Don’t Start From Here: We need a banking revolution
The economic crisis and its aftermath has been a great disappointment to radicals. For a moment in 2008 capitalism tottered and seemed ripe for overthrow. At the least, the crisis and subsequent recession would surely force a fundamental reform of the Anglo-American model of international finance.
But it hasn’t happened. The authorities concentrated first on preventing depression with an unprecedented avalanche of spending and then on strengthening the existing system of financial regulation. The programme of reform was largely agreed by the end of 2008 and has been driven through with unusual speed and cohesion for an international programme.
In sum it has amounted to ‘more of everything’ – more capital, more liquidity, more transparency and closer and more intrusive supervision – rather than a fundamental change in the business model or structure of the industry. As a result, while some big names – Lehman Brothers, RBS, UBS – have disappeared or been cut back, the titans of the sector – Citi, J P Morgan, Deutsche, Santander, HSBC – are in some ways even stronger than before and the shape of banking and capital markets remains recognisably the same.
Many commentators think this is not enough and still hope for more far-reaching reforms. David Shirreff, former Frankfurt correspondent of the Economist, is among them. His essay is not the most rigorous presentation of the arguments. You will find very few numbers and more cartoons than charts.But it has the merit of being short (less than 100 small pages) and being written in layman’s language with the bonus of a useful glossary of financial jargon.
He argues that banks are too big and complex to manage, let alone regulate. The attempt to model the risks they take has led to over-complication and regulatory capture by the industry. A pervasive culture of entitlement in banking has not been challenged. We need a simplifying revolution.
We should split modern universal banks into three: retail, corporate and investment. The retail and corporate banks should be tightly regulated and prohibited from market-making or dealing in derivatives. Their size should be capped and their pay too (at £200,000). Investment banks would join hedge funds outside this regulatory net but only on condition that they are restructured as partnerships. The complex regulatory standards agreed in Basel II and III should be abandoned in favour of much simpler restraints on leverage and liquidity.
Older readers may notice that there is as much reactionary as revolutionary in this prescription. It is a plea for a return to (or beyond) the Glass-Steagall Act which separated commercial from investment banking in the US in the 30s and to a world where brokers and jobbers were partnerships bearing losses as well as gains. It harks back to a world where retail banks were cautious utilities subject to simple prudential rules and more sophisticated players were left to their own devices subject only to rules of market integrity. Shirreff presents the case with a curious combination of nostalgia and outrage.
But he can point to a powerful group of economists who might support reforms broadly on these lines. John Kay, Adair Turner, Andy Haldane, and Mervyn King have written persuasively about the dangers of supervision and regulatory capture, over-complication in ‘the tower of Basel’, the case for size limits and so on. And bankers remain deeply unpopular which creates a political constituency for more radical change.
So why isn’t it happening?
First, finance is international and reforms have to be global in reach if they are to be effective in protecting the world economy. That is why the leaders of the G7 agreed to shift decision-making up to the G20 in 2008. Many members support universal banking. In the Far East they are shocked by our incompetence and prepared to join us in tightening standards but they see no need to reconstruct their own industries. A few countries, like the UK and Switzerland, which came close to having banks too big to save in 2008, will go beyond international standards to limit the size of their home sectors. But most countries think they have gone far enough.
Second, the search for simplicity in a world of growing digital sophistication is likely to be forlorn in regulation as in tax law. After all, the US has always had a gross leverage rule restricting how much banks can lend and it was the source of the sub-prime spiral.
And finally, after their painstaking work, central bankers and regulators believe the new standards and requirements will change big finance over time and can be effective in preventing disaster.
We will see.
Sir John Gieve is a former Deputy Governor of the Bank of England.