Bank reform: getting the policy right
Create new, 'safe' banks if you want to – but not at the cost of lots more regulation and dismembering Britain's hugely important financial services sector. That's the message of a new report and briefing paper being published by the Adam Smith Institute today.
The Independent Commission on Banking (ICB) – set up by George Osborne – was told to work out ways to make the banks more secure and avert future banking crises. Their first suggestion was to split up the banks into 'safe' high-street and 'risky' investment operations. Then load them with higher reserve requirements, so they have to keep a bigger cushion of 'safe' assets.
Both prescriptions are wrong. It wasn't the 'risky' investment banks that caused the UK's problems. It was the retail banks and building societies that got into trouble, mostly by lending too much on mortgages during the housing boom, or buying US investments that they did not understand. When the boom subsided, their customers couldn't repay their mortgages and the US investments turned out to be highly toxic. Regulators daydreamed while this was all happening, and the Bank of England – having fuelled the boom – squeezed hard just when the banks needed more cash to tide them through this rough patch. The retail banks just ran out of money.
So breaking up the banks isn't going to make any difference. And raising their capital requirements higher than anything being contemplated by Brussels or Basel will just put them at a huge disadvantage against world competition. It also means they will have less cash lying around to lend to small firms – the drivers of employment and growth in the UK. Small firms will find it harder to get loans, and will pay more for them.
Investment-bank customers are savvy enough to look out for themselves, but ordinary families and businesses want banks that are safe. So, instead of trying to dismember existing banks, why don't we simply allow people to create new ones? We suggest a new form of banking licence that allows people to create Trust Banks to do just that. They could operate as they pleased, but the Bank of England would have to be sure that they were sound, and could survive the failure of any parent or sibling company. And Trust Bank customers would be the only ones who would get a government guarantee that they would not lose their deposits. It's a market solution to a problem caused by over-complex regulation, badly enforced.