this also allows more lending, especially to SMEs and at a rate lower than if this element was not there.

Addressing the comments in the article

1. Banks should be allowed to fail without bringing the whole system down.

Yes – but to do this the clearing system should be taken away from banks. Both RBS and HBOS were clearing banks. If this clearing system failed, transactions could not be made and monies cannot be paid or received. Further, full deposit insurance should be inserted, as in the US. This takes awy moral hazard for banks and motivates them to put in strong avoidance and mitigation processes. The cost of this insurance should be borne by the banks and strong avoidance and mitigation process and sound regulator monitoring, for which the FSA has admitted failure, shoudl lower insurance costs. It will also offer an additional check by the insurers with that of the regulators. If the insurance charges start to increase, this could indicate a signal of increasing risk to banking activities. Northern Rock was not a clearer but the lack of government support for depositors and savers in the past as with BCCI, eroded credibility and government stepped in to try and restore cerdibility but this was too late.

2. Banks make it easier for consumers to vote with their feet by making it easier for them to switch bank accounts.

Indeed – but severe regulations and unnecessary red tape laid in by successive governments make it difficult for banks to change their system in accepting new accounts. this has to be addressed.

3. New banks should be welcomed, to challenge the market domination of the ‘big five’.
Yes, but the big five exist in the current format because of synergy within their activities internationally and economies of scale. Standard Chartered is a successful bank but has decided the its UK customer base is insufficiently efficient when compared with its Eastern potential. There have been smaller banks but they have been less known and less atractive because of the number, scope and costs (or lower returns) of their product. The statement does not include building socities and credit unions which operate under a different system, parameters and regulations.

4. New regulators – the Financial Conduct Authority – should be given the powers and tools to do its job effectively, such as the power to assess hidden charges.
Certainly, I think this has been done under the re-structuring of the FSA??

5. Competition in the banking industry should be assessed. Yes, but this should be done by an ad-hoc committee periodically (say once in 5years) without a quango being formed, not only for cost-benefit purposes but also that competition issues will not be discernable in short periods.