Vince: the Lib Dems’ plan for the banking sector

Vince Cable has today set out the Lib Dems’ plan for the banking sector. We’re publishing his speech in full below, but for those who just want the skinny, Vince:

  • Confirmed that the Liberal Democrats are not anti bank or anti banker.
  • Stated that his day one, hour one objective as Chancellor would be to devise a fresh and consistent mandate for the nationalised and semi nationalised banks.
  • Argued that RBS and Lloyds are key to supporting the British economy and are currently falling well short of their lending agreements.
  • Challenged Alistair Darling to give a full public account of these agreements on their respective anniversaries.
  • Reiterated the Liberal Democrat commitment to splitting up the banks, unilaterally if necessary.
  • Argued that so long as Northern Rock was re-mutualised in such a way to guarantee that it would continue to repay the Government, there is no reason – at least in principle – why it could not do so as a Building Society.

The full text of the speech is below:

Good morning and thanks to Thomson Reuters for hosting this event.
I want today to outline the Liberal Democrat plan for the banking sector, in the light of recent developments. These ideas build on those which I set out in our New Deal for the City, before the banking crisis broke, and subsequently elaborated in a speech to the Stock Exchange last July.
There has been a massive heart attack in the banking system. Some banks appear not to realise that they had a near-death experience and have been kept alive by government intervention. A cumulative total of 3 trillion pounds – twice UK GDP – has been provided in guarantees and support of various kinds.
I have said some harsh things about the banks in the past – going back a decade or more – warning that their lifestyle was dangerously unhealthy: arguing against misguided demutualisation; irresponsible mortgage and consumer lending; and Government and industry failure to grasp the central logic of the Cruickshank Report: that banks cannot expect to preserve unfettered profit maximisation and growth when they depend on a taxpayers’ guarantee of liquidity and solvency. But I haven’t come here today to rehash the past, claim to be a new Nostradamus, allocate blame or give a sermon. The Liberal Democrats are not anti-bank or anti-banker. We recognise that some banks and bankers emerge with credit from this crisis – HSBC, Standard Chartered, the Co-op Bank and some, but not all, mutuals led by Nationwide. We also recognise that banks have a key role as the heart of a capitalist economy transforming savings into loans and managing financial transactions with minimum friction and cost. I start from where we are and set out where I, as Chancellor of the Exchequer, would go from here.
Lending and Regulation
Let me start with a very basic question: why do banks exist and why did governments, including ours, feel it had to bail them out, as opposed to merely rescuing the deposits of savers? Modern economies depend on financial intermediaries to channel our savings to productive use. One of the key transmission mechanisms is bank lending to companies to finance their working capital and expansion. Some cash rich companies don’t need banks; big companies can utilise capital markets; and equity also has to be found, too. But a breakdown in lending – a credit crunch – threatens the business sector as a whole, especially small business.
A collapse has been averted. But there is still a lending crisis. Evidence from the Bank of England and anecdotal evidence from firms point toward restriction in bank lending to solvent, profitable, companies. In December lending to British business outside of real estate was 16.2% lower than a year earlier. Last week the Institute of Directors highlighted that 6 out of 10 companies were being starved of capital. There is also evidence of a sharp rise in the cost of lending seen most notably in rising bank charges, arrangement fees and security being required from small business clients. The Federation of Small Business and the UK Chamber of Commerce confirm this in detailed reports from the front line. There is some reduced demand from business but that is only part of the problem. Loans are being curtailed by banks in an attempt to shore up their balance sheets and to reduce their risk profile.
Banks have two responses. One is to deny the facts. They insist that they are falling over backwards to help their business customers despite all the mass of evidence to the contrary. The other is to attribute responsibility to government and the regulators for insisting on their holding more reserve capital and for demanding more responsible, less risky, lending practices. Most small and medium-sized businesses however never indulged in the overleveraged excesses seen in the domestic property market or by major commercial property developers. The problem with the banks’ argument is that there is a fallacy of composition. Moreover, restrictions on lending to sound companies by all banks is preventing a sustained economic recovery and thereby compounding the risk of growing bad debts about which banks are concerned. Behaviour which appears sensible to individual banks is disastrous when pursued collectively. And, several leading banks are nationalised and semi-nationalised and, for them, reserve capital is largely irrelevant; they cannot go bust.
Primary responsibility lies, therefore, with government. At present they are relying on a complex array of loan guarantee schemes, which the Tories also favour. But these schemes are proving largely ineffectual, bureaucratic and difficult for firms to access. The residual private sector risk remains a barrier to new lending. Other indirect approaches like quantitative easing improve the capacity to lend but are not generating new lending either. While quantitative easing was an important tool in heading off deflation it seems to have done more to inflate asset prices than stimulate productive activity.
A degree of compulsion is unavoidable. This has taken the form of lending agreements in the semi-nationalised sector. But RBS and Lloyds are falling well short of their legally binding agreements. Bank managers are reported to be playing all kinds of games to tick the boxes without engaging seriously with smaller commercial clients. There are far too many reports for comfort that rich private clients are having their arms twisted to borrow while genuine entrepreneurs are given a wide berth. On the anniversary of the RBS lending agreement this Friday 26th February, and for Lloyds on 7th March I challenge Alistair Darling to give a full, public account of what has happened under these legally binding agreements.
Now that UKFI has finally acknowledged that the semi-nationalised banks will be in public ownership for at least five years, it is time to drop the pretence that a rapid return to private ownership requires a pumping up of the share price on the back of conservative reserve requirements and business lending practices. What is needed is a fresh and consistent mandate for those banks and this would be my day one, hour one objective as Chancellor. I would insist that the banks support recovery by ensuring that viable businesses are not starved of capital. The lending agreements have to be more concrete, long term and better policed. These banks can be tools of government policy securing and maintaining capital to good, solvent small and medium sized businesses that are vital to our economic recovery. Put simply: RBS and Lloyds are key to supporting the British economy.
There is another issue to clarify in the mandate. UK banks are guaranteed by the British taxpayer or have been bailed out by the British government. Yet several, notably RBS, see themselves as global banks catering to global clients. This divergence of interests came to the fore in the Kraft takeover of Cadbury which RBS helped to finance. In principle there is nothing wrong with takeovers (though research tends to suggest that they typically destroy rather than create value), nor with foreign ownership. But as a UK nationalised bank RBS has a primary duty to us, the British taxpayer. We are the shareholders. It is difficult to see how UK PLC was being served by the financing of the Kraft takeover, let alone supporting dodgy Russian oligarchs. Billions of pounds of taxpayers’ money was ploughed into RBS in particular to support British business, not attack it.
Too Big To Fail
This Labour Government has failed to face up to 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 through resolution powers such that large and complex financial institutions can be wound down in an orderly manner. However even this is inadequate.
The Liberal Democrats are committed to splitting up the banks. But we have an open mind on the mechanisms involved. The current Chancellor of the Exchequer has argued that separation is technically difficult if not impossible. The big banks argue the opposite case and point out that they have achieved a separation voluntarily. The regulator, the FSA, implies that the same aim can be achieved by stealth, through differential capital adequacy requirements. 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 especially and Lloyds, they should be broken up before they are returned to private ownership.
Breaking up the existing big banks removes large scale systemic risk; 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: a modern version of Glass-Steagall. President Obama is pressing ahead in the US. It is time to do the same here in the UK. Various counter arguments are advanced in retaliation. 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: Barclays Capital openly aim 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. It is privatising profits and nationalising losses all over again.
