Should we break up the banks?

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.

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6 Responses to Should we break up the banks?

  1. Pingback: Should we break up the banks? - Rick - Member Blogs - HR Blogs - HR Space from Personnel Today and Xpert HR

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  3. Strategist says:

    Yes, if we have to have big banks, let us have a nationalised big bank, offering a fair deal for savers and borrowers, providing credit at times like this, but not going mad when there’s a boom on.

    Without the deadweight of paying crazy salaries and excessive dividends, this bank would quickly be able to outcompete the privately owned banks and win most of the basic retail banking market in the country.

    We should try it.

    • John Jones says:

      Lovely. A bank run by politicians making financial decisions based on electoral considerations. Are you a Labour council wanting a soft loan on non-commercial terms to avoid having to balance the budget with difficult local elections coming up? Or a businessman promising to create jobs with a risky new business venture in a marginal constituency? Or a left-wing pressure group wanting to force a high-profile corporate retreat from a profitable new line of banking business to which you have ideological objections? Or a union leader wanting someone to bail out the bust company for which many of your members work?

      The government’s bank, far more subject to politicians’ whims than even RBS right now where the management can’t do anything without the government’s permission, would be the obvious place for these chancers to look. They’d ensure such a bank could only ever make a loss. And guess who’d be on the hook to pay for it but the good old, long-suffering taxpayer, who is always bilked for subsidies by loss-making state-run companies, as we saw ad nauseam between 1945 and the early 1980s..

      Actually, your absurd claim that banks pay “excessive dividends” (my guess is that that’s the comment of someone without the first idea about what typical dividend yields are on normal businesses) rules you out of being taken seriously.

  4. Graeme says:

    The two mixed banks that failed were both big ones. The separation could take the form of allowing an investment bank to own a retail bank, but not vice-versa: so the risks are not underwritten by government guarantees. That said, it is more important to break up “too big to fail” banks.

    Other than that, I blogged on what should be done in 2009, and most of that still applies in my opinion.

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