Many banks are at fault – but we still need a strong finance sector

Louise Cooper
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OPEN almost any paper and you will read at least one editorial or comment piece slamming the financial sector. Of course, the banking industry has given its critics plenty of ammunition: HSBC failed to stop the laundering of billions of dollars of Latin American drug money; JP Morgan’s mammoth losses; the Libor scandal; mis-selling payment protection insurance. And that list doesn’t even include the industry’s role as one of the major players in one of the greatest financial crises of all time.

Across all classes and political spectrums, banker bashing appeals widely. Readers of the red top Sun enjoyed its top ten banker jokes yesterday, while both the left wing Guardian and the right wing Daily Telegraph have published their top banker gags for readers’ entertainment.

But this is nothing new. Bankers have been the brunt of jokes and criticisms for centuries. “If you steal $25 you’re a thief, if you steal $250,000 you’re an embezzler and if you steal $2.5m, you’re a financier.” This was written in The Nation magazine during America’s banking crisis of the 1930s. Just as today, bankers were increasingly viewed as rogues and crooks, and “banksters” were criticised for leading America into the Great Depression.

Has the scapegoating of the banking industry gone too far? In a word: yes. Most bankers are honest; there is nothing inherently wrong with finance; the recession was caused by a multiplicity of factors; and banks are vital to UK Plc.

A strong country needs a strong banking industry. Banks need to be financially secure to provide credit, which is the engine of growth. But a strong banking industry is not just required for a strong economy – it is also required for a country to be strong politically. History is littered with examples where national political power has been compromised by financial weakness.

At the outbreak of the First World War, America was heavily indebted to Europe. When war was announced, the US was threatened with financial ruin, as European countries, faced with the immense cost of the conflict, demanded the repayment of their loans. The dependence on foreign capital left America’s banking industry weak and exposed – a lesson that many modern politicians need to remember. More recently, in Autumn of last year, American money market funds withdrew their short-term deposits from Europe, which left the French banking system without an important source of funding.

Banking is an industry built to take the position of a scapegoat. In the good times, everyone loves credit, as it enables us all to buy things – holiday homes, handbags and red-soled shoes – that we probably cannot afford. In the bad times, it is all too easy to blame the banks for lending us the money when we cannot pay it back.

Now is not a good time to force new regulation on banks – liquidity and capital rules – which only risks making the banking system weaker in the short term. Banks are already deleveraging, asset quality has gone through the floor, funding (except from the European Central Bank) is difficult, and many European banks are threatened with insolvency. Imposing new regulatory rules at this moment in time is not a great idea. What is needed is a grand plan to acknowledge the scale of the problem, recapitalise some banks and let some fail. Once this is achieved, new regulatory rules can be imposed. Imposing regulation without a plan to sort out the mess is like expecting the cart to lead the horse.

The European banking industry is teetering on the brink and its destruction could take us all into an economic abyss. In America, in the three years between 1930 and 1933, commercial bank credit contracted from $50bn to $30bn and a quarter of the country’s banks failed. National income had shrunk from $100bn to $55bn and a quarter of the workforce was unemployed. This is the terrifying damage that a banking meltdown can cause.

On 4 March 1933 Franklin D Roosevelt was sworn in as US President. One of his first acts, to try to stabilise the banking system, was to close every bank in the country until 14 March. We must hope, that here in Europe, we don’t experience a bank holiday of that kind.

Louise Cooper is a markets analyst at BGC Partners.