How To Break Up The British Banks...

In my Money Week column this week, I've been looking at how to break-up the British banks. Here's a taster....

Perhaps in preparation for the way they will have to work together after the general election, the Governor of the Bank of England Mervyn King and the Shadow Chancellor George Osborne have already formed quite a double act.
Like a pair of street fighters delivering blows to their chosen prey in quick succession, in the last week they have delivered blistering attacks on the way the British banks have been bailed out by the taxpayer – without, it seems, any kind of reform of the way they work in exchange. Both in different ways are looking towards some kind of separation of retail from investment banking.
That is a big improvement on the current Government. Despite the Prime Ministers Gordon Brown’s boats of leading the world on financial reform, he hasn’t proposed a single significant change in the way the system works. After the biggest run of banking collapses in a century or more, that is, to say the least, eccentric. After all, if the implosion of Royal Bank of Scotland, Lloyds-HBOS, Northern Rock, and the rest of them, didn’t suggest to you the system might need a bit of a tweak, it is hard to imagine what might.
A year after the credit crunch, and with the country still piling up massive debts on behalf of its bailed-out banking system, it is clear that the way we regulated our financial sector has to be reformed. The U.K. can’t go back to hosting international banks of the scale of RBS. The interesting questions are how, how fast – and whether either King or Osborne will feel comfortable with the logical conclusions of the positions they are staking out.
Because what they are really suggesting in a system in which the City just plays host to the global capital markets, whilst the British banks get broken up –meaning the two giants of the sector, HSBC and Barclays, either split themselves up, or else leave the country.
Of the two men, King has pushed the argument hardest. In a speech last week, he described the way the banking system had returned to profitability on the back of government bail-outs as “creating possibly the biggest moral hazard in history.” It was fanciful, he argued, to imagine that the regulators could possibly control the sector: the bankers were too clever and too fast. The only long-term solution was to break up the banks into regulated deposit-takers that took few risks, and risk-taking investment banks, which could be allowed to go to the wall when they got things wrong.
Osborne doesn’t go as far as that – yet. In a speech on Monday, the Shadow Chancellor called for controls on bonuses at the retail banks. He argued that they should be forced to pay more of their bonuses in shares. What was really interesting, however, was his distinction between the retail and the investment banks, and the suggestion there should be different regulatory regimes for them. In truth, both men are sketching out a future in which the UK decides it isn’t really sensible to host big global banks.
As the Swiss have also realised, hosting global banks is just too risky for small or medium-sized countries. Both Britain and Switzerland avoided the fate of Iceland – a country bankrupted by the recklessness of its bankers. But it was a close run thing (and Britain is not out of the woods yet). Neither country wants to repeat the experience. The liabilities of a huge global bank such as RBS or Credit Suisse can dwarf those of the host country – and yet it is that country that ends up having to foot the bill if things go wrong.
So what should the UK do? The answer, in fact, is pretty clear.
The City should be nurtured as one of the world’s leading financial centres. There is no need to worry about the risks taken by the likes of Goldman Sachs, Nomura, UBS or Deutsche Bank. If they make money trading in London, the British government will collect a slice of the winnings in corporation tax. If they go pop, it is their governments back home that will have to pick up the bill. The bigger and brasher the City gets, the better: it means more tax revenue for the UK: and more business for the estate agents, shops, and restaurants that feed off the City’s money.
The British banks, however, are a different matter. They need to be broken up.
There can be little excuse for creating another monster on the scale of RBS. The smaller banks such as Northern Rock could easily be re-mutualised by handing shares over to mortgage and account holders, perhaps with a proviso that they couldn’t reverse the process for fifty years. The UK needs more diverse types of banks – and some big new mutuals would be a good start.
Lloyds-HBOS looks intent on returning to the private sector by raising cash from its shareholders to replace the Government’s stake. But it was a mistake to allow a single bank to control more than 30% of the market. It should be split into its separate parts, preventing a single dominant bank emerging. RBS looks in no state to be privatised soon. It should be forced to sell the profitable units of its investment bank, whilst the retail bank should be split into NatWest and Royal Bank, then privatised.
The tougher choice is for HSBC and Barclays, the two giants of the UK financial industry. Both are hugely successful global banks, with both retail and investment divisions. Neither needed state aid. To expect them to sell their investment banking units, or to sacrifice the profits from wholesale banking, would be unfair. At the same time, the UK can’t risk being liable for their failure – think of the cost of bailing out HSBC. Instead, reluctantly, they should be encouraged to move elsewhere – the US or perhaps China.
What the UK needs is a smaller, more competitive financial sector – every part of which can fail if necessary without provoking a wider collapse. Anything else is just setting up a bigger, and potentially much worse, crisis for the future. Whether either King or Osborne really have the guts to push that through remains to be seen – but it is the inescapable logic of their arguments.