It’s time to call the bankers’ bluff

September 17, 2010


Laurence Copeland is professor of finance at Cardiff University Business School. The opinions expressed are his own and do not constitute investment advice. –

I have just reread the blog I wrote for this column last September. A year has gone by, and neither the title – “It’s All Over: the Banks Have Won” – nor the rest of it seem out of date. In fact, last weekend’s Basel III deal looks very much like the final surrender by the authorities.

It is not simply a matter of the feebleness of the reserve requirements and the ease with which they will be emasculated by arbitrage, nor the fact that the regulators have given the banks a few years to satisfy them – “Please Lord, make us prudent…..but not yet”.

Rather, it is the way the banks have so easily fought off any attempt at more radical reform, and in particular their success in silencing the calls to enforce a separation of retail from investment banking and to break up the biggest groups into units which are no longer Too Big To Fail.

Quite the opposite in fact: there seems to be no sense of urgency about undoing the forced mergers we saw in the darkest days of 2008, so that banking in the United States and Britain is actually more concentrated today than it was before the crisis.

There is no secret about how this situation has arisen. As I said earlier, the authorities have given in because the banks are holding a gun to the head of the economy, with the threat: “one false move and the borrowers get it”.

You might think that after a crisis brought on by the mother of all borrowing binges, this threat would not be very effective, but you would be wrong.

The conventional wisdom is that, far from restraining borrowing, the only way to revive the economy is by restoring the volume of lending to its all-time record 2006 level, for which purpose the collaboration of the banks is deemed essential, and has to be bought not only by bailing them out and subsequently, by injecting money into them like water into battery-bred chickens, enabling them to push their gross lending margins to all-time record levels.

And, of course, permitting them to pay their senior management vast amounts of money, as if the turnaround in bank profits had been the result of inspired strategy rather than simply a matter of taking sweets from a baby.

For all its drawbacks, this approach might nonetheless have been acceptable if it had worked, but it looks at this stage as though it is set to fail – probably because the expansionary effect of easy monetary and fiscal policy is being neutralised by the increase in the burden of debt. So where do we go from here?

It is possible – just possible – that we are now being forced into taking the route we ought to have taken all along. We are now reconciled to a degree of belt-tightening and accompanying recession, with reduced government spending and benefits, which should help to shrink the size of the services sector so as to allow an expansion of manufacturing for exports and import-substitution.

To this extent, damaged consumer confidence at home is less of a worry and may even be an advantage if it compels companies to look for markets overseas rather than relying on domestic sales. In fact, letting consumer spending fall is a prerequisite for recovery.

A policy of toughing it out requires far less cooperation from the banks than one of trying to prop up consumption. For one thing, much of the finance for the last decade’s consumer boom came in the form of mortgages, either to buy houses or housing-related goods and services or straightforwardly to pay for consumer goods via equity withdrawal.

The direction of house prices is now clearly downward, but is that such bad news? After all, by every conventional criterion, UK house prices are still at record levels relative to their long-term average.

As far as the corporate sector is concerned, big firms are not on the whole short of cash at the moment, and in any case the corporate bond market is more buoyant than it has been for many years, so it is hard to see them being threatened by a bank credit squeeze.

The only borrowers whose situation should be a cause for concern are the small firms. Ironically enough, the very fact that the banks are so unwilling even at present to lend to this market – at least if the anecdotal evidence is to be believed – means that there is less to lose than is often assumed by taking a tougher line.

By the way, the response of the bank lobby to any threat of regulatory restraint on their behaviour is invariably an implicit or explicit threat to move their operations from London to Zurich or Singapore -mthat well-known free-wheeling-anything-goes paradise – or some undefined Shangri-La.

You don’t have to be a left winger – and I’m certainly not – to wonder why we should care. Employment? There are still vastly more bank employees working in branches and call centres than in investment banking functions, so even if the latter decamped en masse, there would still be many thousand left in the sector.

In any case, HSBC’s chief executive Michael Geoghegan has already relocated to Hong Kong simply in recognition of the fact that he sees the bank’s future as increasingly centred on that region rather than Europe.

As for the taxes paid by the banks, whose gross value is waved around as though it were a measure of the potential damage their departure would inflict, it will be many years before they are sufficient to cover the costs the sector has inflicted on the UK economy. Moreover, departing banks will be replaced by other types of business which will also pay taxes, so this argument is feeble in the extreme.

It is worth remembering that only a year or two ago, all the talk was of how inflated relative to the size of our economy was the UK’s financial sector – the largest in the world, exceeded only by the likes of Luxembourg, Liechtenstein and, of course, poor  Iceland. No less a figure than Lord Adair Turner, chairman of the Financial Services Authority, suggested it was time to cut it down to size. From this point of view, a few bank headquarters leaving London would be a small step in the right direction.

In short, isn’t it about time we called the bankers’ bluff?

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