A Parliamentary blueprint to end banking hazards

 
Kevin Dowd
STEVE Baker MP has proposed a private member’s bill, the Financial Institutions (Reform) Bill, calling for radical reforms to the banking system and an end to state involvement in banking. Baker is co-founder of the Cobden Centre, a free-market institute advocating the restoration of sound banking and honest money, and is the Conservative MP for Wycombe.

His proposals are no less than a free market blueprint for resolving the financial crisis.

A key provision of the bill is to make bank directors strictly liable for bank losses and to require them to post personal bonds as additional bank capital. These measures reaffirm and extend unlimited personal liability for bank directors, which has long been on the statute books but has proven hard to enforce due to the (increasingly difficult) need to prove negligence. Strict liability removes this need and rules out “it wasn’t my fault” excuses from bank directors: if it happens on their watch, they will be liable.

The bill also calls for bonus payments to be deferred for five years. Any reported bank losses would be covered first by the bonus pool, then by directors’ personal bonds, and only afterwards by shareholders.

These measures give decision-makers strong incentives to ensure responsible risk-taking as their own wealth would be at risk: they could no longer expect rewards for failure.

This would rein in rampant moral hazards in banking, restore strong corporate governance and risk management, and end the current bankers’ social contract, in which rewards for risk-taking are privatised but losses are dumped on others, often the taxpayer.

The bill also proposes a tough bank solvency standard. For a bank to be regarded as solvent, its core capital (defined as shareholder capital plus directors’ personal bonds plus the outstanding bonus pool) must be at least 3 per cent of its assets. This definition is more conservative and less easy to manipulate than the Tier I capital of the current Basel regime. Any bank that fails to meet this solvency standard would automatically be put into receivership.

In addition, the bill calls for the government to propose a fast-track receivership regime for insolvent banks, and to produce a timetable for ending all state involvement in the banking system. This would end all bailout support, all lender of last resort support, all public shareholdings in banks, all central bank holdings of bank assets and state-supported deposit insurance. Future state intervention in the banking system would be prohibited.

Among other measures, the bill calls for accounts to be prepared using the old UK Generally Accepted Accounting Principles, governed by Companies Act legislation. This would end various accounting shenanigans associated with International Financial Reporting Standards, such as the manufacture of fake profits and the failure to disclose expected losses and promised future bonuses.

The Baker bill is controversial. However, its provisions are defensible and it opens a debate around issues of liability and moral hazard that we urgently need to have. If not the Baker bill, what alternative would work better?

Kevin Dowd is the co-author of Alchemists of Loss: How modern finance and government intervention crashed the financial system.