All bets are off on another financial calamity

Professor Prem Sikka

The banking crisis has been making headlines for the past three years. Bankers indulged in an orgy of irresponsibility, gambled other people’s money, lied about the quality of their products, published opaque and misleading accounts and collected telephone number salaries.

Yet there has been no public inquiry, no royal commission and no prosecutions, even though taxpayers initially coughed up £1.16 trillion in loans and guarantees to bailout the banks. This amount now stands at around £500 billion and is a major cause of the austerity programme.

The best that the Government has managed to do is commission a report from the Independent Commission on Banking, an organisation only created in June 2010. Its 358-page report shows no urgency and says that reforms can wait until 2019.

The ICB’s key recommendations include ring-fencing the retail side or the general deposit-taking and lending operations from the risky investment side of banking operations. Arguably, this would safeguard depositors and borrowers from any future banking crash. However, banks are given the option of deciding whether or not to ring-fence corporate deposits and loans. This leaves the door open for dubious transfers and creative games, and would make effective regulation difficult.

The banking crash showed that many banks were very highly leveraged and lacked the resources to meet their obligations. So the ICB proposes that large British retail banks should have equity capital of at least 10 per cent of risk-weighted assets. As a cushion against future losses, banks are expected to set aside a “loss-absorber” fund of between 17-20 per cent of certain assets. This is to protect taxpayers and reduce their exposure to future bailouts.

The proposals have generally been welcomed by the press and political parties in this country, but are unlikely to solve banking woes. A key problem has been the ability of the banks to create credit which has no relationship with the real economy. The ICB does not consider any of the issues arising from this. Why is the Government leaving the creation of credit and money to private corporations?

The Commission favours the corporate structure enjoyed by banks, but fails to address any of the systemic pressures that resulted in the current crisis. For example, as corporate entities, banks are susceptible to stock market pressures to report ever-increasing profits. This encourages banks to push shady products and indulge in excessive risk-taking. Banks, in common with many other corporations, are focused on the short term. The tenure of the typical FTSE350 chief executive is four years – and declining. In this period, they have to collect as much private loot as possible, because their economic success and media stardom is measured by remuneration. So there is every incentive to sacrifice the long term. Some of the pressures could be alleviated by alternative forms of banking ownership structure – for example, co-operatives, mutualisation, ownership by communities, employees or even nationalisation, but none of these are considered by the ICB.

Contrary to some press comments, the ring-fencing proposals do not embrace the Glass-Steagall Act, passed in the United States in 1933 and subsequently repealed in 1999. The ICB has not asked for a legal separation of the retail and speculative sides. Its “Chinese walls” proposals will not work. Many banks have complex corporate structures spawning the globe and many operate in tax havens with poor regulation. So it is not clear how these operations are to be classified or ring-fenced. Ring-fencing will not insulate banks from the pressures for higher profits and executive remuneration. Northern Rock did not have an investment arm, but went belly-up as directors sought cheap money to expand profits and remuneration. A legal separation and return to mutualisation for some banks may curb some of the worst excesses, but this is not recommended by the ICB.

Even if the banks are ring-fenced, the destructiveness of their gambling will still engulf society. In December 2007, just before the banking crash hit the headlines, the face value of the gambles (known as derivatives) on the movement of the price of commodities, interest rates, exchange rates and anything else, was $1,148 trillion. Global GDP is about $65 trillion. Just 1 per cent negative exposure or loss can wreck the global economy. Where will the money for gambling come from? Inevitably, it will be provided by financial intermediaries from ordinary people’s savings. If the gambles pay off, bankers and intermediaries will collect mega-bucks. If they don’t, then the savings of ordinary people will be decimated. Remember, ordinary people are never asked by fund managers or insurance companies whether their savings should be channelled into complex gambles. So the ring-fencing of investment operations will not shield innocent bystanders. The way to curb destructive gambling is by removing the benefit of limited liability from investment banking. Let the bankers play with their own money and do not permit them to dump their losses on others.

