How Not to Reform the Banking System

Interesting to hear this morning that Mervyn King (Bank of England) has jumped on the Nick Clegg (LibDem) bandwagon to separate retail and investment banking. Or maybe it’s the other way round….

To be fair, this is an idea that a few months ago I though had some merit. It’s the “masters of the universe” at the big investment banks – or so the theory goes – that took the dodgy risks, for huge personal rewards, that caused the financial crisis. Separate them from the retail banking sector and our savings and mortgages should be safe. This is, after all, what the US did back in the 1930s. And in the UK, the big hybrid banks like Royal Bank of Scotland and Barclays only emerged after Thatcher’s financial de-regulation in the 1980s – the so called “big bang”.

When you really dig into what happened, however, you learn that it was sales-culture driven lending and the invention of ever more exotic financial products and transactions between banks that were at the heart of the problem, not organisational structures.

Northern Rock was a retail-only bank. It went bust entirely by itself as a result of a bonus driven sales culture. And the two big institutions that collapsed at the peak of the crisis – Lehmans and Merrill Lynch - were stand-alone Investment Banks. RBS needed bailed out, but it was bad management and a skewed culture of risk/reward that caused the problem, not its integrated retail and investment banking structure. As for Goldman Sachs……

Trying to re-structure the banking sector now will be like trying to put the genie back in the bottle. And to attempt such a solution in the UK, with what are global companies, would be doomed to failure. What we do need is strong regulation, agreed globally, that is firmly applied.
And we need to think seriously about the old idea of taxing inter-bank transactions, to dampen down self-serving trading between institutions, which generate no external value.

Mervyn King is being very vocal now, but I think its much more to do with making friends with David Cameron than good sense. What did he have to say over the last few years whilst this situation was developing? Not a lot. So I’m not inclined to listen now. Not to him, nor to Nick Clegg and his LibDem colleagues on the bandwagon..