The global banking industry resembles an obese teenager. All the relatives agree that drastic weight loss is necessary, but each has a different diet plan. The International Monetary Fund’s splendidly named FAT tax would slim down the banking sector by targeting profits and pay.
The Financial Activities Tax comes in two varieties. The simple version is a straight tax on a bank’s gross profits — before deducting compensation. A low rate could raise significant sums: the IMF reckons a FAT tax of just 2 percent on UK banks would raise 1.4-2.8 billion pounds.
– Peter Thal Larsen is a Reuters Breakingviews columnist. The opinions expressed are his own –
Britain’s bankers were already braced for an uncomfortable election. But the U.S. fraud allegations against Goldman Sachs, combined with the rise of the Liberal Democrats, have given bank-bashing renewed impetus. The popularity of the attacks means they could resonate well beyond the current campaign.
Central bankers’ speeches tend to be dry affairs. For this reason alone, Andrew Haldane’s latest thoughts on the financial crisis deserve attention. In a discussion about size in banking, the Bank of England’s executive director in charge of financial stability makes reference to the structure of al Qaeda, the limits of Facebook friendship, and the world domino-toppling record. Rhetorical flourishes aside, Haldane’s comments contain a serious message: regulators are thinking increasingly radical thoughts about tackling big banks.
Haldane is not in an academic ivory tower. If the Conservative opposition wins Britain’s general election, the Bank of England will become directly responsible for regulating the country’s lenders. Moreover, he has come up with some startling numbers. Using credit ratings to help quantify the implicit support that banks enjoy from the government, Haldane estimates that the UK’s largest lenders benefited from an average taxpayer subsidy of 55 billion pounds a year over the past three years. An alternative approach, looking at the relative funding costs of big and small banks, suggests the annual subsidy is worth 30 billion pounds.
Regulators and bankers rarely see eye to eye. But at the World Economic Forum in Davos, the two sides were in surprising agreement about creating a global fund, financed by a tax on banks, to deal with future bailouts.
Mario Draghi, head of the Financial Stability Board, which is spearheading a new global financial regulatory regime under the auspices of the G20, floated the idea of a cross-border body to manage this fund. Surprisingly, several big European banks — including Barclays and Deutsche Bank — support it.
What is an acceptable return on equity (ROE) for a bank? That question is likely to dominate the debate among executives, investors and regulators in the coming year. After the spectacular losses of the crash, there is no doubt that banks’ future returns should be lower than the super-charged profits earned during the credit boom. But if ROEs fall too far, the consequences could be severe.
Returns are already on the way down: just look at Goldman Sachs. Between November 2007 and September 2009, the Wall Street bank’s tangible common equity swelled by 74 percent. In 2007, its best-ever year, Goldman earned a 38 percent return on that equity. This year the bank is expected to report the second-highest profit figure in its history. But its ROE is likely to be just half its level of two years ago.
A windfall tax should meet two tests. It should raise a meaningful amount of cash, and be clearly viewed as a one-off. The UK government’s new levy – 50pc of bank bonus pools for bonuses over £25,000 – fails on both counts.
True, banks and bankers have invited some sort of punishment. Governments and central banks committed trillions of dollars to help stabilize them after their reckless behavior helped cause the financial crisis. Huge compensation pools seem like rank ingratitude.
Should the banking industry look more like the hedge fund sector? That’s the surprising suggestion made last week by two Bank of England officials.In a fascinating paper, Piergiorgio Alessandri and Andrew Haldane explore the level of public support given to banks in the crisis and the problem of institutions that are too big too fail. Their main point is that if this issue is not addressed it will lead to new crises and even bigger bailouts in the future – a state of affairs they describe as a “doom loop”.But the most eye-catching passage is a suggestion that banks have a lot to learn from hedge funds:
It may be coincidence that the structure of the hedge fund sector emerged in the absence of state regulation and state support. It may be coincidence that the majority of hedge funds operate as partnerships with unlimited liability. It may be coincidence that, despite their moniker of “highly-leveraged institutions”, most hedge funds today operate with leverage less than a tenth that of the largest global banks. Or perhaps it might be that the structure of this sector delivered greater systemic robustness than could be achieved through prudential regulation. If so, that is an important lesson for other parts of the financial system.
This is quite a change of heart. Until a few years ago, regulators viewed hedge funds as the main threat to financial stability. These fears have proved unfounded. Though plenty of hedge funds have blown up – or turned out to be massive frauds – none has so far threatened to drag down the system.Some things that currently take place in banks are probably better suited to hedge fund structures. Proprietary trading is a prime candidate. There is also a strong case to be made for private partnerships. Would investment banks have grown so large if they were owned by partners who were exposed to any losses?Even so, it seems fanciful to suggest that the hedge fund model is better. Banks fund themselves by taking retail deposits that customers believe to be safe. That precisely the reason they are so heavily regulated. Hedge funds raise money from institutional investors and wealthy individuals who – in theory at least – realise they could lose it all. Without deposit insurance, the failure of a bank can spark a loss of confidence across the industry. The failure of a hedge fund is less likely to have systemic consequences.But the main reason to be sceptical about hedge funds is that their incentive structures are not as conservative as Alessandri and Haldane appear to believe. Most hedge funds are management companies that charge fees for looking after third-party funds. If the fund performs well, the managers share in its success. But if the fund blows up it is the investors, not the managers, who are on the hook. Most hedge funds are private partnerships, but the partners are generally protected from losses in their funds.Hedge funds may have proved they were not as risky as many regulators feared. But that does not mean they hold all the answers to fixing the financial system.