The ICB bemoans excessive remuneration for risk-taking, but thinks that voluntary codes will curb the excesses. Self-regulation has not curbed excesses in the past and will not do so in the future. An alternative would have been to empower bank employees, depositors and borrowers to vote on executive remuneration. It is doubtful that bankers engaging in aggressive practices would ever manage to secure enough votes for their telephone number salaries. But democracy does not enter into the Commission’s vocabulary.

The increase in the capital base may be welcomed, but the banks failed because they were unable to meet their financial obligations. Therefore, the focus should be on solvency or the availability of cash, but it attracts no particular suggestions.

Overall, the Commission’s report is a poor document. It has been produced without any public hearings and collections of facts. The holes in it make it unfit to be the basis of future regulation. For example, it says nothing about the conflicts of interests, incestuous relationship with credit rating agencies, predatory organisational culture that promotes dodgy products (such as payment protection insurance), opaque accounting practices, and the failures of

auditors, bank boards and non-executive directors, the capture of the regulators, or the need for responsible lending to generate jobs.

*This article first appeared in Tribune

Three years after UK’s banking crisis, will reforms deliver?

Prem Sikka

Major proposals designed to reform Britain’s banking sector after its spectacular 2008 crash have been described as one of the biggest shakeups in a generation.

But they are likely be inadequate for a number of reasons.

Three years after the crisis saw banks such as the Royal Bank of Scotland and Lloyds caught up in the global sub-prime mortgage crisis, an independent banking commission has handed down its 358 page report into what went wrong.

The commission, headed by Sir John Vickers, suggests major reforms including ring-fencing the retail side from investment banking operations, arguably to protect depositors and borrowers from any future banking crash.

However, banks are given the option of deciding whether to ring-fence corporate deposits and loans or not – a notable concession to the banking lobby.

The report proposes a number of controls to limit the amount of money that can travel outside the newly established fence and regulators are expected to police it.

The banking crash showed that many banks were very highly leveraged and lacked resources to meet their obligations.

So the commission proposes that large UK retail banks should have equity capital of at least 10% of risk-weighted assets. As a cushion against future losses, banks are expected to set aside a “loss-absorber” fund of between 17-20% of certain assets.

This is to protect taxpayers and reduce their exposure to future bailouts.

The UK government is expected to implement the reforms by 2019, possibly in line with the global agreement on banking, the Basel III framework on capital adequacy.

So why will they be inadequate? Firstly, there is no scrutiny of the ability of the banks to create credit. As long as that remains the case, credit will have no relationship to the real economy and its ability to cause economic crisis will remain high.

The commission seems determined to ensure that banks remain corporate entities and all the pressures that such status brings.

For example, stock market pressures to increase earnings persuaded banks to engage in shady and risky practices. With the average tenure of CEOs at listed companies shrinking to four years, and still shrinking, executives have little incentive to think about the long-term issues.

Their focus is on private earnings and media star status. There is no consideration of the impact of systemic pressures on banking operations. The commission could have argued for consideration of alternative forms of ownerships.

For example, co-operatives, mutualisation, ownership by communities, employees or even nationalisation, but none of these are considered.

Neither does the commission mobilise democracy to check the selfish impulses of bankers. For example, it bemoans excessive remuneration for risk-taking, but thinks that voluntary codes will curb the excesses.

Well, they have not in the past. An alternative would have been to empower bank employees, depositors and borrowers to vote on executive remuneration. It is doubtful that bankers engaging in aggressive practices would ever manage to secure enough votes for their telephone number salaries.

The ring-fencing of the retail and investment arms is not the same as a legal separation and forcing banks to split their trade. Many banks have complex corporate structures spawning the globe and many operate in tax havens with poor regulation. So it is not clear how these operations are to be ring-fenced.

The commission does not scrutinise the funding of the speculative or the investment side of banking. Financial institutions are addicted to gambling.

At December 2007, just before the banking crash hit the headlines, the face value of the gambles (known as derivatives) on the movement of the price of commodities, interest rates, exchange rates and anything else, was $1148 trillion.

