Britain is leading the world on banking reform


The 2008 financial crisis demonstrated that the structure of global banking had become commercially unviable and systemically fragile. Stabilising that structure was therefore exactly the right short-term response and exactly the wrong long-term response. Governments have found this paradox hard to cope with. Mostly they have not tried. Politicians in the US and across much of Europe have become corporatists, tending to equate the success of an industry with the interests of large companies in it. Their counterparts in the UK and Switzerland are the exceptions among the leading financial centres in not succumbing to this mistake.

Switzerland, smaller than these other countries but home to giant banks, was brought closest to national bankruptcy by the 2008 crisis. The country then led the way in demanding higher capital requirements – higher than those proposed in meetings held in the town in the north of the country where international meetings of banking regulators are convened. The Swiss National Bank recognised the futility of the Basel process of attempting to fine tune capital requirements to a particular risk profile of individual banks. It understood that the only way of providing adequate capital for a future that models will certainly fail to predict is to have lots of it.

The UK has gone farthest in the direction of reform. Not far, and not quickly, but farthest. The crucial issues lie in the structure of banks themselves. It is not so much that UK banks are too big, but that they are too complex. Their combination of activities creates conflicts of values, of interests and of objectives. A culture of investment banking that is dominated by trading is incompatible with the requirements of reliable retail banking. Central banks and governments have flooded banks with funds to support domestic lending, but the balance sheets of these banks remain dominated by transactions with other financial institutions.

The primary function of any bank is to secure the savings of small depositors and the continued operation of the payments system. But these objectives have been secondary, not even to the demands of shareholders – bank shareholders have incurred heavy losses – but to the provision of extraordinary levels of pay for the most senior employees. An organisation that only someone of the calibre of Jamie Dimon can run will not continue to find Jamie Dimons – and in the end it turned out that JPMorgan Chase was beyond even his control.

The British government led the way in 2008 in understanding that the survival of the global financial system required the provision of capital, not just liquidity, and that the government was the only possible source of that capital. But this initial insight was followed by a series of missteps. Instead of splitting good banks from bad banks, the government merged its worst bank into its best. It failed to use its majority stakes in banks to impose structural reform – separating retail and investment banking and carving out specialist small business lenders from the conglomerates. It sought to maintain two pointless fictions: that government support for failed banks was a profitable investment rather than a subsidy, and that managerial decisions in the publicly owned institutions would be free of Treasury influence.

But gradually the British government recognised the need for structural change. The Vickers Commission, which reported in 2011, put forward the separation of retail and investment banking. The Parliamentary Commission on Banking Standards, which reported this month, proposed criminal sanctions for those who recklessly pursue their own interests ahead of those of the banks they control. Both bodies demanded more competition in banking and the government is moving towards the parking of legacy assets in a bad bank.

Globally, the Bank of England has been the main source of fresh and sceptical thinking on the future of the financial sector. While this has won it few friends in the City of London, such unpopularity is a mark of success not failure. Mark Carney, the new BoE governor, is welcomed in these quarters by virtue of the improbable premise that he brings some magic Canadian formula for growth. It is far more important that he sustains the reform agenda that British policy makers have slowly begun to define.

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