Insured Utility Banking

“Big, brave or boring” sets out our choices. Trade and credit are important to business, and this involves banks. Society wants banks to unleash the power of credit. Walter Bagehot, writing in 1873, Lombard Street celebrated lending, giving bankers their special privilege, leverage: “A million in the hands of a single banker is a great power; he can at once lend it where he will, and borrowers can come to him, because they know or believe that he has it. But the same sum scattered in tens and fifties through a whole nation is no power at all: no one knows where to find it or whom to ask for it.” Yet Bagehot also recognised the danger: “But in exact proportion to the power of this system is its delicacy I should hardly say too much if I said its danger. … If any large fraction of that money really was demanded, our banking system and our industrial system too would be in great danger.”

Britain has about 50 retail banks and about 50 building societies, so at best British business can deal with about 50 institutions, with 50 really just for individuals. But the reality, as Cruickshank in 2000 and the Independent Commission on Banking in 2011 note, Britain’s SME banking concentration measured using the Herfindahl-Hirschman Index is amongst the highest in the developed world; five banks control over 90% of the market. [ICB, pages 28-29] Further, a very few British banks are very big – “Citigroup’s total assets amounted to 16% of US GDP at the time it had to be bailed out by the US Government. The comparable figure for RBS at the time of its bail-out was 99% of UK GDP...” [ICB, page 24] We are not speaking about banks, rather we are talking about four specific organisations named RBS, Lloyds, Barclays and HSBC. One owned by the government, one almost owned by the government. These banks are too big to fail, virtually too big to save, as Ireland has discovered, and too big to regulate. The government is regulating itself half the time. We’ve tried big.

Brave is more complicated. One needs to distinguish the wholesale financial markets from the retail. The wholesale markets can be brave – though that they too fail where they are concentrated, for example 12 investment banks controlling over 20% of the top 1000 banks’ assets leading to 2008 fear and liquidity collapsing; or AIG, Fannie Mae and Freddie Mac controlling the US housing market, then crashing. British retail banks are more like fools rushing in where angels fear to tread. Think of Barclays desperately trying to buy ABN Amro at the height of the mania, only to be pipped by a bigger fool in the form of RBS. Perhaps the biggest collateral damage in the debate surrounding British banking has been the international financial markets of London. What queers UK debate about the crisis is that when people talk about the Credit Crunch and the City, they confound the global investment banking near-collapse with the UK retail near-collapse that took down Northern Rock and HBOS, and later Lloyds, with RBS a casualty of both global wholesale and UK retail. They ignore the insurers, reinsurers, foreign exchange markets, brokers, lawyers and accountants who generate so much wealth and aren’t that involved with the big 12 global banks. We need brave in the City, but not in basic utility retail banking.

So let’s look to the boring. J K Galbraith put his finger on our relationship with banks and money - “Money is a singular thing. It ranks with love as man’s greatest source of joy. And with death as his greatest source of anxiety. Over all history it has oppressed nearly all people in one of two ways: either it has been abundant and very unreliable, or reliable and very scarce.” What do we want? safe payments; proper credit allocation; efficient service; sensible currency. What are we getting?

  • Safe Payments — Well mostly, though remember those queues around Northern Rock;
  • Proper Credit Allocation — Not if you believe the SMEs bleating about the way banks treat them. No SME has a right to a loan, but in concentrated and uncompetitive UK banking, decisions have been moved away from capable managers to centralised credit committees. Long-term relationships are out the window;
  • Efficient Service — Credit approval is slow as well as low, payments are expensive, particularly overseas, deposit accounts return nothing, even for children, and most British banks fail to meet FairBanking criteria for their products. British bankers have little idea how poor their customer service levels are in comparison to many countries;
  • Sensible Currency — Here we touch on the wider issues of monetary reform. Investors in sterling have lost a lot, 25% in trade weighted terms since 2007. If there were a good currency guide, like the good pub guide, the combination of UK government and British banks isn’t even going to make the lucky dip section.

Adam Smith calling for “free competition” in The Wealth of Nations said: “By dividing the whole circulation into a greater number of parts, the failure of any one company, an accident which, in the course of things, must sometimes happen, becomes of less consequence to the public. This free competition, too, obliges all bankers to be more liberal in their dealings with their customers, lest their rivals should carry them away.” The structure is broken and business is not being served. Perhaps our big mistake was to let our banks and our boring mutuals move over 100 years from a profusion of competitive, controlled diversity to being big or brave. We could strengthen the distinction between boring and brave, between bank with a “k” and banc with a “c”. The former as safe as houses (sic), the latter a finance house. Bank with a “k” may involve utility banking, narrow banking or ring-fencing, and needs discussion. At the moment, Long Finance might suggest that the banks with a “k” be “insured utility banks” and would come with a 100% guarantee for cash and money transmission. They would be barred from introducing interest accounts (interest is an investment – the worst investment in the UK in 2008 was probably a RBS deposit account paying virtually no interest). By their nature, they would have to charge and would probably be few in number. They would compete, but on a narrow range of service rather than structure or product.

Back to the bancs. We need more intense competition among banks with a “c” – move parts of existing bancs into insured utility banks while making the rest hungrier to compete, consider breaking some up radically, lower regulatory barriers, encourage new forms such as peer-to-peer lending and credit unions, make account switching easier. We could rethink fractional reserve banking and the nature of fiat currency, which touches on our thoughts of introducing a Swiss WIR to the UK.

Worldwide, the long-term role of finance in democratic capitalism needs deep thinking. Incredibly, despite major failures, the Credit Crunch has not been crisis enough to jolt radical reform of finance, yet. Willem Buiter noted in the Financial Times in 2008, “The worst outcome of the current financial crisis would be a return to the status quo ante”. Or in the popular parlance, we seem to be ‘wasting a good crisis’ rather than restructuring financial services to serve society.

Competition helps the vigour of greed produce the rigour of fear. It makes alpha males hungry to demonstrate that they have safe pairs of hands as well sharp elbows. Competition with caps on size reduces systemic risk and encourages lending. Equally, we need to cap regulation. Regulation creates barriers to entry, promotes the large over the small and reduces competitive variation. We need to get to a situation in which regulators understand themselves to be the safety device of last resort. We need governments to break up firms which are too big to fail and too big to regulate. Break up would have the merit of being in line with the fundamental, deep and old understanding that capitalism's biggest hazard is oligopoly.

National financial regulators in Europe are bumbling in the right direction, towards smaller competitive banks, propelled by EU competition authorities rather than their national ones. How much better if financial regulators raced in the right direction and we spoke about truly resizing for a competitive industry. Perhaps regulators need to shrink the banks and increase their number, then shrink themselves.

Further Reading