The key issue for the UK is whether to proceed unilaterally or wait for broader agreement. The priority must and should be to make the UK safe. And if necessary that means proceeding unilaterally. Until the process of breaking up the banks is complete, we believe that banks should pay an insurance premium – in the form of a 10% levy on supplementary profits for registered banks in the UK (excluding mutuals). This levy would be to cover counter party risk as opposed to depositor protection, covered under existing arrangements. There is a growing consensus that such an insurance levy is right.
Remuneration and Bonuses
I proceed to another issue which has dominated the headlines: bonuses. This week we will be hearing more on this as RBS and Lloyds post their profits and formally announce details of their remuneration packages. Just as politicians were very slow to grasp the public reaction to duck islands, moats and house ‘flipping’, the financial community has been extraordinarily obtuse in failing to appreciate why the public is so angry about bankers’ bonuses. Many seem to have forgotten that they were bailed out by the taxpayer and would be without a job were it not for the outlay of this public money. To pay themselves way beyond the rewards which would normally accrue to risk taking entrepreneurs outside the City let alone workers on average incomes is insensitive at best and crass at worst. They have to realise they have a role in society as well as a role in business. And we know both from experience that the bonus culture encouraged risk taking which precipitated the financial meltdown. So why are we here again? More depressing is the fact that bonus culture has now infected other sectors of the economy, most notably, the public sector.
There is a role for regulation as laid out a year ago by Lord Turner in his wide ranging report. The key principle is that any bonuses should be paid in shares, not cash, fully redeemable only after a minimum of three years, so as to discourage reckless, short-term, gambling behaviour which potentially damages financial institutions. Under this principle, signed up to at the G20, remuneration policy of regulated financial institutions must be approved by the FSA as a check to ensure that short term risks are not being incentivised that may affect long term stability. It is far from clear that any such discipline is currently being applied. The Turner principles remain theoretical. Even in the publicly owned banks bonuses can be cashed after a few weeks.
I suggest that the FSA should make publicly available the outcome of assessments made of banks’ remuneration policy and action taken to meet the Turner principles. Increasing capital requirements could be one tool to enforce this but a fine would send a more powerful message and would provide greater transparency. It should start with the big institutions which incubate systemic risk, not the small fry. It is not clear why there is foot dragging at present over this basic reform and why the banks are still being allowed to swim around in large bonus pools.
This government has adopted a temporary tax – to the end of next month – on bonus pools. Despite the many potentially straightforward ways of avoiding the tax, most banks appear to have decided to pay up rather than modify their behaviour and have no doubt calculated that a one-off windfall tax of this kind will head off more intrusive controls on bonuses. And so the bonus problem remains. That’s why the Liberal Democrat levy on profits is necessary and is a simpler and more secure system that the one currently in place.
It is impossible to see how large bonuses can be justified for senior executives in the public sector banks, when their banks are losing money, depend on the taxpayer and are failing to meet their legally binding lending agreements. We should follow the Swedish example and attempt to eliminate them altogether. Performance related pay would have left them on the breadline not queuing up for million pound bonuses. UKFI has direct responsibility and it should exercise it, obviously showing an understanding of the need for qualified staff as well as for restraint. But the understanding should be based on the clear assumption any bonuses for specialist staff are exceptional and temporary until the banks are broken up.
For banks in general, transparency is a minimum requirement. All highly paid staff in regulated institutions with a compensation package in excess of the Prime Minister’s £200,000 should publish details of their remuneration. They would also have to declare whether they are normally resident and domiciled in the UK for tax purposes. A voluntary code along the lines recommended by Walker is pointless. Unless disclosure is mandatory it won’t happen.
But regulators can’t and shouldn’t try to manipulate pay like 1970s incomes policy. Progressive taxation has to address the issue of fairness in rewards. The current government’s flag waving approach to top tax rates is not a serious approach to this problem. As long as there are vast disparities between top tax rates in earned income and capital gains, currently 50% versus 18%, any half competent tax accountant will try to structure future compensation to exploit it. There is little genuine economic difference between income and capital gains, and no benefit in a tax system that so clearly encourages capital gains to be dressed up as income. Taxing income and capital gains at the same rate is the only way to deal with this insidious issue.
Public Ownership, Competition and Diversity
The semi-nationalised banks (and nationalised Northern Rock) sit an uneasy, semi-competitive, relationship with private banks and mutuals. One issue, as yet unresolved, is the future of the publicly owned banks. While the Liberal Democrats have no fundamental ideological opposition to selling the taxpayer stakes in the nationalised and semi nationalised banks – indeed we support re-privatisation – there is no hurry and every reason to show patience. UKFI now believes that it will be a state shareholder for at least five years. Experience in Korea, Sweden, Israel and in the US would lead us to believe that the optimal time frame for disposal of nationalised or semi-nationalised assets is probably close to 10 years. That is the time needed to sort out and restructure banks, manage bad assets and restore normal, safe lending. That is why Mr Osborne’s proposal for a quick sell off of bank shares to retail buyers is such a bad idea. It almost guarantees that the taxpayer will not get value for money.
Sweden still owns almost 20% of a bank that it bailed out in the early 1990s (Nordea). We should not rule out the taxpayer taking interests in Northern Rock, Lloyds and RBS for similarly long periods. I can also see a long term role for some state banking, operating on the operationally independent lines of National Savings & Investment to serve the millions marginalised by the main banks, perhaps located in the Post Office Network.
The government’s obsession with minimising the extent and length of public ownership was a driver behind the Asset Protection Scheme (like its American cousin TARP). We argued that it was a misconceived and dangerous initiative. It provides insurance for ‘bad’ loans but with a huge, open ended, risk with the taxpayer once the banks have absorbed the first £60bn of any loss (out of an estimated £300bn). I described the APS last February as a ‘massive fraud on the taxpayer’. I was accused of over-dramatising the problem. But we recently learnt that for the second time in a decade the Permanent Secretary to the Treasury was worried enough to warn the Chancellor in writing about taking on public liability for toxic loans which may have involved fraud and corruption. Any potential privatisation has to cover not just the recapitalisation cost but any losses accruing from the APS. And if banks do come back to the government for more help it should be in the form of ordinary shares, not APS.
The current confused structure of the banks, with a large chunk in the public sector, provides a valuable opportunity to recast it in a way that serves the long term interests of the UK economy. Two themes should be competition and diversity.
A decade ago, Cruickshank was highly critical of the lack of competition in bank lending – for business lending particularly – and there is now even less. There is an opportunity to widen choice by issuing new banking licenses and two or three serious new operators are entering the market. Another opportunity is provided by the break up of the semi-nationalised RBS and Lloyds. The European Union has already mandated a carving up of the retail network.
There is a case for a more varied banking ecology. Those mutuals which resisted the – disastrous – lure of conversion continue to provide a different and, for many, more attractive business model without the pressures to produce shareholder returns. A strong case is being made for transferring nationalised Northern Rock back into a mutual. Our objection has been that mutualisation of the nationalised banks does not produce the return of cash to the taxpayer, but we must remember Northern Rock is in a very different situation to Lloyds and RBS. £23bn of Government money has been pumped into Northern Rock vastly in excess of its market worth even at the height of the credit boom. There is no way this money will ever be recouped purely from a re-flotation. As long as the Rock was re-mutualised in such a way to guarantee that it would continue to repay the Government, there is no reason – at least in principle – why it could not do this as a Building Society.

