The zombie argument of the bank split sceptics

Depressingly, I see that a zombie argument on banking reform is back.

We are told, once again, that because some exclusive retail banks (Northern Rock, HBOS) and some exclusive investment banks (Lehman Brothers) failed in the financial crisis splitting up our universal banks into retail and investment components is not going to make the system any safer.

Ian Birrell cites it here in the Daily Mail. My good Indy colleague Hamish McRae makes the point here. Most disturbingly of all, Mary Riddell reports in the Telegraph that Ed Balls and Ed Miliband see some merit in the case here.

Yet this objection is based on a fundamental misundertanding of what took place in 2008. This was not a case of a few badly-run banks getting into trouble. Rather the entire UK banking sector failed. It was a systemic collapse. All these institutions would have gone under if the Bank of England and the Government had not propped them with more public capital and endless liquidity. Northern Rock simply collapsed before the general state rescue. The same is true of Lehman in the US.

This means we need to examine where the largest losses were concentrated and what form they took to accurately diagnose the sickness that afflicted our banking sector in the years before the bust.

And here we see that losses were concentrated at the universal banks – those that combine high-risk trading with big networks of high street chains.  According to Andy Haldane of the Bank of England here, RBS wrote down $26.5bn, 32.6% of its capital. Barclays wrote down $22.9bn, 56.6% of its capital. Even relatively well-run HSBC wrote down $9.4bn. These sums would have been much bigger in the absence of the Bank’s liquidity support, which amounted to a backdoor recapitalisation.

And those aggregate losses of the British banking system were not a result of domestic lending, but from overseas lending. 75% of the banks’ losses were from their non-UK lending books, as this chart from Ben Broadbent of the Bank’s Monetary Policy Committee shows.

What this means is that these institutions were sunk by their trading arms, not their high street operations.

Splitting the banks up would not, it is true, guarantee that exclusive retail banks would never get into trouble in future. Tighter regulation of retail lenders is plainly necessary too – much tighter than that exercised by the Financial Services Authority over home lender Northern Rock or commerical lender HBOS.

But if the purpose of public policy is – as it must be – to protect taxpayers from the immense costs of having to underwrite irresponsible and incompetent investment bankers, that points clearly to the imperative of splitting up the banks by function.

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• http://www.facebook.com/scubajp Jonpaul ‘jp’ Hosking

  The Government guarantees a certain level of deposits. If a bank is going under the simplest thing to do is keep the bank going. The splitting of the two arms would allow the retail part to be guaranteed, while allowing the casino arm to fail. That is why we need the split.

• http://previousdenial.wordpress.com/ previousdenial

  Excellent article and I agree with the substance of it, the banks do need split up and should never been encouraged through deregulation to become speculators too big to fail. The obvious risk in that though is that without legislation any non-investment bank would be so small as to be gobbled up by the bloated giants. They need to be kept apart by law, like any safari park separates the zebras from the lions.

  As an aside, this is also the best presented and formatted article I’ve seen in the Independent, albeit as a blog. Can you please teach the other Indie journalists how to use HTML code such as embedded links, bold and italic text, and graphic charts to better convey meaning? Further, can you please argue with the online editor that ordinary punters here should again be able to use such basic and useful HTML code ourselves to illuminate our comments without the approval of a moderator?

• http://previousdenial.wordpress.com/ previousdenial

  Which is exactly what happened here until the deregulation in the 1980s, and which is what the cheeky Icelanders did retrospectively once their system crashed.