Can we clean up the banking system?

9th August 2012

But believing Mindful Money is unlikely to be inundated with responses, it could be better to look forward, to work out how finance can escape the clutches of an industry that has become synonymous with greed, gambling and giving great customer service to Mexican drug cartels or the Iranian regime.

There are ideas galore. But how can they be made to work when the bank bosses have monetary might if not regulatory right on their side?

Bankers don't vote for Christmas

There's one assumption that can be made. The bankers will fight every corner, fair and foul, to retain the status quo. They would be daft not to – they are not turkeys, and even if they were, they would not vote for Christmas. They have been living the life where they are paid to succeed, paid to fail, and paid for either handsomely.

They can do this because the bankers know that no one has a new financing model for society. Those who put forward a completely new system for oiling society can be dismissed as academics or wishful thinkers – both terms of abuse in bankerland. Even the much-publicised successes of those wanting to rein in bankers are minor. Other than making people feel better for a time, it is not clear what has yet been achieved by the ousting of Bob Diamond at Barclays.

But still the banks fail to understand. Standard Chartered, now dubbed a "rogue institution" by US regulators following accusations of breaching Iran banking sanctions, comes up with a defence, reported in the Financial Times, describing any transgressions as "small clerical errors".  The US authorities say these "errors" add up to $250bn. Now, Bank of England governor Sir Mervyn King has come to Standard Chartered's aid by questioning the US position – helping the shares recover a third of their recent losses.

With so much stacked in favour of the banks, most pushing for change go for technical increments as in this Hugo Dixon blog. They are well meaning but will they work?

Cleaning the cesspit

"Something must be done," says Dixon and it is hard to disagree with that. He lists some of the sins of international banks before saying: "Some observers therefore want to clear out the entire old guard. The idea is that only new teams can clean the cesspit."

This would include breaking up banks, ending the "too big to fail" mentality and cutting back on bonuses. None of these, Dixon states, are wrong. But – and there has to be a "but – "the snag is that it will take until the end of the decade for all these changes to be implemented. That's partly because the technicalities are complex; and partly because policymakers fear that, if they come down too hard on such a crucial industry, their economies will be driven even deeper into recession."  This assumes the bankers won't fight back, which they will.

And as for clearing out the present, often highly tainted senior management, that's another Dixon no-no. "But if everybody with a senior position in a troubled firm departed, novices would be in charge. That's just too dangerous."

Dixon is radical by being as conservative as he dare. "It is naive to think that breaking up banks would be a quick fix to the sector's problems," he writes. "It's just not true that a combination of investment and retail banking caused the crisis. Plenty of retail-only banks – the UK's Northern Rock and America's Washington Mutual, not to mention Spain's savings banks – got into trouble. And remember: the biggest failure of all was a pure investment bank, Lehman Brothers."

The Northern Rock casino

This lacks logic. The fact is that high street banks were turned into gambling organisations gave investment banking greater respectability. And maybe Northern Rock was a casino in its own way – it certainly took some big bets with borrowers.

More to the point, it is rather like saying that seat belts do nothing to solve pedestrian car casualties or that banning fox hunting does nothing to stop dangerous dogs. And there is no reason why banks should not be broken up more quickly – the impediment is the banking system.

Dixon dislikes capping bonuses – the soft version of saying that, as in most walks of life, there should be no bonuses as someone who is employed should give of their best. Does the ambulance crew get a bonus for arriving a minute early at an accident?

His "better idea" is to "require lenders to pay a big chunk of managers' compensation in the form of the bank's own subordinated debt. If the bank then got into trouble, executives would lose a lot of money. That should concentrate their minds on better risk management." Not, however, if the bonus getters are gamblers willing to bet the bank if need be.

Bankers get a taste for Jaffa Cakes

A second idea is to favour VAT over any form of financial transaction tax. VAT is a tax notorious for loopholes – take the "is the Jaffa Cake a VAT-free cake or a VATable biscuit" argument that amused the courts and enriched lawyers for years.

And don't overlook the "Carousel Fraud" which cost the Exchequer a billion pounds or so. These criminals used high value but small items such as computer memory or mobile phones. How much easier it would be to operate VAT avoidance using electronic money sent between the very many jurisdictions where banks have subsidiaries. Clever banks could end up with a tax rebate from the VATman.

Power and the non-executive

Finally, Hugo says that "boards have too often failed to hold powerful executives to account". That's again hard to argue with – and not just at banks.
The whole non-executive merry-go-round is ripe for revolution. But given the present make-up of boards, just how will Dixon's solution of "regulators and shareholders needing to insist that bank boards have more clout" be implemented.

Serious change needs consumer action. The banks only have money because the public deposit it. A boycott might alter a lot. Older readers may remember how Barclays eventually gave into the public campaign to force it to divest from apartheid South Africa in the 1980s.


More on Mindful Money:

Bankaholics Anonymous – 12 Steps to Reforming the Banking System

Knight Capital: The Rise and fall of the Machines

Standard Chartered: Another attack on the UK banking sector?

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