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.

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