Major proposals designed to reform Britain’s banking sector after its spectacular 2008 crash have been described as one of the biggest shakeups in a generation.
But they are likely be inadequate for a number of reasons.
Three years after the crisis saw banks such as the Royal Bank of Scotland and Lloyds caught up in the global sub-prime mortgage crisis, an independent banking commission has handed down its 358 page report into what went wrong.
The commission, headed by Sir John Vickers, suggests major reforms including ring-fencing the retail side from investment banking operations, arguably to protect depositors and borrowers from any future banking crash.
However, banks are given the option of deciding whether to ring-fence corporate deposits and loans or not – a notable concession to the banking lobby.
The report proposes a number of controls to limit the amount of money that can travel outside the newly established fence and regulators are expected to police it.
The banking crash showed that many banks were very highly leveraged and lacked resources to meet their obligations.
So the commission proposes that large UK retail banks should have equity capital of at least 10% of risk-weighted assets. As a cushion against future losses, banks are expected to set aside a “loss-absorber” fund of between 17-20% of certain assets.
This is to protect taxpayers and reduce their exposure to future bailouts.
The UK government is expected to implement the reforms by 2019, possibly in line with the global agreement on banking, the Basel III framework on capital adequacy.
So why will they be inadequate? Firstly, there is no scrutiny of the ability of the banks to create credit. As long as that remains the case, credit will have no relationship to the real economy and its ability to cause economic crisis will remain high.
The commission seems determined to ensure that banks remain corporate entities and all the pressures that such status brings.
For example, stock market pressures to increase earnings persuaded banks to engage in shady and risky practices. With the average tenure of CEOs at listed companies shrinking to four years, and still shrinking, executives have little incentive to think about the long-term issues.
Their focus is on private earnings and media star status. There is no consideration of the impact of systemic pressures on banking operations. The commission could have argued for consideration of alternative forms of ownerships.
For example, co-operatives, mutualisation, ownership by communities, employees or even nationalisation, but none of these are considered.
Neither does the commission mobilise democracy to check the selfish impulses of bankers. For example, it bemoans excessive remuneration for risk-taking, but thinks that voluntary codes will curb the excesses.
Well, they have not in the past. An alternative would have been to empower bank employees, depositors and borrowers to vote on executive remuneration. It is doubtful that bankers engaging in aggressive practices would ever manage to secure enough votes for their telephone number salaries.
The ring-fencing of the retail and investment arms is not the same as a legal separation and forcing banks to split their trade. Many banks have complex corporate structures spawning the globe and many operate in tax havens with poor regulation. So it is not clear how these operations are to be ring-fenced.
The commission does not scrutinise the funding of the speculative or the investment side of banking. Financial institutions are addicted to gambling.
At December 2007, just before the banking crash hit the headlines, the face value of the gambles (known as derivatives) on the movement of the price of commodities, interest rates, exchange rates and anything else, was $1148 trillion.
The global GDP is about $65 trillion. Just 1% exposure or loss can wreck the global economy. This speculative trading will continue to be funded with ordinary people’s savings by investment managers and financial intermediaries who will collect mega bucks if the gambles pay-off.
Otherwise innocent savers will pick up the losses. The commission could have argued for the removal of limited liability from all speculative trade so that speculators can’t dump losses on innocent bystanders.
The increase in capital bases may be welcomed but the banks failed because they were unable to meet their financial obligations. Therefore, the focus should be on solvency or availability of cash, but there are no particular suggestions.
The eventual reforms will inevitably be the outcome of political negotiations and bargaining.
Even if the commission’s proposals are fully implemented they are unlikely to cage the elephant for long because the systemic problems of banking and credit have not been addressed.