A blueprint for real banking sector reform

After the failure of Project Merlin to introduce any real and significant reform of the banking sector, the call for the government to break up the banks is growing louder.

By Shezal Laing and William Cass

When George Osborne sat down with the major players in the banking sector to try and agree a deal and begin the long process of banking reform we all waited with bated breath. The two key results emerging from the Project Merlin deal were that banks would now lend more to U.K. businesses and in turn take a reduction in wages.

However, along with the two headlines came two key flaws to the deal, no figures were mentioned and the banks have again been left to self-regulate, as no penalty exists for failure to keep to either part of the agreement.

After the failure of Project Merlin to introduce any real and significant reform of the banking sector, the call for the government to break up the banks is growing louder.

The new Compass publication ‘Banks We Can Believe In’ outlines a blueprint for real banking sector reform. Central to this is a call for a U.K. version of the U.S. Glass-Stegal Act of 1933 which statutorily broke up banks and separated commercial banks from investment banks in the wake of the stock market crash of 1929.

Such an act would afford ‘retail’ bank customers protection from more risky investment banking and any ensuing losses incurred on the financial markets. Under the current system by depositing money into a bank account, the customer is consenting to lucrative high risk investment where the risk is shared but the profits are not.

The publication also calls for the expansion of the mutual sector along with the re-mutualisation of Northern Rock and Bradford and Bingley. Mutual banks provide stability and security particularly in times of economic instability.

In 1986, the Building Societies Act was introduced, allowing building societies, for the first time, to demutualise and offer the same services as banks. This meant that members’ mutual rights were exchanged for shares. Demutualisation brought with it enormous salaries and bonuses, as is exemplified by Bradford and Bingley and Northern rock who saw salary and bonus increases of directors rise to 40.2 per cent and 32.3 per cent respectively in just over a year.

Demutalisation has proven to be a catastrophic failure; of the ten building societies that demutualised, not a single one remains as a stand-alone bank and six are now in receipt of government support. The most high profile of these, Northern Rock, turned to the government to guarantee its deposits after its risky lending strategy and over reliance on funding markets resulted in a run on the bank.

Co-operative and mutual banks are more stable than commercial banks, as their main functions are to protect deposits, make limited and secure investments and provide depositors with interest. This means their returns are less volatile and less prone to speculative activity than banks, offsetting their lower profitability and capitalization.

In ‘Banks We Can Believe In’, Compass has set out eleven policy recommendations for Sir John Vickers and the Banking Commission to explore:

• A U.K. equivalent of the ‘Glass-Steagall’ act that separates the retail and investment functions of banks;

• Mandatory living wills;

• Higher capital ratios;

• A ban on naked short selling;

• A permanent tax on personal bonuses of more than £25,000;

• A financial transaction tax;

• The establishment of a locally based Post Office bank;

• Legislative reform of the credit union sector to encourage expansion;

• A U.K. equivalent of the Community Reinvestment Act that forces commercial banks to meet the needs of borrowers in all segments of their communities;

• An expanded mutual sector including re-mutualisation of Northern Rock and Bradford and Bingley;

• The establishment of a nationalised infrastructure bank.

Anything less may leave taxpayers liable for another banking bail out.

16 Responses to “A blueprint for real banking sector reform”

  1. simpkins83

    RT @leftfootfwd: A blueprint for real banking sector reform: //bit.ly/ht52cg by Shezal Laing & William Cass @CompassOffice

  2. Murray

    RT @leftfootfwd: A blueprint for real banking sector reform: //bit.ly/ht52cg by Shezal Laing & William Cass @CompassOffice

  3. sean gittins

    RT @leftfootfwd: A blueprint for real banking sector reform: //bit.ly/ht52cg by Shezal Laing & William Cass @CompassOffice

  4. Watching You

    RT @leftfootfwd: A blueprint for real banking sector reform: //bit.ly/ht52cg by Shezal Laing & William Cass @CompassOffice

  5. reded

    Huge step in the right direction. A public inquiry into the actions of the banks followed by many trials of the criminals in charge would also be a useful measure.

  6. Wendy Maddox

    We need to do this & do it now before further bailouts! RT @leftfootfwd: A blueprint for real banking sector reform //bit.ly/dZfZIN

  7. Mark Stevo

    No one’s yet explained how remutualiation would work in practice. Are people seriously suggesting taking Northern Rock, a now profitable institution owned by all taxpayers, and giving it to a small sub-segment of taxpayers?

  8. Mark Stevo

    It’s a pity the Compass website seems to be so slow and non-functional, as it’s one of the most simplistic pieces of “analysis” I’ve seen for a while.

  9. Compass

    RT @leftfootfwd: A blueprint for real banking sector reform: //bit.ly/ht52cg by Shezal Laing & William Cass @CompassOffice

  10. False Economy

    RT @leftfootfwd: A blueprint for real banking sector reform: //bit.ly/ht52cg by Shezal Laing & William Cass @CompassOffice

  11. downinjamaica

    RT @FalseEcon: RT @leftfootfwd: A blueprint for real banking sector reform: //bit.ly/ht52cg by Shezal Laing & William Cass @Compass …

  12. Sean

    “A U.K. equivalent of the Community Reinvestment Act that forces commercial banks to meet the needs of borrowers in all segments of their communities;”

    So when the lending goes bad, as it did in the US when Freddie and Fannie guaranteed and pumped credit into the subprime sector, is the rest of society meant to pay the bill?

  13. Mr. Sensible

    There’s a lot of talk about breaking up the banks, but I’m afraid I’ve yet to be convinced.

    And I think we only have to look at the crash itself to see why; Northern Rock was a retail bank and we know what happened, by contrast Leyman Brothers was an investment bank that was allowed to fail and it started the crash.

  14. Pauline Hammerton

    RT @FalseEcon: RT @leftfootfwd: A blueprint for real banking sector reform: //bit.ly/ht52cg by Shezal Laing & William Cass @Compass …

  15. William Cass

    RT @FalseEcon: RT @leftfootfwd: A blueprint for real banking sector reform: //bit.ly/ht52cg by Shezal Laing & William Cass @Compass …

  16. Brendan Caffrey

    The Great Merlin Project
    Merlin, son of an incubus, used his magic to help King Arthur; particularly with prophesies. The government wants the magic of the Merlin project to restrain bank bonuses, and increase loans to small businesses.
    Debate over loans centred on whether lending should be net or gross. Net lending is current or new lending, less any repayment of loans. Gross lending is current lending plus the repayment of existing loans. Merlin wanted net lending; the banks argued for gross lending. The banks argued that the gross figure shows more clearly the full extent of their lending. The problem here is that there was a sharp increase in the repayments of loans in 2010. So the banks had more to lend. But net lending to small businesses was not increasing. It was falling by about £1bn a month in February.
    The gross figure hid the real reduction in lending to small businesses. Currently Merlin has agreed that the net lending figure will not be used; and may not be even published in future. The gross figure for 2011 will be £190bn, with a “pledge” to lend £76bn of this to small businesses.
    Debate over bank bonuses centred on what to reveal; options included, the top 5 paid employees, the top 5 dealers or traders, the top paid directors, naming the top paid, and giving individual or aggregate pay levels. The final Merlin decision was none of these. It was decided that the director in charge of the remuneration committee would write to the Financial Services Authority to confirm that bonuses are lower than “normal”.
    As the February news trickles out of the 2010 bonus levels it will become clear if the government’s Merlin has correctly prophesied lower bonuses; or not!

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