Cogent King makes case for radical bank reform

March 8th, 2011

It’s virtually unheard for the governor of a central bank to launch an outspoken attack on the integrity and purpose of his country’s banking sector. But this is what the Bank of England governor Mervyn King did last weekend.

In an interview with former Telegraph editor Charles Moore, King, whose central bank will take back responsibility for prudential regulation from the FSA in 2012, slammed British banks for ripping off customers to fund bonuses, and being so short-termist that all they care about is “maximizing profits next week”.

King’s remarks were not welcomed by the City of London – where obliviousness to the true character of Britain’s banks is a common malaise – and were immediately slammed as “populist” by economists including Tim Congdon, who criticized King for being the architect of the banking crisis! Angela Knight of the British Bankers Association hit back with misleading claims that the UK banking sector has “reformed radically” since the crisis.

King has a clear agenda. His latest tirade about bankers’ immorality and greed will add power to the elbow of Sir John Vickers and the Independent Commission on Banking – due to report to the British government on reforming the banking sector this September.

Vickers is toying with radical but probably necessary reforms including a forcible break-up of the oligopolistic Lloyds Banking Group and the separation of “casino” activities like prop trading and derivatives trading from “utility” functions like retail deposit-taking.

These sort of moves are highly unpopular in some financial quarters since they would signal the emasculation of ‘universal’ banks like HSBC, RBS and Barclays.

King’s remarks, welcomed in an FT editorial, will almost certainly boost the commission’s resolve to push for radical reforms along these lines. They also increase the chance that much higher capital ratios than those agreed by Basel (along Swiss lines), as called for by the governor and David Miles, a member of the Monetary Policy Committee, will see the light of day.

Since the banking crisis struck in September 2008, King and his BoE colleagues have repeatedly blamed UK banks for the crisis, and said that, so long as implicit government guarantees remain in place, they will remain a danger to the economy – and all other attempts at reform will be futile (see No-one can afford ‘too big to fail’ banks).

King and colleagues also want to do whatever they can to stop UK banks from continuing to “rent gouge” and treat customers — both corporate and retail — abysmally.

A former professor of economics at London School of Economics, King attacked current UK banking culture, suggesting traditional sectors such as manufacturing are much more “moral”. Here are some choice quotes from the interview:

“We allowed a [banking] system to build up which contained the seeds of its own destruction.””We’ve not yet solved the ‘too big to fail’ or, as I prefer to call it, the ‘too important to fail’ problem. The concept of being too important to fail should have no place in a market economy.”

“The problem is still there. The search for yield goes on. Imbalances are beginning to grow again.”

“If it’s possible [for financial services firms] to make money out of gullible or unsuspecting customers, particularly institutional customers, that is perfectly acceptable [to the banks].”

King also said there is “too much weight put on the importance and value of takeovers” – a dig at RBS’s Sir Fred Goodwin perhaps, who oversaw 27 takeovers between 2000 and 2007. He said such deals create short-run profits but “it doesn’t make sense to destroy a company with a reputation”. In the past 25 years, said King, banks have increasingly “taken bets with other people’s money”.

“Financial services don’t like the word ‘casino’, but instruments were created and traded only within the financial community. It was a zero sum game. No one knew which ones were winners when the crisis hit. Everyone became a suspect. Hence, no one would provide liquidity to any of those institutions.”“If we had not stepped in for RBS and HBOS, all the British banks would have suffered runs. They didn’t understand the nature of the risks they were taking.”

“It is very unproductive to single out individuals. Bankers were given incentives to behave the way they did. That’s what needs to change. We must resolve this problem.”

King, who failed to push through audacious plans for the recapitalization of developed world banks in March 2008 (details of which were later leaked via WikiLeaks), had the good sense to concede that he and the Bank of England made errors before the crisis, admitting, “I wish I’d spoken out more forcefully about the build-up of leverage.”

King has already expressed disinterest in Project Merlin – a recent deal between the UK government and the banks – and it was therefore probably significant that this was not mentioned once in the Telegraph interview. However he did stand by earlier remarks that seemed to endorse the UK government’s deficit reduction program.

To me, it almost seems that something clicked in the governor’s brain last week – and some, including Asymptotix’s John Morrison, believe he may have had a major falling out with chancellor Osborne and that this interview was his parting shot. I sincerely hope that Morrison is wrong.

Short URL: http://www.ianfraser.org/?p=3642

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