Bank governor calls for radical banking reform
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Mervyn King, governor of the Bank of England, is pressing for a “fundamental debate” to be had on long-term reform of the banking sector which spreads liabilities but protects the financial system.
The Bank governor appeared in front of the Treasury Committee this morning flanked by Paul Tucker, deputy Bank governor and Andy Haldane, executive director of financial stability.
Answering MPs’ questions on whether financial institutions are too big to fail, King hammered home the message that an urgent debate was needed on the structure of the banking system.
King told the committee that the Bank is prepared to consider “radical reform” in order to ensure that wholesale creditors accept risk but are also protected from threats to the stability of the banking system.
He says that what is needed is “a big change in the liability structure of the banking system”, which he says won’t come overnight.
King argues that it is important to get away from a system which has implicit guarantees for banks where firms think they will always be bailed out, citing the example of US institutions Fannie Mae and Freddie Mac.
He says: “For many years the Federal Reserve went to great lengths to say, ‘no no, don’t lend to this institution too cheaply, it doesn’t have a government guarantee.’ But in the end because it was so central and important it got bailed out.
“We need to design a new structure of the liabilities of the financial sector in such a way that that bailout is no longer expected.”
“We have got ourselves into a very difficult position in which the current structure of the financial sector is one in which increasingly large and costly bailouts are simply following one after the other, and that is not a happy position to find oneself in.”
Mervyn King, Bank governor
King outlines a “three-legged stool” proposal which he believes is central to banking reform.
This is based on more capital requirements, clearer strategies for resolution when firms fail, and structure.
He says structure is where President Obama’s proposals come in, which include the break-up of larger US banks and limits on proprietary trading, where banks contribute their own money to investments rather than just company money.
Paul Tucker, deputy Bank governor, told MPs that he believed in “the spirit” of Obama’s plans in curbing risky trading but says that the proposals are only part of the solution.
King says: “We have got ourselves into a very difficult position in which the current structure of the financial sector is one in which increasingly large and costly bailouts are simply following one after the other, and that is not a happy position to find oneself in.”
Andy Haldane, executive director of financial stability at the Bank, also revealed that the size of the banking sector relative to GDP is 500%, which he says is at “the upper end of the international league table.”
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Readers' comments (4)
John Murray | 26 Jan 2010 3:03 pm
Mervyn King and the regulators have slow reactions. Isn't this a debate we should have had two years ago?
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Glen McKeown | 27 Jan 2010 1:05 am
The Banks have had a long time to get themselves, and us, into trouble, and I am not sure that all the factors are yet on the table. And if we had started this debate 2 years ago as suggested by Mr Murray I suspect that there would be a lot of vindictive suggestions, which, if acted upon, could have made matters worse.
Part of the problem is that there appear to be two different types of banking institution, namely retail and wholesale banks, and a whole range of risk taking activities.
Whether we like it or not banks are core to making our current free market system function efficiently - but most people do not fully understand how, or the full range of the activities taken by banks. In order to have a sensible debate I think that the scope of banks needs to be made clearer - which may lead to the conclusion that some activities should not be in the banking arena. In other words we may need to be clearer about the activities that banks are permitted to undertake, and if they step over that line they put themselves absolutely outside any possibility of Central Bank support. That alone would alter the perceived risk of an institution, and therefore the cost of capital.
But before we get there we need a lot more information on the risks strategies that were core to the collapse. And information on how effective any Regulator can be understanding, monitoring and assessing risk strategies.
It is all very well to propose a a new banking structure, but it also needs to be policed.
Enron created a vast array of dummy companies to hide their true status from regulators and accountants. Bank people are at least as bright, so regulation could be a nightmare.
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Anonymous | 27 Jan 2010 11:10 pm
I think a four legged stool is more stable than a three legged one.This would include specific prohibition of bank bailout.It was in my opinion a mistake to bail them out with public money.
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Matt Holmes | 25 Feb 2010 2:40 pm
What Glen McKeown refers to as "vindictive suggestions" is presumably the prosecution of several people for breach of fiduciary duty and the firing of incompetent people.
Everyone in the City is trying to avoid this, just as they are try to justify what they see as their birthright to shove as much of the money as possible in their back pockets.
We all know how the banking system works. It's not that we don't understand the intricacies of the collateralised debt obligation, the way debt is pegged to LIBOR, or the asset management system or the end of fractional reserve banking.
What the public disagree with bankers about is the banks' self-belief that they have the right to nationalise losses, privatise profits and then continue just as they were shoving millions of pounds in to their backpockets without repaying the losses they have made or bailing out other businesses that they have made bankrupt by their reckless and quite frankly unfit for purpose activities.
The idea that there needs to be anything other than immediate complete reform, and the possible complete splitting up of the banking system so that is has some other purpose in the economy other than leeching money out of everyone's pockets is absurd.
There is no more talking or investigating to be done. "Assessing risk strategies" is just yet another piece of misdirection to delay reform, just like all the other pieces of misdirection that we've heard over the last twenty years.
Everyone in the banking system either knew or should have known that enlarging the money supply in a particular asset class in that area would create a massive unsustainable inflationary bubble in that asset class. How long did they think it would go on? Until every single penny of every persons' income was engaged in paying interest on mortgages? It's not banking, it's market rigging.
Everyone in the banking system either knew or should have known, that they were churning debt for commission, and they all knew that sub-prime debt was being written on the basis that the resultant rise in prices created by the money supply increase in the single asset area (houses) was being undertaken.
There are no surprises in this collapse. It was engineered.
The amazingly clever mathematicians that were brought in to solve the problem of pricing CDOs was another piece of misdirection: it's not responsible banking to sell or hold assets the value of which you have no idea about. Surely the sensible thing to do would have been to structure the debt in a way that had a clear price. But that would have meant the whole programme which was to create and sell on deliberately complex and unpriceable junk debt, based on the false principle of Class A "preference" would not have been possible.
So stop stalling and start reforming, and start paying the money back to the public.
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