Named after its chairman Sir John Vickers, the five-member UK Independent Commission on Banking (ICB) delivered its final recommendations on 12 September 2011. There were no surprises; practically everything had been previously leaked and openly discussed with the heads of the institutions affected.
The report is significant, nevertheless. Only in defence spending and banking does Britain punch above its weight internationally. London is the world’s premier international finance centre. What happens in the British banking today often shapes what happens next everywhere else.
The report calls for two big changes. One is an increase in banks’ capital. This is uncontroversial, since a process of capital increases is already under way. More innovative is the call for investment banking activities to be separated from everything else and for a ring-fence to be created that will insulate what is referred to as retail banking from “casino banking”.
The crisis that felled Lehman Brothers was also so devastating that no amount of ring-fencing would have prevented it
Ring-fencing is contentious; it is not being adopted in the US. The criticisms are manifold: how can you distinguish between “casino” banking and everything else? Some non-investment banking activities can be extraordinarily risky; like lending to people with no income or assets.
The crisis that felled Lehman Brothers was also so devastating that no amount of ring-fencing would have prevented it. Banks say ring-fencing is unnecessary and costly. Nobody likes the increased supervision it will involve.
Defenders of ring-fencing have only one good argument. It will not stop banking crises, but it will reduce the extent to which taxpayers might be obliged to support the finance industry when the next one comes. The ring-fence will restrict the government safety net to the part of the banking system that most directly affects ordinary people. Next time, “undeserving” bankers will be allowed to go to the wall.
The ICB recommendations are, therefore, mainly designed to contain the principal negative consequence of the 2007/08 crisis – massive increases in government debt and moral-hazard among bank managers. They say nothing about what they expect the next banking crisis to be and how that might be dealt with effectively. Embarrassingly, the redundancy of the Vickers’ report has been exposed by Europe’s hapless response to the unfolding Greek debt crisis. There is no advice in it to help policymakers take the right decisions this autumn.
Ensuring banks can deal with whatever the future may bring requires changes that are both more radical and yet simpler than the Vickers’ report suggests. The starting point is to recognise that the bulk of what financial institutions contribute to economic activity is providing comparatively small amounts of short-term liquidity to households and small firms. Big corporations can live for months without banks. Most families and small businesses probably would not last a week.
For ordinary people, banks are only used to execute payments and record income. Their salaries are electronically deposited into their banks accounts and standing orders deliver money automatically to essential service providers on time.
When I started at university almost 40 years ago, banks were the only institutions capable of processing my modest scholarship income and expenditures, but that is no longer the case. An IT firm such as Google, which delivers information instantly and costlessly on a 24/7 basis, can probably run the global electronic payments system better than banks. They are also less likely to manipulate the payments system, as banks still do to generate returns from simple money transfers. The intellectual case supporting the bank’s quasi-monopoly over the payments system has consequently collapsed.
The payments system run simply as a digital information business would also require less regulation. So long as customer bank account information is secure, why should the authorities want to interfere with the payments system other than to monitor financial crime, such as money laundering?
So the right first step is to replace segmented and privately controlled electronics payment systems with the financial equivalent of the World Wide Web. This could be managed by one or more high-quality IT service providers in the same way Google and Facebook operate on the web.
So what is left for banks to do? Again, the answer is radical and simple. They should concentrate on helping people accumulate wealth.
As has been demonstrated consistently, facilitating imprudent borrowing adds nothing to global income and always leads to businesses and people incurring crippling losses of wealth.
Personal experience is illuminating. I had a meeting with my personal banker in August. Her principal objective was to sell me a house finance deal. I do not want one, but she was persistent and pointed out how attractive UK mortgage rates are.
Buying property in the UK may indeed be a good investment, but it might not be. My banker was sublimely indifferent to this critical issue. What mattered most was getting me to borrow. This is happening across Britain and elsewhere many thousands of times a day this autumn. The fuel for the next bubble and crash seems to be limitless.
Banks would do better for themselves and their customers by focusing on providing advice about how to save efficiently, not borrow. This should be done on a performance-related basis rather than as a result of a programme of up-front fees that incentivise bank officials to offer money promiscuously.
Banks living purely on earnings generated from value-creating activities would require little regulation. They would deserve no guarantee of government support, regardless of whether they were serving corporate, government of personal customers.
The Vickers’ report tells how we might have prevented the banking crisis of 2007/08. We shall have to look elsewhere to see how we can deal with what is yet to come.