Last year we called for an impartial inquiry into the role of banking and the independent commission announced this week by the chancellor of the exchequer fits the bill in terms of remit and membership. Society needs banks but not the self-serving kind we have today. The commission has an opportunity to put this right. In doing so it will need to acknowledge banks’ vital contribution and distinguish that from the clutter of other financial activities that banks have accrued and now encumbers the system. This is important work, for if the commission is successful it can help to solve society’s riddle, “when is a bank not a bank?”
It is difficult to think of an industry that plays a more vital role in the global economy than banking. In taking surplus cash from people, businesses and governments and lending it to others, banks set the economic machine in motion and keep it running. Without this intermediation, money would not change hands, economic growth would stall and society would ossify, as inheritance replaced entrepreneurship as the principal means of wealth transfer.
Somehow, over the past quarter of a century, banks lost sight of their core mission. Encouraged by voracious shareholders seeking short-term gains and eased by deregulation and technology, the banking model became increasingly complex. Financial innovation changed from a tool to facilitate capital flows into a moneymaking technique for the bankers and their shareholders. Banks became unrecognisable conglomerates doing a myriad things that added little value to and often detracted from the socially useful activity that was at their core.
The consequences are a banking system that has dragged into recession the economies it ought to be sustaining and a banking market in which the implicit subsidy enjoyed by entrenched players distorts free and open competition. The aim of reform should be to refocus banks on their basic purpose and to create the right conditions for market forces to operate. Society needs banks to bring together savers and borrowers, spread risk and operate the payments system. It needs them to do this in a secure, transparent way and for bankers and shareholders to be appropriately rewarded for so doing. Open market competition characterised by falling prices, lots of customer choice and frequent switching between service providers needs to replace the cosy rivalry that is evident today from one end of the banking chain to the other.
Many of the things that today’s banks do involving excessive leverage and frenetic trading are just a means of making money for those in the know, and have no place in the core banking system. Deposit-taking banks should not do them. To keep deposit-taking banks out of markets, it would be necessary to create distinct trading banks and for customer-focused retail and commercial banks to deal with them as agents rather than principals. This would remove conflict of interest from mainstream banking and confine trading risk-taking to these specialists. The institutions carrying out such activities would need to be regulated to ensure they did not threaten the system or become too closely connected to the core banking structure.
This structure would create the conditions for banks to act responsibly and fulfil a vital role in the economy whilst enabling governments to withdraw their status of protected species. It would level the field for competition and simplify banks’ objectives so that bankers could live up to their commitment to put customers first.
Will the commission deliver? It has certainly been given enough time, perhaps too much time given the fast-moving environment. Its deadline is September 2011, a date that is so far ahead that it risks being left behind the curve while consigning the City to a 15-month period of uncertainty about the impact of its own 9/11. There also needs to be an international conversation since there is only so far that any one country can go on its own. We therefore urge the other G20 governments to establish an over-arching independent, global banking commission (of which the UK body might form part) to examine this issue. The solution to the riddle, by the way, is “when it is not a bank”.
John McFall was chairman of the Treasury Select Committee from 2001 to 2010. Philip Augar is a former investment banker who writes on financial services and other matters. Both served on the Which? Future of Banking Commission.