Diversity does not apply solely to ownership structures. The inability of broadly based banks to meet (or even understand) the needs of business, particularly new ventures, and the lack of any mechanism for long term infrastructure funding, particularly with the problems being encountered with PFI, suggest the need for specialist banking institutions. The break up and restructuring of the banks, particularly in the semi-nationalised sector, provides an opportunity to launch and capitalise a range of institutions: another reason for avoiding a quick sell off.
Cross Border Banking and Regulation
The City is almost by definition, a cross border industry. While Britain can try to regulate separately, many financial services activities require global – or EU – regulation. Capital adequacy rules are global with specific EU legislative underpinning. The Liberal Democrats favour a cooperative approach to regulation so as to make regulation fully effective and to reduce arbitrage.
There is a danger however that a reasonable concern about ‘level playing fields’ would prevent action necessary to safeguard banks at a national level. The UK has an exceptionally big banking sector in relation to the economy and therefore relatively large systemic risks. There are areas – like regulation of bonuses, the break-up of banks and an insurance levy – where global agreement is desirable but unlikely to happen within the foreseeable future. Unilateral action must therefore be better than no action at all.
A multilateral approach is, obviously, optimal. And we need to be alert to the weasel words of politicians and bankers who promote inaction in the name of multilateralism. I recall that in the dark days of the Cold War the Russians usually signalled a new twist in the arms race by announcing a commitment to ‘general and complete disarmament’ which they knew no-one else would accept. I hope I am not being too cynical in believing that much of the rhetoric about new global rules is so much camouflage for keeping the unstable, dangerous, status quo. Sensible and safe bank regulation has to begin, like charity, at home. And I say that as someone who has preached, and written about, the importance of multilateral trade rules for decades.
The financial services industry is an important feature of the UK economy. The City is at the heart of it. But the financial crisis must make us look critically at its contribution. There are considerable benefits, but, as we have now discovered, major systemic risks which can spill over into the rest of the economy. It is the job of policy makers, and specifically regulation, to cut the risks relative to the benefits. And the Liberal Democrats are committed to doing so.
Thank you.

