Kieran Lawrence looks at autonomous weapons and the effect they could have on modern warfare
Continuing a series on world leaders, Miles Deverson takes a look at Angela Merkel
Ben Bland examines the fallout from the Iowa caucuses and looks forward to the New Hampshire primaries.
In the first of a series on world leaders, Miles Deverson takes a look at Nicholas Sarkozy
I recognise this article gets a bit technical about banking, so for more information,please do read this article on how banking works.
Over the Summer, Sir John Vickers announced his report on banking, whose main recommendation is that banks should ring-fence their retail operations, so that between one sixth and one third of the assets of the bank are held in the retail banking sector. The idea behind this is it protects the taxpayer if an investment bank goes bust, as it can’t drag the high street side of the bank down with it. They also put in place “capital requirements”, so that they can absorb losses of up to 20%. It also proposed increasing competition in the banking sector. It was fully endorsed by the government.
I remember driving to work the morning this was announced and listening to Nicky Campbell’s breakfast phone-in on Radio 5 live. There were scores of irate callers either championing these proposals, or suggesting they didn’t go far enough because of those “evil bankers” who caused the financial crash by creating debt. There was much talk of bonuses and greed and a general sense that everything the banks have ever done is somehow wrong.
Yet banker bashing, however fashionable it may be, is no substitute for proper policy. The reality is that debt is not an inherently bad thing, and the banks provide a lot of social good by providing debt. Think of a start-up company wanting to buy a factory which will employ lots of people and make profit to cover the investment, debt allows them and the economy to grow, as they pay back when they can afford to. Or consider a student who goes into debt now to pay for an education which allows them to earn more in the future, when they can afford to pay it back. In both these instances, debt is an enabler, a driver of growth, not a burden on society.
One of the greatest problems in the banking sector was not the creation of sensible debt; it was the expansion of risky debt and the failure to price it correctly.
Banks knew that they could bundle up and sell on their loans regardless of risk (and thus were not exposed to that risk) and the ratings agencies would give them a good rating. This insurance meant that they acted recklessly and created loans knowing people would not pay them back as there was no risk involved with doing so – a phenomenon known as moral hazard.
Moral hazard doesn’t have to come from banking – it can come from any kind of insurance. Perhaps a driver with fully comprehensive insurance will drive recklessly, as there is no financial penalty to him if he crashes – a classic case of moral hazard.
Yet by demanding the ring-fence, Sir John Vickers has created a whole new moral hazard. The ring-fence effectively tells retail banks (and the markets) that the government will always bail out retail banks – they’re too important to go bust. Yet done correctly retail banking is significantly more risky than investment banking – remember it was a retail bank, Northern Rock, who precipitated the crisis in the UK.
To effectively tell retail banks that they are fully insured is hugely dangerous and will only further encourage risky lending. When one of the main contributors to a crisis was the problem of moral hazard, the solution should not create more moral hazard.
What’s more is that a ring-fence is very difficult to enforce, plenty of rogue traders have managed to get round other ring-fences easy enough, it shouldn’t be too hard for company management to engage in “creative accounting”. The Vickers report is not based in the modern realities of banking, but in the banker bashing rhetoric which holds little empirical sway.
The consequences of these reforms could be tragic. By creating more moral hazard, Vickers has exposed us to risky retail banking (the real casino banking arm) and conversely is not allowing this retail banking to be supported by the less risky and more profitable investment banking side.
When investment banking is done right (as most have been forced to do over the last few years) it should not create problems. Vickers’ meddling is likely to further worsen the problems, as he failed to address the key questions in banking; why investment banks were holding onto assets for too long and how you avoid retail banks lending without risk.
You must log in to submit a comment.
