- Bob McDowall is research director, Europe, at TowerGroup, a research and advisory services firm focused exclusively on the global financial services industry. The opinions expressed are his own. -

The banking results being published this week are inseparable from the catastrophic financial events of the last two years. It is time to glance back to where we have been and determine where we are now.

Almost two years ago, the slow-burning fuse to a financial services bomb was lit with the run on Northern Rock. The UK Government and its financial regulatory agencies defused that bomb “minutes” before it could devastate the UK banking and financial system in October 2008.

Official records will not be available for public scrutiny for 30 years or more, but anecdotal evidence indicates that at least one bank was within days of literally running out of cash. It has also been speculated that moves were planned by some businesses to prevent the customers of ailing banks from withdrawing cash from joint and third-party ATMs, although this has been denied.

Against this state of financial tension, the UK Government and the Bank of England had no choice but to save the UK domestic banks and stabilise the financial system. If they hadn’t, the loss of confidence in the financial system would have spread to the wider economy and would have weakened the sterling, perhaps irreparably.

It is unlikely that the Government or the Bank of England could have taken steps other than recapitalisation. Surviving businesses could not have been persuaded to acquire the ailing banks when significant financial assets had no market or known realisable value.

The lack of knowledge of the depth and materiality of the ‘bad assets’ held by banks made it near impossible for the UK Government to make a judgement call on how significantly damaging these assets were and how to manage them in any other way.

Recapitalisation was therefore an essential move by the UK Government and Bank of England, but it should have included a legal precedent that was missed.

We are currently in a situation in which the taxpayer’s money is funding the assets the UK Government has deployed and invested in the banking system. But the banks are still reluctant to lend. This power balance is not in the best interest of the taxpayer.

The UK Government appointed the UK Financial Investments plc (UKFI) as an arm’s-length agency to hold investments in the impaired banks and manage those investments for the beneficial interest of the UK taxpayer. However, the UKFI is also faced with the demands of the European Union competition interests and the other shareholders of the banks, including their employees and management.

If in its professional judgment, the UKFI believes that the taxpayer will make a capital gain, in the guise of a tax rebate, by retaining the taxpayers’ investments long term, then this is a course of action they should follow.

The danger in this strategy is that the UK domestic banking system could suffer from a lack of innovation and competition. It is the Government’s responsibility to ensure that this conflict of interests is managed for the best of the taxpayer and the economy.

- Bob McDowall is a research director working in TowerGroup’s European headquarters in London. His research addresses the principle challenges and opportunities affecting the European banking, securities, and investment management markets. The opinions expressed are his own. -

The UK Treasury Select Committee met on Tuesday to discuss the ongoing ramifications of the global banking crisis. High on the agenda was the need for a global reserve currency. A global reserve currency is certainly required to replace the U.S. dollar. No currency can permanently maintain both a domestic and international role in a globally connected industry.

A global reserve currency must be constant and flexible. It must have the elasticity to withstand the pressures of macroeconomic events and reflect, as far as possible, global value. The International Monetary Fund’s (IMF’s) constituted currency, Special Drawing Rights (SDR) — a basket of euro, pounds sterling, US dollars and yen — is currently the most widely held reserve currency globally. Elevating the SDR to global reserve currency status would be a pragmatic solution to the challenge of reforming the international monetary system.

An initiative to replace the U.S. dollar with the SDR could be implemented quickly with only minimal systemic disruption. The initiative could be launched through a number of government bonds issued by the US Treasury, which would go some way to demonstrate the support of the United States for such a move. A basket currency would provide a managed approach to limiting global financial imbalances.

Another advantage is that a basket would not suffer from the constraints of a re-imposed Bretton Woods style arrangement. In the most extreme cases, a Bretton Woods-esque solution could lead to dramatic and disruptive imposition of capital and exchange control and/or managed and dirty floats, all of which would be highly disruptive to the global financial system.

In order for the SDR to be a success as a global reserve currency, the IMF would have to make some representational and structural changes to its governance and membership. These steps would enable a broader number of countries, from the East and the West, mature and emerging financial markets, to participate in the management of the SDR. Broader representation would ensure that any adjustments to the basket’s composition in response to changes in macroeconomic events, could be achieved with greater unanimity.