Leading article: A missed opportunity for radical reform

Share
Related Topics

Britain's banks are too important to be permitted to go bankrupt.

That fact was revealed in spectacular fashion in 2008, when the previous government rescued the sector with taxpayers' money. This was the only route available. The alternative was to see a general economic collapse, quite possibly followed by social breakdown.

But this privileged status enjoyed by the banks has created a disastrous system of incentives for the employees and managers of these institutions. These giant banks do not only take deposits and make loans – they also place large bets with borrowed money. The blanket state guarantee of banks' liabilities means that when these gambles pay off bankers generate large profits and pay themselves obscene bonuses. But when these gambles fail, as they did in spectacular fashion in 2007/08, the taxpayer ends up with the bill. Profits are thus private; losses are socialised. This is not capitalism: it is a welfare state for bankers and their financial backers. Worse, now that the state guarantee has been made explicit, bankers have a direct incentive to take ever more irresponsible risks.

The Independent Commission on Banking (ICB), established by the Coalition last June, was tasked with proposing a cure for this illness in our financial system. The commission's interim report, published yesterday, recommends the medicine of "ring-fencing". Banks' retail operations (the part that is vital to the functioning of the British economy since it administers the deposits of ordinary savers and businesses) would be turned into subsidiaries, separate from risk-taking investment-banking arms. The committee claims this will ensure that the vital retail operations of banks continue when large institutions run into difficulties. The banking arms, on the other hand, could go bust.

Will this create better incentives within the banks? That depends on how credible those who lend money to banks find ring-fencing. Will investors demand a premium for putting their money in the bonds of an investment banking subsidiary of a giant bank because they perceive it as more risky than the debt of the retail operation? If they do, the reform could be effective in imposing market discipline. But if not, it will mean that the assumption of a state rescue for a stricken investment bank has survived. The managements of those firms will then continue their business as usual. In other words, the proof of the pudding will be in the eating. Ring-fencing is probably better than the present situation, in which investment bankers can gamble with the cushion of an unlimited state guarantee. But that is not the standard against which the ICB should be measured. The crash of 2008 was the largest financial catastrophe since the First World War. The job of the ICB was to recommend ways of making the banking sector safe, not marginally less dangerous.

And the ICB had a clear alternative path: complete separation of retail and investment banking. That would have wiped out any doubt in the mind of bankers or investors about the limited nature of the state's guarantee. Yet the committee's members chose not to go down that road. The report's justifications for this are terribly weak. It hints at the "costs" of a full separation and the "benefits" of the universal banking model. Yet it does not spell out what it thinks these are, or how much they are worth.

The report reads as if it lacks the courage of its own convictions. The substance points one way, but the conclusion does not follow. The committee's chairman, Sir John Vickers, bristled yesterday at the suggestion that the ICB had "bottled" the challenge handed to it. But in its failure to explore a truly radical restructuring of Britain's dysfunctional and dangerous banking system, that is the description that is likely to stick.

React Now

Latest stories from i100
iJobs Job Widget
iJobs General

Marketing Manager - Leicestershire - £35,000

£30000 - £35000 per annum: Ashdown Group: Marketing Manager (CIM, B2B, MS Offi...

Marketing Executive (B2B and B2C) - Rugby, Warwickshire

£22000 - £25000 per annum: Ashdown Group: A highly successful organisation wit...

SEN Coordinator + Teacher (SENCO)

£1 per day: Randstad Education Leeds: Job Purpose To work closely with the he...

Research Manager - Quantitative/Qualitative

£32000 - £42000 Per Annum: Clearwater People Solutions Ltd: Our client is curr...

Day In a Page

Read Next
Piper Ryan Randall leads a pro-Scottish independence rally in the suburbs of Edinburgh  

i Editor's Letter: Britain survives, but change is afoot

Oliver Duff Oliver Duff
Some believe that David Cameron is to blame for allowing Alex Salmond a referendum  

Scottish referendum: So how about the English now being given a chance to split from England?

Mark Steel
Scottish referendum: The Yes vote was the love that dared speak its name, but it was not to be

Despite the result, this is the end of the status quo

Boyd Tonkin on the fall-out from the Scottish referendum
Manolo Blahnik: The high priest of heels talks flats, Englishness, and why he loves Mary Beard

Manolo Blahnik: Flats, Englishness, and Mary Beard

The shoe designer who has been dubbed 'the patron saint of the stiletto'
The Beatles biographer reveals exclusive original manuscripts of some of the best pop songs ever written

Scrambled eggs and LSD

Behind The Beatles' lyrics - thanks to Hunter Davis's original manuscript copies
'Normcore' fashion: Blending in is the new standing out in latest catwalk non-trend

'Normcore': Blending in is the new standing out

Just when fashion was in grave danger of running out of trends, it only went and invented the non-trend. Rebecca Gonsalves investigates
Dance’s new leading ladies fight back: How female vocalists are now writing their own hits

New leading ladies of dance fight back

How female vocalists are now writing their own hits
Mystery of the Ground Zero wedding photo

A shot in the dark

Mystery of the wedding photo from Ground Zero
His life, the universe and everything

His life, the universe and everything

New biography sheds light on comic genius of Douglas Adams
Save us from small screen superheroes

Save us from small screen superheroes

Shows like Agents of S.H.I.E.L.D are little more than marketing tools
Reach for the skies

Reach for the skies

From pools to football pitches, rooftop living is looking up
These are the 12 best hotel spas in the UK

12 best hotel spas in the UK

Some hotels go all out on facilities; others stand out for the sheer quality of treatments
These Iranian-controlled Shia militias used to specialise in killing American soldiers. Now they are fighting Isis, backed up by US airstrikes

Widespread fear of Isis is producing strange bedfellows

Iranian-controlled Shia militias that used to kill American soldiers are now fighting Isis, helped by US airstrikes
Topshop goes part Athena poster, part last spring Prada

Topshop goes part Athena poster, part last spring Prada

Shoppers don't come to Topshop for the unique
How to make a Lego masterpiece

How to make a Lego masterpiece

Toy breaks out of the nursery and heads for the gallery
Meet the ‘Endies’ – city dwellers who are too poor to have fun

Meet the ‘Endies’ – city dwellers who are too poor to have fun

Urbanites are cursed with an acronym pointing to Employed but No Disposable Income or Savings
Paisley’s decision to make peace with IRA enemies might remind the Arabs of Sadat

Ian Paisley’s decision to make peace with his IRA enemies

His Save Ulster from Sodomy campaign would surely have been supported by many a Sunni imam