et us remind ourselves of the banking crisis. The UK government bailed out banks by initially committing £1.2 trillion in investment, loans and guarantees, now standing at £456 billion. Bradford & Bingley, Northern Rock, and Halifax followed the Thatcherite road to demutualisation, market competition and easy mortgages and had to be rescued. Banks, aided by credit rating agencies, could not tell the difference between a shack on Ben Nevis and AAA securities. Consequently, assessments of risks were misleading. Banks recognised profits in their accounts that had not yet been made and this enabled them to pay huge salaries to their executives. At 31st December 2007, the face of value of bets (known as derivatives) on the movement of exchange rates, interest rates and commodity prices stood at $1148 trillion, but were hardly accounted. Auditors, selected by bank executives, continued to dole out clean bills of health.
Banks have a history of predatory practices. Excessive charges, mis-selling of endowment mortgages, pensions and payment protection insurance are just some of the examples. Despite extensive anti-money laundering legislation, the late Nigerian dictator General Sani Abacha managed to pass US$1.3 billion through 42 separate bank accounts in London. Royal Bank of Scotland is accused of using a series of complex transactions to avoid around £500 million in taxes. The infamous 'NatWest Three' bankers were repatriated to the UK to serve the remainder of their three-year prison sentence resulting from Enron related frauds. UBS and Deutsche Bank have been fined in the US for aggressive tax avoidance. HSBC is under scrutiny in the UK and the US for allegedly enabling some of its customers to dodge taxes. JPMorgan Chase Bank paid $154 million to settle charges that it misled investors in complex mortgage-securities transactions. Goldman Sachs has been speculating on the price of wheat to drive the price sky high and create hunger and social mayhem.
Against the above backdrop, the nearest whiff of reform is provided in the report published by the Independent Commission on Banking (ICB), under the chairmanship of Sir John Vickers. The 358 page report is disappointing.
The major recommendation is ring-fencing of the retail and investment side of banking rather than a legally enforced separation. The Chinese-Walls to police ring-fencing will encourage creative compliance and cannot work. Nor is ring-fencing a cure for a corrosive culture. Northern Rock did not have an investment arm but went belly-up as directors chased cheap money to expand profits and remuneration.
Vickers offers nothing to curtail gambling and the speculative side of banking will continue to benefit from limited liability. This will enable bankers to privatise profits and ultimately dump losses on to the rest of society.
Vickers recommends that banks continue to trade as corporate entities. This inevitably exposes them to incessant pressures from stock markets to provide higher profits. Markets have never cared whether they are made from shady practices, tax dodges, gambling or abuses of people. The faith in corporate entities assumes that shareholders have long-term commitment and are thus motivated to police companies. It will not happen because there is no long-term commitment. The average duration of the shareholding period is only seven and half months. Shareholders do not bear most of the risks either. For example, prior to its collapse Bear Stearns had a leverage ratio of approximately 33:1; i.e. for every $1 of shareholder funds it had $33 from other sources. Alternative structures built around public ownership, co-operatives and mutualisation could mitigate many of the problems, but these are ignored by Vickers. Prior to the crash, most financial institutions had leverage ratios between 11:1 and 83:1. They crashed because they did not have enough cash to meet their obligations. So Vickers 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 17-20% of certain assets. The difficulty is that this does not address the solvency and liquidity issues.
The Commission notes excessive remuneration for risk-taking, but thinks that voluntary codes, backed by the Financial Services Authority (FSA), will curb the excesses. These have not worked before and there is no reason to assume otherwise. An alternative would have been to empower bank employees, depositors and borrowers to vote on executive remuneration. It is doubtful that bankers fleecing depositors and borrowers, or paying low wages would secure enough votes for their telephone number salaries. Democratisation forms no part of the Vickers' reforms.
Vickers does not even look at bank auditors, accounting, credit rating agencies, tax dodges, money laundering, disregard for honesty and corrosive organisational culture that has led to the biggest economic crisis in recent times. A wise man once said that ‘Those who do not learn from history are doomed to repeat it'. The UK government should take note.