The head of the government’s Independent Commission on Banking, Sir John Vickers, confirmed at the weekend that a break-up of Britain’s banks is being considered. The idea has widespread support from across the political spectrum. Nick Clegg called for such a break up on Sunday’s Andrew Marr show.
The argument for separating investment and retail banking is simple. The government protects savers by guaranteeing their deposits. It would therefore have to intervene in the event of another retail bank failure, as it did when Northern Rock, RBS and HBOS collapsed. Bankers can therefore take savers’ cash and use it to fund their risky investment banking operations, secure in the knowledge that, should the bank fail, the taxpayer will wade in and bail it out. The taxpayer is therefore underwriting the banks. By separating the banks, the depositors’ money is protected from the riskier side of banking and bankers don’t get to play fast and loose with cash underwritten by the government. Who, except the greedy banks, could disagree with such a suggestion?
As ever, though, things are a bit more complicated than that. Critics of the plan point out that, of the British banks which failed, only one was an investment bank. The others, Northern Rock, HBOS and Bradford and Bingley, were retail banks which had over-stretched themselves. Globally, as the Wall Street Journal’s Simon Nixon observes, only two mixed banks failed during the financial crisis; Citigroup and good old RBS. The banks that were worst hit were either pure retail or pure investment banks. The list of small to medium-sized US bank failures is mind-boggling. Most of the universal banks, by contrast, weathered the crisis pretty well.
It is comforting to think that retail banks can be protected from the storms created by investment banks but the fallout from the collapse of Lehman Brothers suggests otherwise. Investment and retail banks alike were dragged down in its wake. Having seen the consequences of one bank being allowed to collapse, governments were reluctant to let it happen again, hence the Bush administration’s bail out of investment banks such as Goldman Sachs.
So retail banks don’t need to be attached to investment banks to fail. Splitting banks up gives no guarantee that taxpayers will not, once again, be forced to pay for the poor decisions made by bankers.
There is, however, another flaw in the plan to break-up the banks – it only covers UK banks. The British government can break up British banks but it can’t do the same to foreign ones. The regulation would have the perverse effect of making it illegal for a British retail bank to be attached to a British investment bank but perfectly legal for a British retail bank to be attached to a foreign investment bank. Thanks to recent takeovers, one of our biggest high-street banks is the Spanish group Santander. It has an investment banking arm, albeit a relatively small one. Internet bank Egg is owned by US-based Citigroup which has one of the biggest investment banking operations in the world. Neither Egg nor Santander would be affected by the forced break-up of UK banks.
Worse still, breaking up the UK-based banks could make them more vulnerable to foreign takeover. The government might put a lot of energy into separating British retail banks from British investment banks, only to see them attached to foreign investment banks a few years, or even months, later.
The panicky headlines at the time obscured some of the complexity in the financial crisis. Each of the banks failed for slightly different reasons – all due to the financial contagion but also to factors brought about by their own management decisions. As Malcolm Gladwell pointed out in Outliers, most airline crashes occur not because of one big failure but because a combination of multiple small factors. Something similar could be said of the financial crisis.
Complex problems cannot be solved with a single silver bullet. Politicians and commentators tend to seize on one idea as being essential to stop a re-run of 2008. Breaking up the banks is one such cure-all.
We can’t protect ourselves completely from another financial crisis. These things happen from time to time. The best we can hope for is to mitigate our risks. Something which had multiple causes requires a number of different solutions. Stronger capital requirements and the recent deferred bonus rules will help. A break-up of the banks, though, seems to have few advantages and potentially a lot of disadvantages for the UK’s banking industry, its customers and British taxpayers. It might work if other major financial centres were to do it too but the UK would do itself no favours by going it alone.