We should kick this terrible Banking Standards report into the long grass

Andrew Lilico
AS IS traditional in receiving the recommendations of Parliamentary commissions, most of the reaction to yesterday’s Commission on Banking Standards report involved warm noises about how thoughtful and detailed and useful its analysis was – and how it would be considered deeply, or should be implemented in full. I’m not going to tell you that. I’m going to tell you that its main headline recommendations are terrible and that no-one should go anywhere near them.

Let’s start with the idea of introducing a new criminal offence of running a bank in a “reckless manner”. Following the treatment of senior bank executives in recent years, almost no prudent and skilled person will want to run a bank – doing so means public mockery, the reneging on all the undertakings made to you about salary, bonuses, pensions, and tenure, and the likelihood that your reputation will be so destroyed that you will be toxic and unemployable thereafter. But just in case anyone hadn’t yet been put off, the Commission says you should be vulnerable to being locked up, on a political whim.

Let’s be clear: there would be no possibility of conducting yourself, in running a bank, so as to ensure you didn’t go to jail. The very same management strategy that got RBS’s Fred Goodwin lauded and knighted only a few years later resulted in his being pilloried. If there had been a criminal offence available, he would probably be in jail. His only offence would have been to have happened to be in charge of a bank when it went bust. There is no knowing with certainty, in advance, what kind of business strategy will lead to success for a company as opposed to company failure. If a bank takes risks to generate high returns, it may go bust because the loans it makes go bad. If a bank takes no risks and generates very low returns, it may go bust because all its depositors withdraw their money to invest in other higher-interest-paying banks.

We can’t even say, with the benefit of hindsight, that you made a mistake if your bank goes bust, or that you weren’t the best person for the job. Suppose your bank fails and is £50bn insolvent – how could we guarantee that anyone else could have done better than being £100bn insolvent?

If you were guilty of fraud, there are already criminal offences that cover that. If you were negligent in your duties as a director, there are already sanctions that apply. The only purpose of generating additional sanctions relating to banks is so that we can scape-goat bankers when banks fail next – which one day they certainly will, as they have many times in the past. Scape-goating is obviously satisfying in tough times – unions, foreigners, ethnic minorities, bankers; whoever’s convenient on the day. But it’s not edifying, and prudent and skilled people won’t volunteer to manage banks when instead they could manage oil companies or hedge funds.

Another daft idea is deferring bonuses for ten years. Who is going to want to wait ten years to get paid? Banks simply wouldn’t use bonuses. Instead they’d raise base salaries and have to monitor staff performance with a vast array of middle managers and compliance systems.

The idea of these recommendations is to increase personal accountability in banks. But we don’t want bank employees to be more accountable to regulators and the state. The Commission proposes “requiring directors of banks to ensure the financial safety and soundness of the company ahead of the interests of its members”. That’s exactly the wrong direction, making bank directors responsible to broader society instead of the owners and creditors.

The problem with banks was that there was too much relationship with the state, not too little. The state promised to bail bank creditors out. That was why banks and their employees took high risks. The solution is regulation that makes it credible in future that banks won’t be bailed out – bail-in mechanisms, Special Administration regimes, and the other promising developments the regulators are introducing, and that we’ve seen implemented recently with Co-op bank.

If bank creditors are exposed to risk of loss, they will control risk-taking by employees and executives. The more the state makes bankers responsible to the state, instead of the shareholders and creditors, the greater will be the moral pressure for the state to bail them out if they get in trouble.

My advice to George Osborne: if ever there was a report for the long grass, it was this one.

Andrew Lilico is a fellow of the Institute of Economic Affairs.