THE Independent Commission on Banking (ICB) misdiagnosed the causes of the banking crisis, and its prescriptions are therefore equally wrong. That is the blunt message of a report and briefing paper that Miles Saltiel and I are publishing today with the Adam Smith Institute.
And yet – there is some merit in the idea of creating “safe” banks for high-street customers who may not be financially savvy and who have been shocked to learn that their savings might be put at risk by the international investment operations of their bank. Which is why we propose a completely new kind of bank – “Trust Banks” – that would be safe and would bring much-needed competition into a sector that is nearly three-quarters dominated by the big four.
The ICB, chaired by Sir John Vickers, was set up by George Osborne, and told to find ways to improve bank security and avert another crisis. But it had another, unspoken objective – to spare government the expense of future bailouts. So it came up with structural reforms aimed at just that: forcibly splitting high-street from investment operations (ring-fencing), and raising capital requirements to make the banks “safer”.
Actually, higher capital requirements would do no such thing. For a start, it is not obvious how safe or risky a capital asset is: the banks in 2007 thought mortgages were safe as houses, but they were not. And the extra capital burden – higher than anything proposed by the EU or the Basel Committee – would put UK banks at a serious disadvantage to those in other countries. If the ICB thinks this policy is so sound, it should be urging Brussels and Basel to adopt it for everyone, not imposing its costs unilaterally on UK banks.
Not just Britain’s banks will suffer. With more money locked into reserves, the banks will have less available to lend to UK businesses, particularly the small and medium-sized enterprises that drive the UK economy and UK employment. Small firms will find it even harder to get bank loans, and will pay more for them. So the UK’s economic stagnation and unemployment will persist. That will cause problems for the government when it faces the next election – and for no good purpose.
The crisis was not caused by any lack of financial regulation. The banks were already highly regulated. But the regulators were looking elsewhere, divided and confused about their responsibilities under the tripartite system. Instead of seeking to improve supervision though, the ICB wants to impose new regulatory burdens. Such complexity is worse than useless. Regulation must be clear, simple and properly enforced.
Huge macroeconomic mistakes – a long spending and borrowing boom that inevitably had to end in bust – prompted bankers to make over-optimistic decisions. Yet the ICB again says nothing about how to improve either economic policy or bank governance. Nor how far the dismal lack of competition in the sector was to blame for bankers’ poor judgement.
Overlooking these factors, the ICB puts the problem down to bank structure, and even this it gets wrong. It was not Britain’s investment banks that sparked the crash, but its retail banks and building societies. They got into trouble by providing mortgages to home owners who could not keep up repayments when times got tough, buying US investments they did not understand, pursuing risky takeovers, and borrowing too much from other banks.
Regulation should focus where it matters – on protecting high-street customers with modest needs and deposits. Sophisticated investment customers are better able to look out for themselves. But we have no system to deliver the safe banking that high-street customers want.
Our report proposes a new form of bank licence, allowing the creation of “Trust Banks”. They would be run and capitalised separately from investment banks. But they would be market-led rather than created by some forced break-up of existing banks (which, being politically designed, is bound to be a disaster). We would not impose a long list of regulatory controls, as the ICB would on retail banks. Instead the test should be overall solidity and whether a bank can survive the failure of related companies.
To keep Trust Bank executives’ eyes on solidity, we would impose severe penalties (including disqualification and clawing back bonuses) on directors that preside over failure. That would even up today’s lopsided incentives, where success is rewarded and the cost of failure is passed onto the taxpayer.
Trust Bank status would be a kitemark that would appeal to smaller banks and new entrants alike – bringing fresh competition into high-street banking. Competition, after all, is much the best regulator.
Tim Ambler is honorary senior research fellow at the London Business School and a senior fellow of the Adam Smith Institute. The briefing paper Bank Reform: Getting The Policy Right and the full report Bank Reform: Can We Trust The Vickers Commission are available at www.adamsmith.org/publications