Banks and UKFI

Today we are promised a statement from UKFI on the future of the nationalised banks.

I expect to agree with them that Northern Rock should be an early disposal, but I do not agree that all its tricky liabilities should remain with the state. The point of the sale should be to get rid of as much risk as possible.

I expect to disagree over the conglomerate banks. If UKFI say they will wait and then sell shares in RBS and LLoyds at prcies they think more acceptable, I say “No”. These mega banks should be split up and sold in bits, to increase taxpayer value, to cut risks and to create a better structure to Uk banking.

In future the competition authorities should block mega mergers that damage markets and weaken financial underpinnings for banks. ABN Amro and HBOS were mergers that should have been banned. The government was wrong to ignore competition advice and wrong to allow or encourage these mergers. It can now be put right because the government owns the lot on behalf of taxpayers. Its the price of their mistakes that they do so. If they had blocked mega banks earlier we would not be in the pickle we are now in.


  1. Javelin
    July 13, 2009

    I think it’s difficult for the public to understand that the current price of an asset also factors in risk. There is an argument that RBS should be slowly sold off as the price improves. I agree with you though, high risk is not the place of Government, why not sell off the shares. Pay the mortgage off early and sacrifice growth. I think the immediate sale would cost in the region of 26bn (on today this morning) but this price is against the original over inflated value.

  2. Mike Stallard
    July 13, 2009

    (Wow! You have been busy this (early) morning!)
    More generally, you are so right. Monopolies in banking are dangerous because the bankers are not out to help us: they are out after money. They need the control of competition therefore.
    The State, composed as it is, of “Professional politicians” cannot, by definition, provide “Professional bankers”. Therefore it must be running the banks on our (vicious) taxes when it does not know how to do it.
    Time, as you say, to unload – in bits.

    (PS Could you write something on PFIs? We have got one here and I honestly do not understand anything about PFIs.)

  3. RobertD
    July 13, 2009

    The most urgent need is for the government to get out of UK consumer and small business banking. This is the area where they are most tempted to intervene for political advantage to the detriment of the British economy.

    I agree that while they are geting out of these businesses they should split them up into at least four new independent companies, so that with Barclays, HSBC and Santander there will be at least seven major players in UK retail banking giving customers choice and the prospect of competition keeping them honest.

    It may be prudent to remove from their balance sheets a proportion of the bad assets, so that with profit magins on these businesses at an all time high, the new banks should command a good price from new shareholders and floatation should set them free to invest in the UK economy and promote economic recovery.

    That will leave three other slugs of business. Non-UK retail operations, commercial and investment banking, and a slug of bad UK retail debts. In dealing with these the government needs to meet three potentially conflicting objectives. They need to raise cash to pay down government debt, they need to deleverage the UK balance sheet and its excessive exposure to foreign currency debt, and to rebuild the stream of income, employment and tax revenue that used to come from banking.

    Non-UK retail business could be sold to other operators in those markets, or if large enough be floated off in their own right. The residual UK bad debts should go to a specialist operator to run down on a “share of recovery” deal.

    That leave the commercial and investment banking sector that has to be rebuilt as a global powerhouse if the UK is to retain its postion as a world leader. This will take time and probably selling and buying bit of business to reconfigure them to become viable independent entities. Other than as backstop guarantor, and if necessary provider of modest additional capital, there is little direct role for government in the process They should content themselves with setting a timetable and target exit price and incentivising management to reach those goals.

    Unfortuanately I don’t think this arrogant and economically illiterate government has the capacity or the motivation to do any of it. Is there any chance that you can get Osborne & Co to pull together a credible alternative.

  4. Mick Anderson
    July 13, 2009

    If the banks were smaller, they would be more manageable should one be in a position where it might fail.

    This is also why retail and investment banking should be split. It is partly to prevent the investment arm of a bank from bringing down the retail side, but also to reduce the overall size of the individual entities.

    The only reason anyone seems to give for not splitting these functions is that they are already interwoven. Surely it is not difficult to issue two sets of shares (one for the retail arm, one for the investment arm) to separate them. It reduces the risk for the taxpayer (who will always be expected to support a retail bank) without forcing too many restrictions on the investment facilities.

    We are currently in a position where the financial climate makes this spilt commercially acceptable and relatively easy. It might even be the simplest way to sell the nationalised banks off piecemeal. Delay only makes this sensible move harder to achieve.

    I know that you (JR) have written that you don’t wish to split retail banking from investment banking, but I don’t remember reading why you take that view.

