Banking reform – never a cost free revolution
April 27, 2011
Now that some dust has started to settle on the Independent Banking Commission’s interim report on reform of the industry it would be wise to recognise this as merely the opening salvo in what promises to be a prolonged battle.
Amidst the smooth consensual tone of the IBC’s report no one should be under any illusions that this reflects merely the starting point in the reform process. Negotiations between the Commission (and by extension the UK government) and the banking fraternity alongside their public affairs advisers will now begin in earnest.
Let me stress again what I have observed many times – the most remarkable aspect in the three years since the global financial crisis began is the complete absence of agreement amongst policymakers as to a desirable future shape of the international banking sector. Whilst the ICB may in its recommendations desire to influence this debate, there are clear dangers ahead. Unilateral British action risks diminishing the competitiveness of domestic financial services in the only sizeable sector where in the foreseeable future the UK can really boast global leader status.
The long path towards rebalancing the domestic economy needs to begin with measures that promote UK participants in growth industries of the future. It is sheer fantasy economics to imagine that we will be collectively better off by shrinking the UK banking sector any time soon.
Yet for all their good intentions, the ICB’s capital adequacy proposals risk doing precisely that. By goldplating the Basel III requirements, our own retail banks risk under EU law being placed at a severe competitive disadvantage to European players who would be able to operate here without such stringent capital requirements.
It is also difficult to see how insisting upon a 10% capital buffer is compatible with broader government economic policy on consumer protection and bank lending to SMEs. I fear that the understandable desire in a future crisis to protect the taxpayer from the colossal costs and economic disruption that we have witnessed since September 2008 brings with it plenty of unintended and potentially undesirable consequences. Higher capital requirements will almost certainly increase the cost of banking to the many millions of retail accountholders. ‘Free’ banking will soon be a thing of the past. It is also difficult to see how meddling in the regulations on holding capital will do anything to alleviate what most MPs in their correspondence regard as the number one pressing problem with the banks, namely their perceived reluctance to lend to the sort of growing businesses that should be the vehicle for private sector employment growth in the years ahead.
The ICB quite properly identifies that in any future crisis the bondholders must not be allowed to get off scot-free. George Osborne has been similarly lucid in recent months on this issue. Indeed the entirely rational banking response to each consecutive Eurozone bailout over the past year has been to pile in to risky but lucrative Greek, Irish and Portuguese bonds, knowing full well that EU taxpayers alone will carry the can in event of default.
Nevertheless the new arrangements both on the Continent and as proposed here by the ICB should not be seen as a panacea for all problems on the financial markets.
From 2013 a precondition facing any stricken nation needing to borrow from the European Stability Mechanism is a restructuring of its debt in the event that its finances are deemed as unsustainable. Superficially this might seem unobjectionable in the extreme. However, two rather less desirable consequences flow. First, until the ESM comes into force there will now essentially be a moratorium on any attempt to restructure debts of struggling Eurozone nations. The interconnectedness of the financial system would otherwise trigger a catastrophic wave of debt write-offs amongst banks across the EU.
Second – and this is where the ICB’s silver bullet may not prove to be such a good idea after all – the effect of penalising debtholders in any future banking collapse will undoubtedly have an effect on the pricing of risk. In short, the cost of servicing UK government debt in future may rise substantially. As ever, it is the unpredictable outcome of new regulatory initiatives that has the potential to lead to a host of unintended consequences.
Much of the press coverage prior to publication had focused on the likelihood of Barclays Bank, in the event of ‘draconian measures’, to relocate their HQ outside the UK. Unsurprisingly such speculation is now more muted. Indeed the Treasury may have been rather relaxed at the prospect of no longer needing to be the ultimate guarantor to a bank whose balance sheet stands at over 100% of the UK’s GDP.
A more salient question might be to ask where Barclays (or indeed any of our other retail banking giants) would go in the event of relocation. In truth the size of their loan book makes the only plausible alternative HQ the United States, although whatever benefits might accrue to Wall Street’s status would most likely be outweighed by additional taxpayer risk at a time when the Obama administration is trying to wean itself off its own perceived vulnerability to the financial services sector. That might feasibly leave Japan or mainland China as domicile options, but would either of these regulatory options really be what Barclays would want for its business?
My hunch is that we may not have heard the last of banking reform as a bargaining chip between coalition partners if, as expected, the ‘NO’ campaign prevails in the AV referendum. The conventional wisdom is that such an outcome would necessitate the Liberal Democrats being given a ‘quick win’ in order to placate its disappointed supporters.
House of Lords reform will be both difficult to deliver (many Conservative politicians in both Houses are utterly unbiddable on the issue of a largely or fully elected Upper House) and time consuming. As a result, I wonder whether the implementation (and even goldplating) of the IBC’s agenda might be seen to provide the Liberal Democrats with a populist cause, which in view of our Party’s traditionally strong links to the City, might also be felt to be more expediently delivered by the junior partners in the coalition.