Liz Truss and her Chancellor, Kwasi Kwarteng see the international financial services sector as a key driver of economic growth. That explains the controversial planned deregulation of bankers’ bonuses, reform of prudential regulation of insurance under Solvency 2 as well as new legislation to elevate the sector’s overall “competitiveness” as a regulatory priority and to override regulators: part of what is being called “Big Bang 2.0”.
We should absolutely have a sectoral approach to growth and to promote the City as one of the priority sectors. It houses world class services for global markets generating considerable employment and tax revenues. Both David Cameron’s coalition and Theresa May’s government supported an “industrial strategy” which prioritised City professional services alongside advanced manufacturing, biotech, energy supply chains and creative industries.
This long-term approach, with business and government cooperating to promote investment and productivity growth, has been dropped. Instead, we have “deregulation” with little strategic thought.
This risks upsetting the balance between business expansion and overall financial stability. The economic damage caused by the collapse of leading banks in 2008 was massive. It helps to explain subsequent stagnation of real wages, the doubling of the share of government debt in the economy and the recourse, until now, to unorthodox expansionary monetary policy which has distorted asset markets.
For those reasons, the Coalition government and others in the US and the Eurozone tightened regulatory standards to reduce excessive leverage in the finance sector and destabilising risk-taking. We mandated tougher capital requirements, ring-fenced investment banking and taxed bank balance sheets as an insurance premium against the risk posed by “too big to fail” institutions and curbed or exposed egregious remuneration. Nothing to do with ideology; overall economic policy was liberal.
The long history of financial crises tells us, however, that financiers will always lobby to weaken regulation. And they meet diminishing resistance as public and political indignation gradually fade. It is now 15 years since the height of the financial crisis. Most of those directly involved have moved on.
This presents a moment of danger as the memory of the consequences of excess fade. We have a new generation of ministers with an ideological agenda and no experience of past crises. None of the present cabinet were around the table with me when we wrestled with the consequences of the banking crash.
They may not remember the rage caused by bankers’ bonuses. In fact, there are good technical reasons for criticising the current regulatory regime, devised in the EU: criticisms made at the time by George Osborne amongst others. The cap on bonuses causes a bigger share of fixed as opposed to variable pay, reducing the flexibility of fragile institutions in a crisis. But even the most tin-eared minister must surely understand that prioritising bankers’ bonuses at a time of extreme hardship for many will turn the public against the financial services sector. Reform is needed. But not now.
The danger of approaching financial regulation through libertarian slogans is also illustrated by proposed reforms to insurance regulation. There are undoubtedly problems with the EU-era Solvency 2 regime. It discourages the savings industry from long term infrastructure investment and over-prescribes holdings of government bonds (though the current government will need captive lenders). But the regulation is incredibly complex and involves a careful balancing of risk against adequate reserves in different parts of the savings industry.
The bigger worry is promised legislation with the seemingly innocuous commitment to promote “competitiveness” as a regulatory objective. Alongside rhetoric about ‘Big Bang 2.0’ the impression is being created that the “bovver boys” are back with all their excesses.
Critics and supporters talk of Singapore-on-Thames. Singapore is a good role model with a well-regulated financial sector which has channelled vast amounts of compulsory savings into social housing. What the deregulators are after is altogether more dangerous: Cayman-on-Thames, a dodgy offshore centre with a financial free for all.