    1. Robert K, Oxford
      July 13, 2009

      The danger of this argument is the fallacy that investment banks de facto are risky and that retail banks are prudent. Northern Rock was a retail bank that was run badly, which is why it went bust. Sure, there have been plenty of spectacular investment banking collapses, but there are plenty of investment banks whose activities outside fixed income have done very well since the start of the credit crunch.
      The only system that will work is one in which the government makes a categoric promise that it will not intervene to save a bank that goes bust. When investors believe that their savings are at risk they will accept a lower level of return for a higher degree of security. Counterparties in the investment banking world will make a similar calculation.
      As JR has explained in previous posts, one of the main problems is the invidious relationship between the state and the banking sector. When the state has burned through all the cash it has excised from the wealth creating elements of the economy it simply turns to the Bank of England to print some more: for this, it relies on the retail and commercial banks as a distribution conduit. That’s why the government is happy with a distorted and over-concentrated banking sector whose continued existence is reliant on the state. Remove that once implicit and now explicit state guarantee and you will get a more risk-averse, prudent and competitive system.

      1. Mick Anderson
        July 14, 2009

        Hi Robert,

        If I understand your drift, the assertion is that there should be no protection for any bank, and that competition alone will be enough for the general public to determine which bank is sufficiently safe for them to use on a daily basis.

        You’re quite right when you say that some investment banks have done well in the existing climate, and that’s wonderful – as long as the mirror image is true, and they would be allowed to fail if things went wrong.

        Much of the problem has been created by political involvement, but what should be put in place so that the political angle is removed? How can an autonomous system be designed? Even if the promise you want for non-involvement is made, would anybody actually believe it?

        I subscribe to the theory that if every bank is treated to a variable level of suspicion (because any bank could fail under the “right” circumstances), the economy would suffer. Most people have their salary paid directly into a bank account, and the use of cheques and direct debits is dependant on this. Changing bank accounts is an arduous task, no matter what the industry claims, so what happens if the bank you chose last year goes through a sticky patch? Surely this is what regulation and protection is there for – to give everybody enough confidence in the system for it to work.

        However, an investment bank (that is not required for day-to-day living) is a different animal, and should be allowed to live or die unfettered.

        The only other alternative to splitting retail from investment banking that I can see is a protection scheme that protects retail customers of a bank. Using Northern Crock as an example: all “retail” transactions (cheques, debit cards, direct debits) would be honoured seamlessly by all the other banks in the UK when the original collapses (managed by the clearing system), with the money recovered to the helpful saviour bank when the remaining assets are distributed by the official receiver. The saviour bank would then hope to win the trade of the grateful customer. The obvious problem is that it would require an unfeasable amount of co-operation within the banking industry and probably not work in a global banking market.

        I’ve no problem with the idea that banks should be allowed to fail (just like any other business), but such a failure should not be allowed to damage the lives of the hapless member of the public (for example, by taking their months salary but not paying the mortgage because of the failure, or your employers bank failing before everyones salary was paid). If the only viable solution to protect the customer is to protect the bank (which is the current and possibly simplest solution, albeit badly administered), how can that protection be limited to just those customers who deserve it?

        Thus, my vote is to manage the overall risk by ring-fencing the retail functions of banks, and the simplest way to build this fence is to keep retail banking separate.

        1. Robert K, Oxford
          July 14, 2009

          Hi Mick
          Thanks for your response.
          To take your points in order.
          1) I do believe there should be no state protection for any bank. The argument here is one of simple morality: the money the state uses to bail out bad businesses is forcibly extracted via taxation from other, more profitable and successful segments of the economy. This is immoral. To give a practical example, UK depositors in Icelandic banks were receiving interest rates of 7.2% before the crash, which was part of the reason the banks went bust. Having enjoyed a premium return on their investment, depositors were bailed out by taxpayers who deposited their savings in less risky but less remunerative accounts. This is not to say that protection cannot be arranged. In a free banking market, one could imagine banks grouping together to provide insurance for depositors should one of them fail. This would be up to the banks to arrange and would obviously come as a cost to investors, reflected in the interest rate they receive.
          2) No investment bank should be bailed out.
          3) I agree that the current problem has been caused by political involvement. The answer, surely, is for political involvement to stop. On the most basic level, this should be the promise I alluded to – that the state will never bail out a failing business or industry. On a more developed level, one could imagine a monetary system in which the supply of money itself is privatised and its cost determined by factors of supply and demand. This is not as far-fetched as it might sound. JR has already alluded to the fact that the banks currently are pricing money at very different rates of interest than the Bank rate. Other examples of private money are the nascent payment systems on the internet. In other words, I have no system to propose. Left to its own devices the market will figure out the optimum means of exchange.
          4) I disagree that if banks were regarded with a variable degree of suspicion that the economy would suffer. In fact, the reverse would be true. People who are entirely risk averse would happily pay to run their current accounts – I certainly would. They would only invest in institutions which maintained the highest levels of solvency and liquidity. One important root of the current crisis is the misallocation of capital and the mis-pricing of risk. If you deposit money and want a rate of return in the form of interest then you must accept the risk that you will lose your deposit. The higher the return the higher the risk. Thus, a system in which there was a multiplicity of banks offering different balances of risk and return would ensure that depositors capital was being allocated more closely to the depositor’s perception of risk and return. This would lead to a healthier economy, not a weaker one. (If the bank you chose last year goes through a sticky patch, change bank.) Finally, on this point, surely we can all agree that the banking system was an is one of the most highly regulated business segments. It doesn’t take a huge intellectual leap to conclude that state regulation is the problem, not the solution.
          5) I addressed your point on saviour banks in point 1) above. But just to highlight – there is no reason not to expect banks to collaborate to provide deposit protection for investors, assuming that investors wanted that facility and were prepared to pay for it. Bear in mind that prior to the government underwriting all bank deposits after Northern Rock collapsed, there was a scheme (admittedly state sponsored but nonetheless one that could have been replicated in an un-regulated setup) that guaranteed deposits up to GBP 35,000 in any one financial institution. People who deposited more than that in any one place were taking a risk and should not have been bailed out.
          6) Your point about the hapless member of the public being fleeced because his bank goes bust is persuasive but, if I daresay, mis-founded. Life is not without risks and people are very aware of how to tailor risk, financial or otherwise, to their own needs. Some people get kicks jumping off mountains with paragliders; I prefer to take the funicular. Left to its own devices markets would throw up a multiplicity of banks that offer the services their customers need at appropiriate levels of risk and reward. If a bank failed then the consequences of that failure would lie with the shareholders, bondholders and depositors of that institution, in that order. The truly hapless person is the taxpayer in a state-dominated economy who has no control over how the majority of his money is spent and wasted.
          7) Finally, beware the law of unintended consequences – the plan to forcibly split retail and investment banks has an internal logic that has enduring appeal. However, the adverse unintended consequences of intervention are much harder to quantify, other than to say that they are invariably malign.

