Wednesday, July 29, 2009

Vince Cable on allowing banks to fail

The government has yet to grapple with the challenge posed by the Governor of the Bank of England: that if a bank (or other institution) is too big to fail it is too big. One approach is to make it easier for big institutions to fail. Resolution powers could be put in place such that large and complex financial institutions can be wound down in an orderly manner. The key assets required to continue the operation or provision of the ‘public service’ would be easily and quickly extractable from the organisations that currently supply the service. Banks would be required to operate in such a way that this separation is possible. Importantly these plans for orderly wind down and separation must be produced by the institutions themselves and subject to approval by the regulator. This will dramatically strengthen the position of the regulator in the event of failure. Sharing information across borders where the bank is operating internationally is vital to ensure that large cross-border banks could be wound down. This approach is however untested and long term at best.

Another approach is to break up the existing big banks so that large scale systemic risk is removed; banks become small enough to fail; and more competition is restored. One version of this argument is that investment banks should be split off from what is called ‘utility’ banking. Various counter arguments, often self serving, are advanced in reply. It is said that small banks (like Northern Rock) as well as big banks (like RBS) collapsed in the latest crisis: true. Also that risk is not necessarily correlated with structure: some investment banking is low risk; some small business and mortgage lending is high risk. Also true. But size matters; if Barclays Capital continue their ambition to be the world’s largest investment bank the British taxpayer will be left footing the bill for any future collapse. This is wholly unacceptable.

We believe big banks must be split up but are open minded about the mechanisms involved. The essential point is that within a realistic time frame the British taxpayer has to be totally disengaged from the risks involved in global investment banking. For existing publicly owned institutions, RBS and Lloyds they should be broken up before they are returned to private ownership. The European Trade Commissioner has already warned of over concentration in the UK market for - for example - mortgages. The Lloyds-HBOS merger should be unscrambled as part of this process and RBS should also be split with its investment banking operations floated off.

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