Living wills are the best idea for banks

Allister Heath
Here are a few of the facts that show why the City is worth defending. Financial services alone account for seven per cent of UK GDP, with half of this made up of banking. In 2008, which of course was a much better year for the industry than this year, the financial sector’s net exports hit £50.5bn. Bank earnings made up 62 per cent of the total; prior to the recession, banking export earnings were worth £30bn-£40bn a year, paying for a lot of imported manufactured goods. We must put in place policies to avoid another boom, bubble and bust cycle; but over time we need strong, independent banks that can continue to prop up the UK economy in this way.

Financial services paid £12.4bn in corporation tax – 27 per cent of the total – and £18.7bn in employees’ pay as you earn taxes – 15 per cent of the total – in the year prior to the recession. A last statistic: volumes of new lending to small businesses are holding up, with over £5bn of new loans provided so far this year, while the stock of lending has grown over four per cent in the last year. It is obviously a myth that all small firms are seeing all their funding slashed (though of course overdraft rates have shot up and banks often fail to distinguish between good firms and risky ones).

All of which confirms that the City needs to be more proactive at selling itself: it should apologise for its past mistakes, go even further than it has in tackling problems such as insufficient capital – but it should also stick up for itself and explain to the rest of the electorate why it matters. Which brings us to the latest from Adair Turner’s Financial Services Authority yesterday. While he was at pains to try and make out that he wasn’t at odds with Mervyn King’s call for a Glass-Steagall type break-up of integrated banks, many of the FSA’s proposals were in fact much more sensible.

Its central aim is to devise a procedure by which banks can be allowed to go bust in a controlled manner. The other imperative is for the industry to hold much more capital made up of far more liquid assets. Again, this makes sense, as does the fact that several banks have started working on living wills as part of a pilot scheme.

The FSA is saying banks that can’t show in advance that they could be safely wound-down in the event of a crisis should be forced to break themselves up now; but in practice, it is hard to imagine why proper, safe living wills cannot be written for all institutions, even the largest conglomerates.

Turner also believes that there is a case for applying capital and liquidity surcharges to the largest banks, a move which may incentivise them to be smaller. This penalty would be reduced for firms with standalone subsidiaries which wouldn’t require the regulator in its home country to rescue the entire group.

The question of whether it is possible for local subsidiaries of global banks to be treated as domestic players for the purposes of bailouts is a key one; but any reform should be treated with care as we must avoid any further deglobalisation of finance. And as long as proper living wills are written, and the “too big to fail” problem thus resolved, I don’t see why we should force big banks to shrink. Small banks are usually much more likely to go bust than big ones.

But at least the FSA’s report was balanced, which makes a change. Any proposal that moves us closer to a world where bailouts are banished and bad firms can go bust is to be welcome.