  5. Brian Tomkinson
    July 13, 2009

    So far the UKFI seems to have been a pretty toothless operator despite the fact that HM Treasury states that: “Its overarching objectives will be to protect and create value for the taxpayer as shareholder, with due regard to financial stability and acting in a way that promotes competition.” Have we seen evidence that it is doing any of that? Perhaps today’s statement will cast some light but I’m not hopeful.

  6. Lola
    July 13, 2009

    Trouble is Mr R, that Brown and his henchmen will take action before the election just to deny your lot the glory (?) of properly sorting this out. And all that they will achieve by doing so is to finally and completely bollox up the whole thing.

  7. oldrightie
    July 13, 2009

    My support for smaller and more localised banks and mutuals is a given. I also would go further and wish to see the globalisation of food processing changed and a shift away from enviromentally expensive markets.
    As for the UKFI. Yet another Jimmy Brown inspired waste of money.

  8. Martin
    July 13, 2009

    You are very right that the banks are too big. Chopping up Lloyds and RBS will make them much more easy to privatise.

    Hopefully you will push whoever is in power to break up the banks.

    If this breaking up becomes fashionable maybe the local councils will be next!

  9. no one
    July 13, 2009

    yep split em up

    just as BT should have been and still should be split into lots of smaller companies

  10. APL
    July 13, 2009

    JR: “ABN Amro and HBOS were mergers that should have been banned. The government was wrong to ignore competition advice and wrong to allow or encourage these mergers.”

    Could it be it was encouraged by the governement in order to bolster its EUro credentials?

  11. Denis Smith
    July 13, 2009

    I couldn’t agree more. I don’t want to sound like a conspiracy theorist, but I always felt that this Scottish administration that we have had for a dozen years was determined to promote Scotland at the expense of England, and that this was why they favoured the BOS and the RBOS, permitting them – encouraging them, perhaps, for all I know – to go on a wild, unfettered acquisition spree, in the hope of building ‘International Champions’, in the French style. I know the arguments for needing to be big domestically before you can be big internationally, but it seems to me that the deals done by the BOS and the RBOS were only ever in the interests of BOS and RBOS themselves, and were always against the interests of the other banks, the man in the street and the UK as a whole. Now that the whole pride-and-ambition-fuelled enterprise has crashed (a bit like the story of Macbeth, really), these grotesquely huge businesses must be split up, and the sooner the better.

  12. StevenL
    July 13, 2009

    It’s all well and good calling for “competition authorities” to block stuff like this. In reality the head honcho’s of the OFT are not going to go against the top-brass political appointments at the FSA and the head honchos at the Treasury acting on the Chancellor/PM’s (who may have been lobbied by doners) orders if they want to stay in their jobs and/or receive the funding they are after are they?

    Maybe big mega-mergers should be put to a jury in future?

  13. Brian E.
    July 13, 2009

    Of course if you believe in conspiracy theories, you might start to wonder why the government pressed Lloyds to take over HBOS.
    After all, had they not, there is not reason to believe that Lloyds would have needed government help.
    I believe that the government’s actions are a precursor to full nationalisation of these banks if they win the next general election. There is no doubt in my mind that “Old Labour” are back in power, and although Gordon might pretend differently, he is most definitely on the left wing of the party, as is shown quite clearly by his wish to get large swathes of the population dependent upon government handouts such as tax credits. Various largish companies have already realised this and have moved their domicile from London to other parts of the EU where they will have less government interference as well as lower taxes.

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