Andreas Whittam Smith: The banking story may yet have a happy ending

The next chapter is how governments introduced much tougher regulation
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The Independent Online

Chapter one: The banks over-trade. This ceases only when the property they have taken as security begins to lose value. They hurtle towards insolvency. Governments around the world step in to rescue them; only Lehman Brothers goes over the edge.

Chapter Two: As a consequence credit dries up. Banks won't lend to each other and they would rather not lend to their customers either. The worst recession since the 1930s begins.

Chapter Three: The banks cannot believe how quickly the sun starts to shine after the storm. Competition has been reduced. In the British home loans market, to give a local example, Northern Rock, Bradford & Bingley and even the Halifax are shadows of their formers selves. The big, surviving banks have been able to increase their fees.

Moreover near-zero interest rates means that lending has hardly ever been so profitable. This is what bankers are born to do: borrow cheaply and lend at considerably higher rates. Their bonuses should be excellent.

These are the opening chapters of a very short history of the Great Crash of 2007 - 2009. In Chapter Four, however, there is another unexpected twist. It is headed: 'how governments finally introduced much tougher regulation'.

For suddenly since the summer holidays, the pace has quickened. On 4 September the finance ministers of the so-called Group of Twenty countries (all the big ones including China, Brazil, Russia and India) agreed to develop "tougher prudential requirements" for too-big-too-fail banks to reflect the higher costs of their collapse.

Then, as an official of the European Commission explained a few days ago, the heads of government of the G20 nations are going to spell this out when they meet in Pittsburgh on 24-25 September. For they are likely to insist that big banks put up significant amounts of extra capital. This can only be introduced by international agreement. If London were to do it alone, for instance, foreign owned banks would start leaving in droves. Note also that greater capital requirements mean smaller profits.

This at last gives policy makers a way of tackling the vexed issue of bankers' bonuses. For an international body of regulators and central bankers, the Financial Stability Board, has agreed that banks will face limits on the total amount they pay their staff in bonuses until they meet more demanding capital requirements. This proposal will also be submitted to the leaders of the G20 countries. The heads of government will be presented with specific guidelines on bonuses to ensure that regulation is 'full and consistent across countries'.

The chairman of the Board said that 'it's important that firms conserve profits so they can rebuild capital and support lending. We will have a link between total bonus pool and the firm's overall performance'. This doesn't go as far as the French demand for permanent restrictions on bonuses but it should be flexible enough to gain American support. It is an important break-through.

Finally, in a surprising development, the Chancellor of the Exchequer, Alistair Darling, is to force banks to draw up 'living wills' so that they can be dismantled more easily in any future financial crisis.

It is normally older people who draw up living wills. These documents set out patients' wishes regarding health care and how they want to be treated if they become seriously ill and unable to make or communicate their own choices. Among the advantages is seen the encouragement of a full discussion of 'end of life decisions'. How humiliating for the banks to be treated in this way.

But the Financial Services Authority (FSA) is already drawing up plans to impose such disciplines. Lord Turner, the FSA's chairman said it would be a forcing device for the clarification and simplification of complex bank structures.

Large banks would have to state what businesses they would sell to raise emergency funds. They would also have to show how quickly they could liquidate their trading books. An FSA official commented: 'If an institution cannot wind down its trading book in 60 days we will have to have a discussion about why certain things are in the trading book at all'.

This probably can be done in the London market alone without driving foreign owned banks away. Indeed it is more likely that the technique will be adopted in other financial centres. As a device, it is also going to reduce bank profits. This is because their extremely complex structures have been set up and refined over the years for no better reasons than avoiding regulation and avoiding tax.

So the short history of the Great Crash of 2007 -2009 is likely to have a surprising denouement. Banking becomes less profitable and bonuses are restrained.

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