Don't make banks safe, just make it safe for them to fail

How on earth, most people wish to know, did we get to the precipice of full scale economic collapse in 2008? Aren’t banking and financial services one of the few things Britain is supposed to be truly world class at – so how did they get to be so disastrously mismanaged?. Or, as Her Majesty the Queen asked pointedly, “why didn’t anyone see this coming?”

Sir John Vickers’ Independent Commission on Banking reports today, having essentially been given a remit of ensuring the events of three years ago are not repeated. But, sadly, it seems the Commission’s proposals address the wrong question in the wrong way.

The heart of Sir John’s thesis is that retail banking and investment banking are ring-fenced or “firewalled”. This reflects the prevailing – and inaccurate – view that some banking is essentially safe and some inherently risky. The day-to-day banking operations that most of us mere mortals engage in – having our salary paid into a current account, withdrawing cash from hole-in-the-wall machines, paying our monthly bills and mortgage by direct debit - are the supposedly safe, “retail” side of banking. The more esoteric, and profitable, activities are the supposedly dangerous “investment” banking – often characterised by populist politicians as “casino banking”. The impression given is that the hard earned cash of the British people is being gambled on the spins of roulette wheels. If it comes up black, the bankers make a fortune. If it comes up red, the taxpayer bails them out. 

But this is a grossly simplistic view of how banking works. All forms of banking involve risk. Every mortgage agreed, every personal overdraft authorised, every line of credit extended to every small business (all examples of the supposedly safe, retail side of banking) carries a danger that repayment will not be forthcoming. Northern Rock was, of course, a retail bank that went bust.

Read the rest of the article on MailOnline.

Indeed - it's crazy that news media and politicians constantly refer to investment banking as 'casino' banking when it was good, solid old mortgage lending which brought the whole system down! But the main problem with the Vickers Commission (and virtually all the discussion around banking system reform) is that it attempts to deal with effects and not causes. The banking crisis was not caused by a banking crisis! It was caused by government manipulation of the money supply leading to an asset boom, exaccerbated by regulatory and legislative interference and incompetent crisis management. Further, the Vickers Commission recommends increasing the capital adequacy ratios as per Basel III - but we already had capital adequacy rules under Basel II (this is the typical statist response - regulation didnt work, so we just need more regulation). Such ratios instead make banks more vulnerable as instead of having proper assessments of risk and capital, they simply follows the rules which are simply an arbitrary figure impose by a committee rather than a proper assessment of the needs of each particular institution, which only that institution can know. If the institution miscalculates and goes bankrupt, that is a proper outcome of excessive risk-taking, if too little profit is made this is the proper outcome of excessive caution. Such regulation also present massive compliance issues and discriminates against smaller banks and prevents competition and encourages consolidation - which is exactly how we ended up with such big banks in the first place! My last question is why taxpayers should have to guarantee deposits in a bank - depositing money in a bank is inherrently risky, which is why we have interest rates. If you want zero risk, put it in a vault and forego the interest. Depositors need to know that if they make a bad investment, they lose their money.

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