It was spun by George Osborne as an attempt to take the politics out of banking. Yet the Independent Commission on Banking (ICB) has achieved the opposite: its interim report, out this morning, will merely kick-start the bitter row over how banks should be regulated. Banker-bashing, which had subsided in recent weeks, will rear its ugly head again; and as usual politicians will compete to call for the most crippling possible action to be taken, with no regard to Britain’s competitiveness, the economy’s real interest and jobs.
But it’s not all bad. Substantial reform is needed, as I have been arguing for years, to ensure that no institution is ever bailed out again and that the City can once again grow in a stable manner. Many changes have already happened. Regardless of whether the ICB’s recommendations turn out to be sensible or silly, at least there will now be a more intellectual backdrop to the discussions. It won’t just be about emotion or a simplistic, incomplete understanding of the events of the past few years. Here are a few principles against which today’s report should be assessed.
First, market forces should be allowed to discipline large institutions once again – firms should be able to go bust and taxpayers should never have to be called in again. We need more capitalism (not less) and an end to the socialisation of losses. One of the main problems with large banks – and also nation states such as Portugal – is that they benefited from implicit bailout guarantees, which meant that they felt more relaxed about riskier decisions. Crucially, bank shareholders were wiped out - but not bondholders - while those staff who retained their jobs also retained their contracts. There was no real Plan B. What is needed instead is special bankruptcy rules tailored to the needs of large, systemically important financial institutions. Under such schemes, shareholders are wiped out, bondholders lose much of their money, all contracts can be renegotiated and bust firms can be wound down in a gentle and controlled manner. The threat of this would focus everyone. To achieve that, some subsidiarisation and ring-fencing of activities may be necessary; living wills in the form of detailed manuals on how to wind-down complex firms definitely so.
A related rule is that innovative financial instruments can make the banking system more resilient. Co-cos or other such instruments can allow an automatic recapitalisation if capital falls below a threshold.
A third rule ought to be that governments should not try and micro-manage the industry. As long as there is a fear of failure, and that firms are holding enough good quality capital to withstand a serious, low probability event, the rest shouldn’t matter. Capital levels were too low previously – but that doesn’t mean they should be increased to ridiculous levels deliberately to reduce profits and wages, especially given the move to longer-term remuneration policies.
Fourth, the best way to improve competition is to empower consumers, not impose arbitrary break-ups. It ought to be made easier to change bank. Account numbers ought to be made portable, just like mobile phone numbers. Switching bank should be almost instantaneous.
These are some of the principles that a rational, radical bank reformer ought to pursue. We shall soon find out how the ICB measures up.
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