When I was asked to chair the Future of Banking Commission in 2010, I started out determined not to let it become a banker-bashing fest. In my view too much anti-capitalist rant and rhetoric had been expressed after the 2008 crisis. We needed cold, forensic analysis of what had gone wrong and how to stop it happening again.
Unfortunately, as we heard one witness after another, it became clear that huge bonuses were a perverse incentive to act in ways that, if not illegal, are borderline immoral. The rapacious mindset of some bankers was bending one of Britain’s biggest and most profitable industries completely out of shape, distorting major financial markets and undermining both retail and investment banking. What was going on was simply wealth extraction for executives, not wealth creation for investors or society at large.
Serial, widespread rule-bending was assisted by accounting standards and procedures that can at best be described as lax and at worst irresponsible. All of this was worsened by the West’s political leadership being caught between admiration, incomprehension and intellectual subservience to the financial sector. Governments were in awe of this enormous cash machine, and loath to meddle with it.
This is visible even in the language politicians used to describe regulation of the financial sector. “Light touch” is a case in point: it does not distinguish between minimising the burden of a regulatory system (good) and undermining its effectiveness (bad).
Until 2008 the Financial Services Authority was complicit in the regulatory arbitrage that was common in London. The FSA has taken a tick-box approach to regulation and focused more on small players and technical offences. The first complaints about Libor-fixing surfaced in 2007, and The Wall Street Journal wrote about it in 2008, yet it has taken until 2012 to deal with it.
It is plaintive nonsense for regulators to whinge that they “don’t have the powers”. They have the power to pick up a phone, but the FSA seems unable to involve the police where a serious fraud or crime has occurred. Obtaining money by telling lies is a criminal offence, in breach of several laws. These should have been enforced by very large fines or jail sentences. If the FSA could not do it, the Serious Fraud Office or the police were only a phone call away.
We need commonsense application of law backed up by a high-calibre investigation and ferocious enforcement, particularly where there is dishonesty or a threat to financial stability. The supposedly record fines over the Libor scandal — £291 million, of which the FSA imposed just £59.5 million — are ludicrously small. They are a tiny fraction of Barclays’ profits. If we want shareholders to remove incompetent or corrupt management, we must make the fines a large fraction of annual profits. Last year Barclays’ profit after tax was about £3 billion. Any fine of less than £1 billion is, therefore, largely irrelevant. If Barclays shareholders had seen a significant chunk of the profits disappear in a fine, with a concomitant drop in the share price, it would not be long before they straightened out the board.
The Government’s proposed inquiry into the Libor scam is too narrow. The proper response to this scandal is pretty straightforward. Libor should in future be based on real transactions, subject to independent external audit. Those responsible for generating it should face large mandatory fines for any errors. That this was not done when Sir Mervyn King, the Governor of the Bank of England, suggested it some years ago just shows how overmighty the City had become.
What is really needed now is for London and New York to clean up their house. There are undoubted behavioural problems arising from the spectacularly perverse incentives and serious structural problems that must be resolved if we are not to face a generation of zombie banks paralysing our economy.
However a public inquiry along the lines called for by Ed Miliband would not give us the answers we need. As the Leveson Inquiry shows, it is not always possible to get to the bottom of the issue in a public hearing, especially if criminal cases are in play. Yesterday the Government announced a parliamentary inquiry led by Andrew Tyrie, the chairman of the Treasury Select Committee. To be effective it will have to include a fast, tough and penetrating inquiry behind closed doors. It will also require the power to investigate, near-absolute rights of access and high-powered legal teams to analyse evidence. On top of that it will need the sanction of criminal penalties for those who destroy any information from this day forward.
Although this inquiry should take place in private, its report and findings must be published, regardless of how embarrassing they are. Unless we clean up this mess, London’s reputation will be damaged forever and people would think twice about lending to our institutions or bringing investments to the London markets. That will cripple the long-term growth of the City and its value to the country.
Meanwhile the Government must accelerate its very leisurely reform of our financial industry. It is time to give full force to the Vickers report and to reform Britain’s overconcentrated, oligopolistic, and it now seems either incompetent or corrupt banking sector. We need at the very least a Glass-Steagall-style firewall between investment and retail banking, if not total separation. We need a sharp increase in competition by spinning off and breaking up the bigger banks. Far from implementing Vickers lite, we need Vickers plus, as soon as possible.
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