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6 Comments

  • Jock, it’s not just Austrians who realise that what banks do is change deposits into loans

  • Matthew Huntbach 25th Feb '10 - 1:37pm

    Bankers seem to believe that because they have jobs which involve moving very large amounts of money from one place to another, it is only natural they should take a cut of that money. Even a very small cut of a very large amount is a large amount for one person, hence these bonuses.

    In other countries, this is an attitude that politicians have. A politicians whose job it is to manage a budget of billions naturally supposes he should be paid millions for doing so, whether in salary or by taking some sort of commission or whatever. On the whole, countries which have this sort of behaviour are not the best governed. It is something we associate with corrupt and failing third world countries. Why does anyone suppose it is the best way for private business to be governed?

    On Vince Cable’s call for splitting up the banks and more mutuals etc, haven’t we seen precisely the opposite happening for years? Always justified – correctly – by efficiency of scale. Just as we like the idea of shopping at local small shops but in reality pile up at the big supermarkets, so we do similar with our banks. I was a member of a small building society which merged with a big one last year, and the big one is currently merging with a bigger one. All justified by the claim that the small ones couldn’t compete.

    We have not seen the failure of any banks and building societies because it always gets covered up by a merger with a bigger one. It’s only recently that ones too big to merger and too big to fail have started failing, so the bail-outs started. Then we find that had they paid their staff the sort of salaries anyone else gets for the sort of routine paper shuffling jobs that the big bonus banking industry is really about (they dress it up with a lot of mummery to make it sound more exciting and fool us), they would have been be nowhere near failing.

    So they took the money, lived lives of luxury, expect us to bail them out, as we are doing at the cost of throwing thousands of public sector employees out of work, and still they live their lives of luxury and complain when we ask them to pay a bit more tax in this country’s hour of need.

    Let us at least make sure that any privatisation leaves a personal liability for any banker taking the bank over. Repossess their mansions should the bank fail in future. They’re happy to do that to us when they lend us money, so why can’t we do it to them?

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