Headline: Bank of England Governor says banks are exploiting customers. So what’s the news? The fact that the Governor, Mervyn King is saying this is politically important. Bashing the banks has become ‘salonfähig,’ as the Germans say, acceptable in polite society. No longer are the bank bashers merely an ignorant, envious, vindictive public or journalistic rabble, or loudmouth politicians who, rather like Vince Cable, find it hard to give substance to their rhetoric once they are in office. Mervyn King is a respectable and respected economist and governor, and now regulator-in-chief of the banking sector. Dinner party conversation may never be the same again.
“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.”
King directly links this unhealthy over-importance with incentive practices: the implicit state guarantee encourages short-term profit-seeking behaviour without regard to relationships, customers, employees, or the wider world. The guarantee allows high returns to be extracted without the attendant high risk being priced into costs, so allowing banks to realise excess profits. Since this activity is personally risk-free for the people engaged in it, pay and incentives will naturally be structured to encourage as much of it as possible. King sets out a clear mechanism and his analysis of it is almost a commonplace, except in the financial sector and the Treasury.
King made another more technical but key point in his interview.
“The problem is still there. The search for yield goes on. Imbalances are beginning to grow again.”
The figures bear this out. Barclays reported a post-tax return on average equity for 2010 of 7.2% (or 8.7% on tangible equity – which excludes the value given to items such as goodwill). HSBC declared a 9.5% return on average shareholders’ equity. State-controlled RBS, still busy writing down the value of its pre-crash loan book, managed to achieve a pleasing 13% ‘core’ return on equity. Its target for the year 2013 is a return exceeding 15%.
In comparison, the UK’s GDP increased by 1.5% during the whole of 2010. Forecasts for 2011 are in the region of 2% growth. Yields on long dated government debt, a good proxy for long-run nominal return expectations, are running at just over 4%, pre-tax. Short-term rates are near zero.
The search for yield has already yielded results.
Any business that not only can but expects to make a long-run return on capital multiples of that obtained in the economy as a whole must have at least one of: (a) power to control the market; (b) hidden subsidies; and (c) cleverer people than everyone else. The banking sector has consistently, in essence, argued that the case is (c), and that lies behind the threat of a brain- or HQ-drain if the environment gets too tough.
The argument could plainly never be true of all banks, and the evidence is that many financial institutions – at board as well as divisional level – traded recklessly, ignorantly and conceivably fraudulently in pursuit of returns irrespective of risk.
The practice of making money at other people’s risk without their consent must be stopped, and if it not stopped by voluntary means, it must be stopped by compulsory means. This won’t be achieved by adjusting capital requirements or requiring more reporting of senior pay. The activities themselves may simply have to be prohibited, either altogether or in organisations that take money from the public in any way. Alternatively, the public must be fully informed of the risks it is being asked to accept from the banks and its consent must be properly obtained – a politically unthinkable task.
Mervyn King is still too cautious to start suggesting concrete answers. Perhaps his intervention supports the suggestion of Lorenzo Fioramonti and Ekkehard Thümler that the financial sector needs a civil society actor – a financial Greenpeace – to investigate the way financial institutions do business and pressurise them and legislators in the wider public interest. Even more intriguingly, it’s possible that King has started to position the Bank of England itself as this new, toothy financial watchdog, going way beyond narrow regulation into the manner and purposes of banking business. No wonder his comments attracted concern and criticism from industry insiders, but in taxpayers he has the resources and may just be able to acquire the public backing to take on the fight.