A Lack of Trust: “Banking in the Wake of the Crisis”

A couple of weeks ago, I went to the RSA twice in a week: first to see Steven Levitt and Stephen Dubner on their new book – they rather painfully described it as a “freakquel” – Superfreakonomics. I would tell you about it but I couldn’t do it better than they do, so if you’re interested keep an eye on the RSA’s event page where they said a video of the talk would be posted.

Then I was back to see a discussion entitled Banking in the Wake of the Crisis: how will confidence be restored? It was slightly misnamed: John Kay and Heather McGregor largely agreed with each other, and reckoned their solutions were unlikely to be enacted by the UK authorities.

Their prescription was essentially to

  • break up conglomerate banks into their retail and investment bank constituents
  • regulate the retail banks to prevent them risking customers’ deposits and creditors’ assets
  • make it clear that investors in the investment banks could lose their capital

McGregor was a bit more optimistic than Kay, though neither believed that government of whatever flavour would have the guts to do what was necessary to prevent a recurrence of the banking crisis.

Kay in particular believed that retail banks should take a leaf out of general retailers’ books and sell their customers what their customers want. I thought they had done – they provided cheap credit and enabled borrowers to borrow 125% of the value of their house, thereby creating an asset bubble. They provided credit cards to people who couldn’t actually afford the repayments.

Kay didn’t mention that HBoS, one of the collapsed UK banks which was taken over by Lloyds, was run by Andy Hornby prior to its collapse. Before joining HBoS, Hornby was managing director of retail of Asda, one of the UK’s largest food retailers. He had a solid retail background. This wasn’t what HBoS needed.

Kay’s view of retail banks providing products that customers want seemed to ignore the recent mis-selling scandals: endowment policies, personal pensions, split capital trusts – there is a long list of financial products which have been designed to provide customers what they thought they needed and which ended in disaster for those customers.

I am also not certain that the fundamental proposal – splitting retail and investment banks – would prevent contagion between the two. If we let investment banks fail – as happened to Lehman Brothers – how would we stop the effect ripple through the financial system?

McGregor believed that an essential prerequisite for more stable markets was increased competition in investment banking. She reckoned that investment banks such as Goldman Sachs made excessive profits in an uncompetitive market. She then went on to discuss, however, that the market was bound to be uncompetitive: if a company is trying to raise capital, they can’t very well do the rounds of bankers – indeed, it would possibly violate insider trading rules.

Both she and Kay put the one necessary condition for a return to confidence: trust. This has also been a recurring theme of Mike Mainelli‘s recent lecture series at Gresham College. Lack of trust explains why the wholesale money markets froze last year (lending banks didn’t trust borrowers to pay back), and explains why banks aren’t lending to retail borrowers despite record low interest rates (ditto). McGregor pointed out that the word “credit” is derived from the Italian and Latin words for “trust”. No one seems to trust bankers much at all; not even other bankers.

Winning back that trust will be difficult. I am not sure that governments can legislate for it; I am not sure that splitting up conglomerate banks will accomplish it. Kay and McGregor believed that sorting out the finance industries many conflicts of interest might bring it up about.

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