Public anger at the way banks and bankers have “got away with it” since the crisis has hardly been assuaged by the hefty fines meted out for wrongdoing. The fines for foreign exchange and Libor manipulation are ultimately being paid by the banks’ shareholders, and taxpayers who are still giving big banks implicit support. Meanwhile the bankers who presided over such a terrible market failure - and their regulators - have come out more or less unscathed.
There can be no better argument than this ridiculous outcome for advocating top-to-bottom reform of the way banks are structured and run.
The reforms proposed here, and in my book[1], are not aimed at stifling financial innovation and the ingenuity that made the City of London a prime financial centre – far from it. Those banking geniuses presently at the big banks will be encouraged to take as much risk as they and their co-investors like, and to reward themselves accordingly – with no deferrals, clawbacks or other such obstruction that discourages them from realising their full potential. The one proviso is that they find their own sources of funding from open-eyed investors not blind retail depositors, and that they do not enjoy the privileges and responsibilities that a full banking licence would give them, nor benefit from the cushioning effect of a lumbering universal bank beneath them.
Investment bankers, in this brave new world, will be indistinguishable from managers of hedge funds and other alternative investments. An investment bank, in order to call itself by that name, would need to be a partnership whose members are open to losses as well as gains. And it would be supervised only for fraud and compliance with stock-exchange rules. There would be no financial co-dependence between investment banks and heavily-regulated retail and corporate banks. Such a change would lift a huge burden from regulators, who have struggled and failed to keep up with the arcana of financial engineering since the turn of the century. Under the new regime the plodding regulator will have more time to bother about the banks that affect the lives of retail depositors and the fortunes of small businesses. These banks will be boring and simple, but they will be safe. Investors seeking super-returns will have to look elsewhere. Simple retail and commercial banks would find a new investor base, and a measure of explicit government subsidy should not be ruled out. Why should it if these banks are serving the public good and not posing unquantifiable risks?
Breaking up the one-stop-shop universal bank is a matter of urgency. The thrust of the Dodd-Frank Act in the United States, the Vickers Commission report in Britain, and the Liikanen Report in the EU, was to promote the ring-fencing of risky trading activity from less complex commercial and retail banking. But those early initiatives have run out of steam. Watered-down implementation means that behemoths such as JPMorgan Chase, Barclays, Deutsche Bank, BNP Paribas continue to operate as integrated universal banks and are still being perceived as too-big-to-fail. They continue to present their home governments and their regulators with a huge potential problem if they were to stumble. Living wills, which map out how they would be wound up under threatened insolvency, are a fig-leaf. Their sheer size would still force governments to step in before all their creditors are wiped out. Recent stress assessments by the European Banking Authority and the European Central Bank have not provided much comfort on this score.
In Britain in particular the giant banks not only present the burden of too-big-to-fail, they stifle competition and discourage newcomers. A break-up of Lloyds, Barclays, RBS and HSBC into three component parts would at least kick off an anti-trust process. Barclays, for example, would be split into a retail bank (serving consumers and small businesses), and a wholesale/commercial bank (providing corporate customers with loans and simple financial services such as foreign exchange and interest-rate protection). Meanwhile, Barclays Capital, the investment bank, would be spun off as a partnership, along with any investment bankers who have the guts to stay with it.
The challenge facing any politician who dares to suggest slaughtering sacred cows in this way would be to persuade the electorate that it will give them a better deal. He or she can argue that consumer deposits will be insured at less cost to the taxpayer; that small businesses will be better served by banks less dominant and less hungry for profit; that only sophisticated investors and companies will be offered complex financial products by investment banks; that the widening pay gap between key employees at banks and those in other professions will narrow again; and that surviving investment bankers and their pervasive bonus culture will be pushed out of the regulated sector and no longer enjoy implicit state support.
That brave politician must also convince others that this change will not damage the City of London or drive much valued talent offshore. The City consists of far more than universal banks. Arguably it was a more colourful and competitive place before 1986 when Big Bang forced consolidation. It was no golden age, but even so, one recalls that brokers, jobbers and merchant bankers fought over the spoils of corporate finance with a more palpable risk to their own financial fortunes and reputation.
The City would not suffer as long as that prized financial wizardry is channelled into more independently financed investment-banking boutiques. Global corporations are as well served in this area by small competing houses as they are by global flow-monsters. In fact big corporates are, or should be, wary of putting too many eggs in one big basket like Citibank or JPMorgan.
As bank reform lurches from one public-relations disaster to another it surely makes sense to make a clear step change rather than continue to muddle through.