Banking on us

8 Apr 10

The government now owns billions of pounds worth of banks in the UK, which it will have to restore to the private sector at some point. But when, how and what should the taxpayer get back? PF convened a round table to discuss the issues. David Williams went along

The incongruous appearance of two tulips on the front cover of the Treasury select committee’s latest report on banking was more than a simple, optimistic reference to the spring. It was in fact a deceptively cheerful financial memento mori, as committee chair John McFall explained at Public Finance’s latest round table debate. The image referred to the Dutch tulip mania of the 1630s, which was arguably the first recorded speculative bubble – an early bloom and bust in the history of capitalism. As the first green shoots of economic recovery are becoming visible, the image reminds us that the financial cycle is as dependable as the turning of the seasons.

The inevitability of financial disasters became a recurring theme during the debate on the future of ‘the people’s banks’. The government’s unprecedented move into the banking business began in ­September 2007 when it promised to guarantee deposits at Northern Rock after spooked customers began withdrawing their savings en masse. The bank was later nationalised.

In autumn 2008, as the credit crunch billowed into a once-in-a-century financial disaster, the government intervened again, brokering deals for the sale of Bradford & Bingley to Santander (and taking the ex-building society’s mortgage book into public ownership), and Halifax Bank of Scotland to Lloyds TSB. The latter conglomerate lasted two weeks before stock market panic forced the government to step in again, buying out around 40% of its shares, along with most of Royal Bank of Scotland. The action is widely believed to have averted the total collapse of the UK financial system in the short term.

But with tens of billions of pounds of public money still at stake, and the future of the banking industry yet to be decided, there remains a vigorous discussion to be had. The expert panel, assembled at Church House, in Dean’s Yard, Westminster, included representatives from across the banking industry and public sector. Those joining McFall included: Angela Knight, chief executive of the British Bankers’ ­Association; shadow City minister Mark Hoban; economics professor John Kay; Ian Mulheirn, ­director of the Social Market ­Foundation; Andrew Hilton, director of the Centre for the Study of Financial Innovation; and Pam Walkden, group treasurer at Standard Chartered bank. The ­discussion was run in ­association with Ernst & Young, and chaired by public sector guru Tony Travers, of the London School of Economics.

There was widespread agreement that, while the bail-out was justified, the situation as it stood is unresolved and unsatisfactory. The industry is more consolidated and thus less competitive than it has ever been – a situation Hilton described as an ‘oligopoly’, not a free market.

Mulheirn argued that the government’s intervention was failing to ­revitalise the economy. Much of the sector’s most ­energetic activity was in mortgage lending, he said, propping up the ‘ridiculous Ponzi scheme’ of the UK property ­market while more economically vital lending to small and medium enterprises remained sluggish. The importance of this, he added, was that as state spending subsided over the next Parliament, strong growth in the private sector would be necessary to pick up the slack.

Professor Kay agreed that much of the public contribution to the banks had gone towards building up asset prices. He ­argued that the bailout had failed to ensure that commercial or domestic ­customers were well served. Meanwhile, no mechanism had so far been put in place to ensure the credit crunch was not repeated.

But Knight said that not all the blame for the ongoing malaise should be laid at the gates of the City. She emphasised a lack of leadership among the banking sector’s political masters. ‘All the political messages [to the banks] are uncertain... there’s nothing in place at the moment that talks about economic recovery.’ This vagueness was causing the City to hold off making firm decisions about where to place investments, slowing the transition back to business as usual.

‘There’s been too much feeding of the mob,’ she said, referring to the prevailing mood of banker-bashing. Now the focus had to be on leading the country.

The Financial Services Compensation Scheme, which secures £50,000 worth of investments per depositor, was also highly questionable, said Kay. ‘The financing is ill-defined and has been underwritten by the taxpayer. There are some random levies to repay a very small proportion of it. We’ve no idea what the final bill is going to be, and we’ve no idea who is going to pay it in the end.

‘This is a mess,’ he concluded, to no ­audible dissent.

That the public purse has an enormous amount invested cannot be disputed. More contentious is whether the government would ever have allowed any bank to fail. Has the crisis simply shown that the taxpayer was liable all along?

Knight acknowledged that some bankers might have assumed the taxpayer would step in if things went wrong, but said it ‘beggared belief’ that this had been a general view in the City before 2008.

So was it realistic to establish a situation where it was possible for ordinary people to lose a fortune in a failed bank?

Philip Middleton, partner at Ernst & Young, said that, whatever implicit or explicit guarantees had been in place in the past, ‘I doubt any government in any country is now going to allow any retail depositors to lose money.’

So even when the Treasury stops ­underwriting the entire industry, public funds will still be vulnerable to further losses if a bank – any bank – goes down in the future. What then can taxpayers expect from their investment?

Hoban suggested three possibilities: taking control of the banks’ lending policies to ensure the needs of the economic recovery were well served; getting a good price when the publicly owned stakes were sold off; and restructuring the ­banking industry to be more competitive.

But is it possible to achieve all those objectives at once? Shadow City ­minister Mark Hoban admitted there was ‘a ­tension’. The economy might need more credit now, but the taxpayer needs viable banks to sell off – and that requires them to store up more capital reserves. ‘It’s quite a difficult position for a government to be in.’

