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Are self-destructive banks wrecking the economy?
Any rational person must wonder what has got into our banks. Rarely the most popular of institutions, they have become renowned for treating their customers with disdain: closing branches in one-bank towns; calling for the end of free banking (even though it makes them £9 billion a year); PPI mis-selling; selling inappropriate, complicated interest rate derivatives to small businesses; abolishing cheque guarantee cards and wanting to do away with cheques altogether.
On top of this, we’ve had the RBS, NatWest and Ulster Bank debacle, which caused widespread misery and pointed up how extraordinarily dependent we have become on computer-based payment systems. In the light of the recent warning from the head of MI5 about the growing incidence of cyber attacks on British companies, bank customers may be wondering about the wisdom of the banks’ preference for doing as much online as possible, preferring to have as little physical contact with real people as possible.
The RBS disaster appears to have been the result of nothing more sinister than incompetence, possibly exacerbated by outsourcing IT overseas. Barclays’ long-term manipulation of interest rates in the Libor market to make it look safer and to massage profits, however, is quite simply – as the bank’s former chief executive Martin Taylor put it – “systematic dishonesty”. Given that other banks also seem likely to be drawn into this scandal, trust in banks and the financial industry in general is likely to erode still further. It will also be harder for the UK to resist EU demands for tougher City regulations and sanctions.
Heads the banks win, tails the taxpayer loses.
The bank’s role in precipitating and prolonging the financial crisis has caused much bitterness and anger. Imprudent, not to say downright reckless, lending led to the government recapitalising Royal Bank of Scotland (including NatWest, Ulster Bank, Drummonds and Coutts) and Lloyds Banking Group (including Halifax and Bank of Scotland) and nationalisating Northern Rock, whose problems were caused by using short-term money markets rather than savers’ deposits for lending capital.
Given that UK public sector net debt in March was £1,022.5 billion without financial sector intervention and £2,311.6 billion with it, the liability to the taxpayer of the bailouts would appear to be almost £1.3 trillion.
Knowing that the poor (and getting poorer) taxpayer is standing in the wings to help out has, according to the Bank of England, given the other major banks and their investors an implicit subsidy of £220 billion. Borrowing costs have been lower than they otherwise would be, boosting profits, pay and bonuses and distorting banks’ risk-taking incentives.
The moral hazard is that if the banks make money, they get to keep the profits while, if they make losses, the taxpayer has to stump up. The Bank believes that, as a result of this backstop, banks could take on even more risk and thus make failure more likely. In his Today Programme lecture Sir Mervyn King said:
“In good times, banks took the benefits for their employees and shareholders, while in bad times the taxpayer bore the costs. For the banks, it was a case of heads I win, tails you – the taxpayer – lose.”
After the crisis hit, the government set up the Independent Commission on Banking under Sir John Vickers. Its main recommendations were that banks’ high street operations be “ring fenced” to separate them from the riskier investment banking activities and that major banks should have 4% of capital in relation to their assets, rather than the 3% which the new international Basel rules stipulate.
Sir John criticised the recent White Paper on banking reforms. This went against the Commission’s proposals by permitting retail banks to sell financial derivatives of the sort which have recently caused controversy and opted for a 3% leverage ratio rather than the proposed 4%. The government appears to be putting its desire to see banks increase lending above the Commission’s recommendations for improving the stability of the banking system.
Worrying that heavy lobbying from the banks will water down the proposals still further, Sir John urged “the Government to resist pressure to weaken their effectiveness.” The ring fence reforms are, in any case, not due to come into force until 2019, more than a decade since the onset of the crisis. As Robert Jenkins of the Financial Policy Committee, the new regulator, said, this delay “will allow lobbyists to chip away until the proposal becomes both unrecognisable and ineffective”.
There is a concern that the cost of the reforms, estimated to be between £4bn and £7bn a year, will be passed onto customers. And, despite Sir John’s hopes, the White Paper appears to do little to increase competition in the banking sector, not even embracing the recommendation of full account portability, which might have sharpened up banks’ attitude towards their customers.
Whose money is it anyway?
Most people believe that when they deposit money, they are simply giving it to the bank for safekeeping and that the money still belongs to them. That is not the case. Since 1811 legal ownership of bank deposits passes to the institution. Within limits, the bank can do what it likes with it.
At any one time, banks may only have 3 or 4% of depositors’ money available for withdrawal, which is why bank runs can so quickly threaten a bank’s solvency. Thanks to this system of fractional reserve banking, banks make loans many times the size of their money deposits, effectively creating money. In theory, these loans are assets but, if the loans are of dubious quality or asset prices fall, a bank can quickly find itself in hot water.
According to the IMF’s recent Global Financial Stability Assessment, UK banks have a leverage ratio (assets to capital) of 22 against a multiple for the USA of 11. Although some banks had leverage ratios before the crisis of more than 30, current levels are still extremely high. It only needs a fall of 4.5% in asset values for the average UK bank to be insolvent.
The Vickers Report did not even consider whether the whole system of fractional reserve banking itself might be dangerous and destabilising. Yet it is because of fractional reserve banking that we need the Bank of England as a lender of last resort and savers are only too aware how they have been affected by the actions of our central bank.
Bring back Captain Mainwaring
Given some of the recent behaviour of banks in the UK and elsewhere, is it not time to question the very role of banks? Should the high street banks not exist to take in money from savers and use that money for lending to suitably vetted customers, both domestic and business? The business of corporate bankers should surely be to help companies raise money and advise on mergers and acquisitions.
What exactly is the rest of it for? Why do banks take risks by trading on their own account? Surely that is what hedge funds do? What do banks invent complicated investment vehicles that increase risk and volatility? How does a bank that was supposedly one of the “safest”, J P Morgan Chase, manage to lose upwards of $2 billion in a risky trade? How can Barclays, with the apparent connivance of senior management, believe it is acceptable to manipulate the Libor interbank lending rate?
Why do we have “casino banking” at all? Why has their been so little comeback for the bankers’ behaviour? If any other business landed the taxpayer with a multi-billion pound clear-up cost (let alone a trillion), surely there would be serious consquences. The most worrying thing is that there is no sign that the banks have learnt any sort of lesson or that they are likely to be any more risk-averse in the future. Perhaps it is time for more attention to be paid to Steve Baker MP’s proposed bill to make bankers personally liable for any losses. If a bank is “too big to fail”, is the answer not to make it smaller?
Watching Dad’s Army the other day, I was struck how far we have come since banks were managed by the likes of Captain Mainwaring. Stuffy he might have been, but such managers knew their customers and assessed risk sensibly. In recent years, banks appear to have found conventional banking far too dull for their exaggerated talents.
Only a week before the meltdown at RBS, the bank announced a new system for getting cash from an ATM using a phone rather than a card. Save Our Savers dismissed the idea as a “gimmick”, saying in the Daily Mail: “RBS might be trying to make banking look sexy but, if the experience of the last couple of years is anything to go by, it would be better if they stayed dull and steady.”
Let’s have more dullness in our banking system. And if Captain Mainwaring returned to run every branch, that would be no bad thing.