UK leads the great banking debate

It is more than a little hard to take any positives from the financial crisis but if there is one to be had it is the fact that people are aware like never before of the power of the financial system to decimate both the collective and individual economic wellbeing.

Before the disaster the world of finance existed somewhere out in the ether: a blizzard of electronic book entries that had very little to do with the business of day-to-day living. Until now.

Now the destructive force of the broken financial system is all too apparent at least the people are to some extent switched on to its capacity for destruction and, hopefully, resolved that there should be no repeat.

Nowhere is this more evident than in the United Kingdom where a fierce debate is raging on the behavior of the banking system before and after the crash.

Thanks to the traditionally powerful position of the City of London, the UK has a place in the global financial services pecking order way above the size of its domestic economy. The importance of financial services to the UK balance of payments has been such that it has received almost unqualified support from government and establishment.

But such is the sense of outrage over the banks and the perceived arrogance of bank management that the UK is on the brink of initiating a process that will lead to the most profound change to the sector.

This came to a head last week with an interview given by the Governor of the Bank of England, Mervyn King, when he made an extraordinary attack on the sector whose wellbeing he is charged to preserve. According to King, for the past 25 years, banks have increasingly “taken bets with other people’s money”.

Central to that assertion is the position of the so-called universal banks – banks that combine retail with investment banking and which number some of the most powerful names in banking such as HSBC, RBS and Barclays.

The UK’s Independent Commission on Banking, set up in the wake of the financial crisis that led to the almost total UK government takeover of RBS and the rescue of HBOS, is widely believed to be considering seriously the breaking up of the UK’s universal banks in order to separate their retail from investment banking activities.

Until now the top management of those banks, investment bankers who are used to getting their way in most things, have assumed that their sophisticated lobbying that mixes velvet with cold steel, would prevail, but the intervention of King has set off near-panic and the Governor has been subjected to unprecedented criticism from the industry.

The argument for separating retail and investment banking seem clear:  they are fundamentally different businesses. One is based on the protection of depositors’ funds through prudent lending; the other based on something that bears a resemblance to saloon-bar gambling.

There is nothing wrong with investment banking so long as the principals are not “taking bets with other people’s money” (King’s words). But the fact is that universal banks use retail depositors’ funds to finance their activities. If they win the bonuses are massive; if they lose, the public gets to pay the bill.

Investment banking is a notoriously volatile business while retail banking is, comparatively speaking, consistently profitable. Indeed, not only are the cumulative profits of investment banking questionable, they are achieved with the benefit of access to cheap retail deposit funding and the cheap funding that comes with the implicit government guarantee against failure.

To compound the injury, such profits that accrue are only achieved after staggering payments made by way of compensation to the bankers themselves.

And yet, investment bankers have been showing their sensitive side of late, bridling at depictions of their activities as somewhat useless in the scheme of things apart from their own enrichment.

Two diametrically opposing views of the business are apparent. Is investment banking “God’s work” as per the opinion of Goldman Sachs’s chief executive Lloyds Blankfein? Or is Goldman Sachs, the epitome of the red-blooded investment banking culture, in the unforgettable words of Rolling Stone magazine, “a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money.”

King leans decisively towards the latter, as in his recent interview:

“Financial services don’t like the word 'casino’, but instruments were created and traded only within the financial community. It was a zero sum game.”

But do not mistake the investment bankers’ sensitivity over their reputation for acquiescence. Rather, since King’s utterances he has become the subject of a relentless tirade as more and more the investment bankers come to fear the fact that the honey pot that is their retail banking deposit base may be taken away from them and investment banks forced to stand alone as separately capitalised businesses.

The UK public – and indeed the Government and regulators such as Mr King – can take great credit from the level and sophistication on the great banking debate that is taking place. Perhaps it is the British sense of fair play but when following the UK media, it is hard to think of any other country where the natural urge to do the right thing in the face of scaremongering and intimidation and regardless of secondary economic consequences would be so apparent.

The lesson for Ireland is that we too must increase our overall levels of engagement with the financial industry to say nothing of improving financial literacy. Regrettably, such is the scale of disaster here that something like resignation seems to be the prevailing sentiment but, if a repeat is to be avoided, the financial services industry must always be subject to the relentless scrutiny of the public eye.