Middleton said: ‘There’s room for a debate around whether we necessarily want to go back to business as usual. Is the object of the exercise simply to tell the shipping company to put more lifeboats and a couple of extra watchmen on the Titanic and let them go off again? Or should we change the rules about the direction of travel and the way the ship is built?’

For Mike Denham, research fellow at the Taxpayers’ Alliance, the objective was to make sure that as much of the public investment as possible was recouped when the banks were sold. He said this meant a quick sale would be necessary. ‘The market does not like the fact these things are in the control of the government,’ he said. ‘The longer that continues, the worse value we’ll end up getting out of them.’

But Tony Dolphin, senior economist at the Institute for Public Policy Research, asserted that making the banks’ resale value a priority would be a mistake, as the government was ‘never going to sell them at the peak of the market’. Citing the selling off of much of the Bank of England’s gold reserves between 1999 and 2002, he said the sale of the publicly owned banks was likely to increase their value afterwards, making it look as if the Treasury could have made more money by ­choosing a different moment.

 Jonathan Williams, professor of banking and finance at Bangor University, asked whether the time was ripe to split investment banking from commercial banking. ‘If the objective is to sell RBS, surely it would be better to strip out the investment banking bits and sell those off?’

Knight replied that investment banking was the only part of RBS making money at the moment, but this made the case for keeping big, diversified, universal banks together. She said that financing a large international economy like the UK’s required a big financial centre such as the City of London, with its range of ­multi­national and smaller specialist banks.
What else could the taxpayer’s investment in the banks give the public?
Hilton and Kay agreed that the public sector now had unprecedented leverage on the City, and that this presented a chance to reconfigure UK financial services. ‘It would be better to have more, smaller, institutions, and to encourage specialist lending institutions at a whole range of levels,’ said Hilton.

The prospect of more central government interference is unlikely to go down well in the Square Mile. Pam Walkden – whose employer, Standard Chartered, is one of the few UK banks to have escaped the crash relatively unscathed – ­cautioned: ‘The risk is you’re going to overdo this… we feel there are guns being fired and you get caught in the collateral damage.’ But she added that some change was necessary, particularly concerning regulation around liquidity.

Knight said emotional responses to the crash were conflicting with rational analysis. ‘We want nice small banks we can get our arms around, that lend to the ­people we want them to lend to, at low rates, and to give savers high interest rates, and we want good regulators who go in and tell them when they get it wrong. Unfortunately, that’s a logical, practical and economic nonsense.’

There was a balance to be struck between interventionism and being hands off, said McFall. UK Financial Investments, the arm’s-length company created to manage the taxpayer’s shareholdings in the banks, could improve corporate governance in the publicly controlled institutions, he said. But, to reform the way the entire sector ran, the government should not just interfere in the banks it temporarily owned, but legislate for everyone. ‘The alternative is ad hoc improvised reform that plays to the gallery, and risks our banks becoming more politicised.’

McFall also praised mutual banks, and called on the government to stimulate competition in that sector, and to encourage more regional banking to help local economies.

Adrian Coles, director general of the Building Societies Association, cautioned that the mutual model was ‘not a panacea’. But, he argued that their democratic structures, diversity and low appetite for risk made it less likely they would act as a herd and stampede towards disaster as the bigger banks had over the past decade. ‘In the masters of the universe world, the economies of scale are balanced by the diseconomies of ego,’ he said.

But Jane Fuller, co-director of the Centre for the Study of Financial Innovation, cast doubt on whether even a restructured banking industry could be truly ‘socially useful’ – a phrase popularised in the UK by Financial Services Authority chair Adair Turner, when he claimed last year that much banking activity was the opposite. Fuller asked if the decision to set up a green investment bank and a social investment bank suggested that the government itself doubted whether some socially useful lending was possible on a commercial basis.

Mulheirn said that if banks were to become primarily useful to society in the future, the government would first have to set up a marketplace that worked properly. ‘There’s clearly a role for some kind of levy,’ he said. But he dismissed transaction taxes and bonus pay taxes because they would not address the underlying causes of the crash. New taxes on short-term, high-risk borrowing, as mooted in the US, could point the way forward, he argued. ‘If you borrow on those markets, you’re imposing a risk on the taxpayer who will have to bail you out if it all dries up suddenly. You don’t tax it to raise money, you tax it to curtail that behaviour.’

Denham countered with International Monetary Fund figures which suggested that the 2007/08 crisis would cost the UK taxpayer £130bn in total. He said the sector paid £70bn in tax in just one year before the crash, which suggested that the occasional catastrophe might be a price worth paying.

‘You maybe come back to John [McFall]’s tulip picture – this thing sort of happens now and again with financial markets. There are a lot of benefits, but banking does have a tendency to go “bang” every now and again.’

That ‘bang’ could yet have a seismic impact on politics and industry, said Travers. ‘This was an unusual event that made everyone with a bank account think they might lose their own money. It reached into every household in the UK – it’s very unlikely that it won’t have some long-term effect on British government and politics that we’ll only work out 10 or 15 years from now.’

Banking will remain the public’s business for the foreseeable future, agreed McFall. ‘We have a common objective in rebuilding trust, both in us and in the banking sector. We’re joined at the hip,’ he said. ‘But we can’t let change slip off the agenda.’

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