Time to let go

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The “regulation” of the banking industry is more like “supervision”. The difference is more than semantic, and the result is less than satisfactory.

The danger in Whitehall reform – as in the shift of responsibility for banking regulation from the Bank of England to an expanded Securities and Investments Board – is that the only thing that changes is the name on the brass plate at the door. In the offices behind, the same people go on doing the same jobs. The change in institutions needs to be accompanied by a substantive change in what the institutions do.

What I have described as banking regulation the Bank of England describes as banking supervision. The difference is more than semantic. Supervision is gentler, but more wide-ranging, than regulation. When I was a child in the school playground, I was supervised by my teachers. But now that I am grown up and responsible for my own actions, no one supervises me any more. My behaviour is regulated by the law, the police, and conventions about how decent people behave.

And we do not usually supervise other industries. There is no Board of Retailing Supervision. No authority asks Sainsbury’s and Tesco to submit their business plans. No one invites them to regular meetings to discuss their affairs, or passes on helpful hints about the good practice of their rivals. There are no raised eyebrows for them to watch.

Nor do we have a Board of Pharmaceutical Industry Supervision, or a Board of Restaurant Supervision, although we do have a Committee on the Safety of Medicines and we look to the Health and Safety Executive to monitor standards of catering hygiene. But these are very different bodies. Their purpose is not to promote good practice in the industry and to encourage good management in firms. They do not want to know about anybody’s business plan.

Their object is to address specific and legitimate public concerns and, if necessary, to take tough action to deal with them. There used to be supervision of some other industries. The Civil Aviation Authority once took on that role for British aviation, reviewing the financial soundness of operations and worrying whether fares were high enough to guarantee a profit. But such regulation has gone the way of Gosplan. Today CAA sensibly concentrates on issues like the safety of aircraft and leaves tariffs and scheduling to airline companies themselves.

The Bank’s supervision failed to remedy Barings’ dismal management and poor internal controls. But the right answer to this is not to say that supervision should be more rigorous. It is to ask why it is appropriate for a public authority to supervise Barings at all. The only victims of the collapse were those directly involved with Barings. The British monetary system and the external reputation of the City of London survived intact. Some other merchant banks were affected. Their customers wondered whether there were similar management failings there, and understood that they could not rely on the British taxpayer to bail them out. It is all to the good that they should have asked the first question and learnt the answer to the second.

The whole concept of the supervision of an industry undermines the responsibility of management and customers for their actions. The Bank of England should not be held to account for the collapse of Barings. It is time to end supervision and replace it, as has happened in other industries, by regulation targeted directly at those areas – the financial analogues of aircraft safety and drug testing – where market forces are not enough to protect the public interest.

Small savers are anxious to be able to make deposits in banks without risk of loss. It is not practical to suggest that they investigate the solvency of banks themselves. They have to rely on public reputation. That makes it necessary to ensure that these reputations are well deserved. Such a role demands the high profile interventions of IMRO and the PIA rather than the highly confidential activities of the Bank of England.

The further protection of small retail investors is best achieved by deposit insurance. But deposit insurance cannot be made available unconditionally, and we need to monitor its terms and availability. There is no need for such a scheme to be universal, so long as it covers a wide range of institutions, and the public knows who is – and is not – covered by it. The current Deposit Protection Scheme meets some of these criteria but, with an upper limit of £20,000, is inadequate in amount.

And then there are some institutions – probably less than ten – whose role in Britain’s financial and monetary system is such that their collapse would endanger the UK payments and settlement systems. These companies have grown so large that they have assumed a central social and economic role and their solvency is, in practice, underwritten by the British government. That creates an inescapable need for government oversight of their activities.

But the best means of doing that is to insist on fire walls between the retail deposit activities of these institutions – which should enjoy government guarantees and where the risk of failure is negligible – and their other operations – where no risk of failure lies and where government guarantee is inappropriate. The taxpayer, of necessity, stands behind the retail banking operations of Barclays Bank but should have no liability whatever for the proprietary trading activities of BZW. But today the assets of one support the other. That means the Bank of England has a responsibility for BZW which it ought not to have, probably cannot realistically discharge, and which exposes it and the public at large to needless risk.

Since this implicit cross-subsidy from retail deposit taking to other financial activities has been behind the increasing dominance of world capital markets by the major retail banks, we must expect these banks to oppose such a change. But the relationships of regulators are necessarily less comfortable than those of supervisors.

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