The global GDP is about $65 trillion. Just 1% exposure or loss can wreck the global economy. This speculative trading will continue to be funded with ordinary people’s savings by investment managers and financial intermediaries who will collect mega bucks if the gambles pay-off.

Otherwise innocent savers will pick up the losses. The commission could have argued for the removal of limited liability from all speculative trade so that speculators can’t dump losses on innocent bystanders.

The increase in capital bases may be welcomed but the banks failed because they were unable to meet their financial obligations. Therefore, the focus should be on solvency or availability of cash, but there are no particular suggestions.

The eventual reforms will inevitably be the outcome of political negotiations and bargaining.

Even if the commission’s proposals are fully implemented they are unlikely to cage the elephant for long because the systemic problems of banking and credit have not been addressed.

*This article first appeared on The Conversation website

Don't scare off the banks, says Demos

Amid all the suffering - unemployment, welfare cuts, redundancy notices, pay freezes, etc - some of us have turned our frustrations on the banks. Thankfully the self-described 'leading independent think tank in British politics' (Demos) has come to their rescue with a new publication by New Labour's former City Minister Kitty Ussher.

The Guardian reports that Ussher carried out in-depth interviews with senior bankers and gleaned anecdotal evidence that suggests banking may be on the verge of leaving the UK citing rising taxes, threats to split the big banks and scrutiny of bonuses. Hmm, the 'we'll go overseas' line. Ironically the Economist recently gleaned some anecdotal evidence of its own that "they might be bluffing".

Ussher's report asserts that UK-based banks employ "1 million people and supporting a further 500,000 – and data showing the sector brings in £53bn in tax, 11.2% of the UK's total tax take". So best not push them away or that's 1.5 million jobs gone and £53 billion in tax down the swanny?

But Ussher, rather conveniently, conflates two issues: elite speculative investment bankers with the banking sector. Allow me to elaborate. Let's say Bob Diamond and his ilk despair at the bank levy, 50% tax rate, and the findings of the Vickers Commission and decide to relocate their head offices to Zurich. Does that mean every branch of Barclays would close on UK high streets and its 60,000 staff be made redundant? No, in fact no branches would close, and all but a global elite of staff would still work and pay their taxes in the UK.

Funnily enough, I have an ally in the Financial Times too - which wrote the below in its editorial earlier this month:

Such threats should be faced down, not just because they are unreasonable but because they are of questionable credibility.

It is not clear what “moving abroad” actually means. Were a bank such as Barclays to shift its headquarters, the impact on the UK would surely be minimal as it would still do much of its business and pay taxes in the country.

What is more likely anyway is that rather than upping sticks altogether, some banks may reduce their new investments in Britain. This might make the City slightly less of a hot spot, but it would not be a disaster. And were it to be the price of financial stability,this would be a price worth paying.

So where did Ussher's '£53bn in tax' figures come from? Again her anecdotal assertions are of "questionable credibility". Given the total corporation tax take in the UK was only £43 billion in 2010-11 this seems a pretty fanciful calculation. Indeed the report doesn't explain how the figure was arrived at, just that PriceWaterhouseCooopers calculated it.

So what do the banks - not their staff - contribute in tax? According to the Richard Murphy penned TUC report - The Corporate Tax Gap - not much. It says that as well as benefiting from an £850 billion bailout from taxpayers and the Bank of England during the recession, banks are able to offset their £19 billion [cash value] of tax losses between 2007 and 2009 against paying tax on future profits.

In 2009 Barclays paid just £113m in corporation tax - just 0.26% of total corporation tax and a would-we-miss-it 0.02% of total tax receipts.

Let's say the four big UK banks are similar to Barclays - that's 1% of corporation tax receipts and 0.08% of total tax receipts. And we wouldn't have to bail them out again (not that we should have done before without full nationalisation).

Despite what Demos might tell you, there is little to be lost from the departure of these parasitical tax avoiders. Nevertheless expect the Cabinet of millionaires to pay more attention to Demos than to LEAP.