Business in Politics

Well George Osborne said they were going to be ‘robust’ in dealing with the banks to try and prevent them from reckless speculative investing and unacceptable risk.

So, what has he done?

Basically, very little of any substance.

They set up Project Merlin to get banks lending (particularly to small businesses) but it hasn’t really made much of an impact. Evidence from Chambers of Commerce and FSB indicates that business lending is still not very forthcoming.

The banks agreed to pay less in bonuses.  But that means little since the banking sector is struggling so bonuses were going to be down on recent years anyway.

The Chancellor introduced an extra levy on banks but it will only bring in an extra £800m, which isn’t much when compared with banking profits (especially since Barclays only pays about 3% tax).

They’ve forced the banks to keep more capital reserves which reduces the likelihood of another bailout since they can call on their own money if they get into difficulty.

The Independent Commission on Banking suggested breaking up the banks to split off retail and investment banks but George Osborne’s solution is to put into place a ‘firewall’ between invesment and retail banking and this is where I take issue.

In my view the bank firewall is a sham.

And here is why I think that:

1. The fact that investment and retail banking are still linked means that there is still little to stop the retail banks from allowing the investment arm from taking risks with the bank’s (or rather the clients’) money. They will still be the same company and there is no imperative for the retail arm to do due diligence on investments made.
2. If the investment arm fails and takes all the retail arm’s investments with it then the firewall will be worth nothing. Even former Chancellor Lord Lawson as expressed doubts about how it watertight the firewall would be since the pressure to make a profit will encourage banks to find workarounds for the sake of profits (something banks are very good at).
3. Investment banking isn’t banking at all, it’s a financial service. It’s purely for making profits on markets and nothing to do with deposits and lending. Retail and investment banking should be considered very distinct business types.

So here are my suggestions to improve the situation:

• Break the banks apart to make retail banks and investment banks into standalone businesses. Thus the investment companies could be allowed to fail (as Lehman Bros did) and the retail banks would be less affected. In the USA, retail banks are not allowed to engage in investment activities.
• Regulate the debt derivatives markets. Debt derivatives are very complex and very few people understand them, even among those in the investment banking sector.
• Regulate the investment ratings agencies such as Moody’s and Standard & Poor. The ratings agencies were heavily swayed by the banks who created complex debt derivative products that were inherently high risk. Thus the ratings agencies gave A ratings to investments that should have been considered junk.
• Force the banks to do proper due diligence (as they do with lending) with any investments they make. Lack of due diligence is the reason why banks invested so heavily in debt derivatives that they simply did not understand.
• Change the rules so that the CEO and other board members of any bank that fails will face jail time if it can be shown that the bank has taken on unnecessary risk with client’s money. After all, the money that the banks use belongs to their clients and shareholders and not to the bank.

These moves will help to avoid the likelihood of retail banks getting too heavily into risky investments that they don’t understand. The knock-on effect is that the chances of retail banks failing will reduce significantly.

If we rely on the banks to regulate themselves then we’ll be back in the same boat sometime in the near future. However, it seems that governments have a habit of ignoring the past when tackling the banking sector.