Breaking Up The Big Banks

A special report from SBT’s Financial Editor, Graham Carn.

Chucka Umunna, the shadow business secretary has said that Mark Carney, the Bank of England Governor, should stay out of politics. This followed two remarks of the Governor, firstly, in agreement with the chairman of the Select Committee, that an EU cap on bank bonuses was “crude” and that “variable remuneration” linked to deferred compensation and claw back clauses was better than a rigid cap. Secondly, the Governor commented on an even more sensitive issue linked to the latest ‘big idea’ of Ed Milliband who wants two new ‘challenger banks’ and suggests the carving up of Royal Bank of Scotland and Lloyds Bank in particular to achieve this. The Governor has made his thoughts clear that “just breaking up an institution doesn’t necessarily create a more intensive competitive structure”, which is supposedly the policy aim.

Umunna’s criticism of the Governor has been since down played by Ed Balls seeking to avoid any rift with the Bank of England, but Umunna is a clever, articulate and thoughtful politician so his comments are concerning perhaps his real motive is that of attempting to stifle comment by the head of the UK’s central bank on Labour’s popularist policy of continued bank-bashing.

My area of familiarity is the financial world and I don’t relish the idea of straying too far into the often-changing arena of political banter. Like many I usually take whatever politicians say, of all persuasions, with a large pinch of salt and regrettably I find myself thinking what other agenda do they have. In respect of the possible breaking up of banks however I must make comment as I fear it is not that Mr Carney that is playing politics with the banking system but Mr Umunna and his boss that are doing so – for popular appeal.

Banks are at the very heart of this country’s economy and surgery on vital organs is always risky! The implications of breaking up banks are serious so an objective view must be taken. Of course the banks are big, they have been bad in getting their act wrong and had to be bailed out, and they’re ugly in the eyes of many as, at the top of the corporate pile, the remuneration of executives is well beyond the reach of the average man or woman in the street. I dare say Mr DiCaprio and the Wolf of Wall Street will not help matters!

Breaking up is hard to do – and what will it achieve?

The suggested route for dissemination would be yet another banking review undertaken by the Competition and Markets Authority (CMA). Since the banking crisis first erupted in 2008 there have been numerous reviews and what have they achieved? This one would be different in so much as the Labour leader appears to be planning to, possibly illegally, simply instruct the CMA on its conclusions before it has held the inquiry. Labour is stating that the two currently partially state-owned banks, RBS and Lloyds should be broken up to enable the creation of at least two “challenger banks”, and to limit the size of all banks by capping market shares for both retail customers and business lending. The CMA’s ‘review’ is just to decide the extent.  Mr Miliband has stated that he would instruct the Competition and Markets Authority to report within six months of him winning the May 2015 election on the level at which the threshold should be set and the timetable for the sell-off of branches, which should be completed by 2020. This would also mean that the Labour leader would have to override the current remit of the Competition and Markets Authority, since the body would ordinarily take 18 months to two years to report, and the government would have effectively removed its independence by dictating its conclusions.

My main concern is how much serious follow through thought has gone into this popularist plan as to what it actually may mean and what could be the consequences. It concerns me that Ed Milliband was a member of the government that is widely attributed to having brought us to the present economic situation in the first place and that he was firstly an adviser to Gordon Brown before being a member of his cabinet when in 1997 the Labour government looked into competition in the banking industry – and when the Office of Fair Trading found no evidence of anti-competitive behaviours.

The creation of new market entrants and increasing competition in banking soon fell off Brown’s agenda, practically also given the enormous tax revenues they were contributing and the decision was made to let them get on with it. What followed was an unprecedented period of banking consolidation which Labour sanctioned every step of the way, culminating in what turned out to be the worst decision of all – the suspension of competition rules so that Lloyds could acquire the virtually insolvent Halifax Bank of Scotland. Miliband was unfortunately complicit in what could be argued as this negligence but now asks us to trust his judgment on how best to introduce banking reform. The plan, it seems, is to risk the creation a further number of Paul Flowers, the clerical gentleman who served the Co-op bank so well and oversaw the disastrous attempt by them to absorb part of Lloyds!

