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Research

Banking reform should not rely on US model

The proposals of the Independent Commission on Banking (The Vickers Commission) have recently been endorsed by George Osborne, the Chancellor of the Exchequer, and Vince Cable, Business Secretary. Implementation is scheduled for 2015 with banks given until 2019 to make all the arrangements required.

There is an all-party consensus that the proposals of the Vickers Commission must be carried into effect with any disagreement being confined to practical details of how that is to be achieved. Such a consensus reflects popular opinion that sees banks as the root cause of the Global Financial Crisis of 2007/8.

Greedy bankers and their bonuses remain prime targets of the media in all its forms with great sympathy being expressed for anti-capitalist protesters. However, is a time of populist and media hostility towards banks the best occasion on which to plan the future of British banking system?  As banking is one of the few remaining successful sectors of the British economy its fate is of major concern. 

In Barclays, HSBC and Standard Chartered Britain possess three banks that are major international competitors and survived the Global Financial Crisis without any support from governments, including that of Britain. They were too big to fail because their size, diversification and business model gave them the resilience required to survive a financial crisis, unlike HBOS, RBS and the recently de-mutualised building societies. It is thus important to recognise the differences as well as the similarities between banks when introducing legislation that applies to all, even though these nuances are ignored by both the public at large and the media.

There are historical parallels here. Throughout the 1920s there was sustained criticism of the British banking system which was blamed for the problems being experienced by British manufacturing industry.  Envious comparisons were made with German banks at that time, which were seen as being more supportive of domestic business. The most famous outcome of this was the identification of the 'Macmillan Gap' in the 1931 report of the government inquiry into finance and industry, in which Maynard Keynes played such an influential role. This supported the claim that banks were failing to provide the finance required by medium-sized companies, though evidence is lacking that it ever existed. However, in the wake of the financial crisis at that time, which forced the German government to rescue its banks, the British government took no action.

In the face of the Global Financial Crisis of 1929-32 the British banking system emerged largely unscathed, cementing its reputation for stability. British banks were too big to fail not because of some implied government guarantee but as a result of the resilience of their individual and collective business model.

However, circumstances today are different. Britain is no longer the large and powerful economy it was then, and so British banks have to survive in a highly competitive global economy. To meet these challenges British banks cannot be subjected to legislation that undermines their ability to compete with other banks located in jurisdictions in which such laws do not apply.

The purpose of the British banking system is not simply to serve the needs of British savers and borrowers, but also to operate global businesses, and so generate highly paid employment and tax revenues. That raises the question of whether politicians, and their advisors, possess the knowledge, expertise and vision to create a legislative framework that will allow the British banking system of future to remain globally competitive or, instead, restrict its ability to respond to the unknown.

Unfortunately, past experience suggests that this is not where the strength of politicians lies. Once in government there is always a temptation for governments to intervene in financial matters so as to obtain some temporary party-political advantage. This is now recognised by politicians themselves. In 1997 the incoming Labour government abandoned direct controls over the setting of interest rates because of past manipulation.

In 2010 the incoming Coalition government established the Office of Budgetary Responsibility to provide independent scrutiny of future tax and spending plans, because of past manipulation. Though measures to curb British banks have a strong populist appeal now is not the time to enact them. Britain needs a strong and robust banking system to see its way through the ongoing global financial crisis and its worrying implications for the health of the world economy.  The time for action on the future shape of the British banking system is only when these concerns have disappeared.

It should not be forgotten that the principal threat to global stability today is not directly the British banking system, or that of any other country, though it is through banks that any crisis will manifest itself. Instead the cause of the current global problems lies with the Euro, which was the creation of politicians who believed that they could make economic fundamentals conform to their collective will.  That belief has now been exposed as false but its legacy is numerous banks holding government debt denominated in Euros whose future value is uncertain.

If the Euro does experience a disorderly collapse then governments the world over will be forced to intervene to save those banks that are most exposed. The alternative of not doing so is a repeat of the 1930s when all governments looked to their national self interest first, with disastrous consequences for the world economy. The result was that all suffered.

Professor Ranald Michie is a historian at Durham University and a member of the Tipping Points research project in the Institute of Hazard, Risk and Resilience.