So much for Barclays’ ambitions to be a magnet for banking talent. When the British bank hired Frits Seegers, the Dutchman arrived with a big reputation and an even larger price tag — the cost of buying him out of his previous job at Citigroup. Three years on, he’s on his way, the main casualty of a management shake-up that leaves his main rival, Barclays president Bob Diamond, looking stronger than ever.As ever, the reorganisation is not entirely without strategic merit. Barclays is shifting responsibility for the corporate bank from the retail side of the business to its Barclays Capital investment banking arm. The logic is that even small companies want to hedge foreign exchange and commodity risks — products they are more likely to find in Barclays Capital. Besides, most rival banks have combined corporate and investment banking. There is something in this. Though it is hard to see Barclays’ investment bankers wasting much time on small British businesses with a few million pounds in turnover.The other argument for the move is that Barclays wants to give some of the thrusting managers coming through the organisation a place at the top table. So Barclays’ executive committee, which previously had just four members, will now need to find another eight chairs for its meetings. This gives more executives direct access to the board, and provides plenty of choice when drawing up a shortlist of potential candidates to replace chief executive John Varley.It is also true that Seegers’ tenure was mixed. Several of Barclays’ retail businesses, such as its Barclaycard credit card division, had already installed strong management teams before he arrived. His main achievement has been to expand Barclays in far-flung countries like Indonesia and Pakistan. Whether this flag-planting approach survives his departure remains to be seen.The shake-up also speaks volumes about where Barclays sees its future growth. Diamond’s empire used to include the Barclays Global Investors fund management arm until it was sold earlier this year to raise capital. But even after the successful acquisition of Lehman Brothers’ U.S. operations, Varley still wants the investment bank to account for no more than a third of the bank’s income. The latest reshuffle gives Diamond a bigger share of Barclays’ remaining businesses. It also removes one of his few rivals for the top job.
The debate about reforming the financial system is often presented as an argument between regulators on one side and banks on the other. But it is also beginning to throw up some differences among banks. One such rift has been exposed by the suggestion that banks should be forced to hold greater reserves of liquidity and capital in national subsidiaries.Regulators see this as a way of dealing with the future failure of a big bank. Rather than relying on the bank’s home government to pick up the tab — something it may not be able or willing to do — each country where the institution operates could take responsibility for its local subsidiary.Josef Ackermann, chief executive of Deutsche Bank, is concerned that this approach will lead to the fragmentation of the financial system. On Monday, he warned a conference organised by the Financial Services Authority of Britain that it would make markets less efficient and lead to lower economic growth.However, the chief executive of Abbey, the subsidiary of Spanish giant Santander, told the same conference that his bank already operates along the lines envisaged by regulators: its British, Brazilian, Mexican and Portuguese subsidiaries are all separately capitalised.António Horta-Osório acknowledged this might be less efficient, but said the structure creates a “firewall” that limits contagion if one part of the bank were to run into trouble. HSBC is organised in a similar way.Indeed, such an approach may even support globalisation. According to Adair Turner, the FSA’s chairman, integrated global banks were quickest to withdraw liquidity from emerging markets when the crisis struck. Those with local subsidiaries stayed put.True, a federal structure may be better suited to retail banks, which are more likely to have matching assets and liabilities in the same country. Investment banks are less easy to carve up.One of their main functions is to match buyers and sellers of risk around the world. This would be harder to do efficiently if, say, each derivatives trade had to be booked in a local subsidiary. It would also make it more difficult for banks to manage their overall exposure.Nevertheless, Santander’s approach shows that what regulators are proposing is not impossible. Ackermann may be right that a system of local subsidiaries is less efficient. But he should also recognise that globally integrated banks are inherently more risky.Taxpayers are rightly suspicious of underwriting banks’ global ambitions. Short of breaking up big banks, a federal structure may be the best compromise on offer.
The two most emotive issues in the political furore surrounding British banking are bonuses and the shortage of lending. So George Osborne must be delighted to have found a way of linking the two. However, it is far from clear that the shadow chancellor’s proposed solution – forcing banks to pay bonuses entirely in shares — would increase the supply of credit to the economy.Osborne is attempting to capitalise on public anger about resurgent bank bonuses at a time when the UK is still mired in recession. By banning all cash bonuses, he goes further than the principles agreed by the G20 group of leading nations and — crucially — the guidelines introduced by Britain’s Financial Services Authority. This makes it hard for the government to respond. Bankers, meanwhile, can expect little public sympathy.Yet while Osborne may have earned some political capital, his financial logic is suspect. First, the British banks fingered by Osborne — including Royal Bank of Scotland, Lloyds Banking Group and Barclays — have already agreed to pay a “significant” proportion of future bonuses in deferred stock. The remaining cash element of this year’s bonus pot is unlikely to amount to more than a few hundred million pounds per bank. Even if this additional capital was fully converted into lending, it would equate to a few billion pounds of additional credit — a tiny proportion of the 550 billion pounds that the Bank of England estimates has been borrowed by British businesses.But there is a more fundamental objection. While it is true that British companies are repaying debt, it is far from clear that a shortage of credit is the problem. Companies may also be reluctant to borrow. Of course, loans have become more expensive, and businesses at the margin that were able to borrow a few years ago have found their access to credit constrained. However, this partly reflects the withdrawal of aggressive Irish and Icelandic banks from the UK market. Short of forcing British banks to cut their lending rates — something neither the government nor Osborne has suggested — it is hard to see how this can be resolved.Osborne’s proposals would also create an unequal playing field, as U.S. and European investment banks operating in London would not be subject to the same restrictions.Some may argue that opposition proposals should not be taken at face value – after all, Osborne is unlikely to become the Chancellor of the Exchequer until May next year, when the furore may have died down.However, given his party’s lead in the opinion polls, Osborne’s words carry additional weight. As with his flawed plan for overhauling Britain’s system of financial regulation, his attack on bonuses appears more interested in scoring short-term political points than contributing to meaningful long-term reform of the financial system.