Selling off branches has proven to be difficult so far – there are few buyers at the moment, and when someone is found their ability to complete the deal has fallen short.

Breaking up larger companies is a sledgehammer solution and when you apply it to a complex business such as banking, with all its facets it has all the ingredients to create a worse or skewed outcome. The general goal of “more competition” is not enough – what would the challenger banks do so differently, given the regulatory system that they would still be operating within?

In the short term Labour is only headlining, with detail thinly available. Regrettably however their noises left of stage will have adverse effects. This year, possibly as soon as in the spring, and certainly before next year’s election, it was widely expected that the government would look to sell the taxpayer’s remaining stake in Lloyds. Now this is going to be overshadowed by whatever’s happening in the opinion polls. The City will inevitably demand a lower price to take account of the Miliband break-up risk, and Lloyds will have to list Labour’s plan as a potential future risk in its prospectus. This is something that the Labour leader seems to think is a ‘price worth paying’ if it benefits the economy in the long run. I fear he is mistaken as not only is our national debt balance is not going to be helped by a lower share price sale but now bankers, not just at RBS and Lloyds, are worrying about how they might be ‘restructured’, and what this will mean for their businesses. Rather than concentrating of new lending for example, the agenda is moving backwards to survival and damage limitation.

Like it or not the financial sector and banks are at the very heart of this country’s economy and surgery on vital organs is always risky! We need a very full debate, and real cognisance and quantification of the benefits if we are to even consider splitting up our economic engines. For example, forcing banks to downsize and shed customers could easily mean banking costs would rise. Limiting market share would mean banks deemed too large or successful, now or in the future, would have to shed customers. The easiest method to do so would be to increase charges, sending customers elsewhere. Additionally, smaller banks are often considered riskier, and would have to pay more to raise money on the wholesale markets. The price of all personal and business loans is reflected in the price the banks pay to borrow themselves.

Also, where are the buyers going to come from and what sort of experience and background will they have? Selling off branches has proven to be difficult so far – there are few buyers out there at the moment, and when someone is found their ability to complete the deal has fallen short. The cost and demands of regulation is huge and major businesses with the potential financial clout have so far steered well clear and stuck to trading in what they know best.

If there was no break up, what would happen?

I appreciate this article may sound like a defence of the banks when clearly their operations were flawed and change is required.  However, since the financial crisis of 2008, when more than £100 billion of taxpayer money went into preventing several major UK banks going bust, the sector has been in permanent change:

• There is to be a ring fence between high street and ‘casino’ operations,

• There is a new Commission into Banking Standards,

• The regulator body has been overhauled,

• There is to be new legislation to jail errant bankers,

• The EU also is requiring RBS and Lloyds to shed branches while both await the full return to the private sector.

It is therefore unnecessary and disappointing that Labour has once more jumped aboard the anti-bank bandwagon, lumping bankers in with payday lenders and energy companies as examples of the sort of “predatory capitalism” which, if elected, he plans to outlaw. Bankers still make easy scapegoats for political failures, as a substitute for hard choices on structural, welfare and wider economic reform.

The political appeal of bank-bashing is thus obvious but simply lashing the bankers to the mast again for another whipping is not going to cure all ills. The very real danger is that much of what’s proposed will not just be off target and ineffectual, but positively counterproductive. I will not be alone in my concerns – there will be much adverse comment, I am sure, in the media commentary about Labour’s ‘plans’. The CBI’s chief policy director, Katja Hall, has reacted immediately by saying that “there are already new entrants making an impact on the market without the need for artificially carving up existing bank branches”. Possibly that comment too will draw Mr Umunna’s fire but already the heavyweight opinion is co-ordinating against a break-up plan. I hope that politicians advocating such action are honest enough to reconsider and certainly do not try to muzzle opinion that does not suit their shorter term electoral aspirations.

Graham Carn, SBT Financial Editor. Graham is also the senior partner of Blackstones Consulting – if you have any comments or questions on this article please email: blackstones@btinternet.com