Labour must push for more bank regulation from the EU

Written by: Todd Foreman on 15 January, 2013
Filed under Economy

The British people have been failed by financial services regulation.  The “light touch” regulation favoured by both New Labour and the Tories contributed to taxpayers having to stump up hundreds of billions of pounds to prop up failing banks to avoid an economic meltdown.  The Tory-led coalition government has used the financial crisis as an excuse to implement ideological cuts in public services and scale down the role of the state.  Nevertheless, casino capitalism continues, and the very real risk remains that taxpayers could again be asked to foot the bill for a major bank failure.

Governments must put in place regulation to ensure that taxpayers are never again asked to bail out the few at the expense of the many.  Progressives are also absolutely right to look for means of curbing the excesses of the bonus culture that exists in the financial services industry.  As Ed Miliband put it in his recent address to the Fabian Society, New Labour was “too timid in enforcing rights and responsibilities, especially at the top, and it was too sanguine about the consequences of the rampant free markets”.  While some would not mourn the passing of the banks, the best outcome for progressives is not to drive the industry from our shores, but to keep a properly regulated financial services industry in the UK as a source of jobs, tax revenue and capital.

As a matter of urgency, the issue of banks that are “too big to fail” must be addressed, that is, banks that are so large and interconnected with the wider economy that they have to be propped up by governments when they get into difficulty.  These banks benefit from a competitive advantage over smaller banks in the form of an implicit guarantee from central banks.  There also is a moral hazard that these banks will take risks that they otherwise would not take because they know that they will be bailed out if things go wrong.  This amounts to an unfair situation for smaller competitors and an unacceptable risk borne by taxpayers.

“Too big to fail” has recently been joined by the even worse moral hazard of “too big to jail”.  Recently, US and UK authorities failed to prosecute responsible officials at Britain’s largest bank, HSBC, for years of criminal activity involving money laundering related to terrorist activity and Mexican drug cartels. The US Justice Department said that sending responsible HSBC executives to jail would be damaging to the economy because it would have threatened the future of the bank and the stability of the entire banking system.  The US authorities let HSBC off with a fine that amounted to a mere four weeks’ of the bank’s earnings; don’t expect UK authorities to send anyone to jail for these activities anytime soon. So that’s one set of rules for most of us, and another set for the big banks.

Unfortunately, even a Labour government of our dreams can’t solve the problem of “too big to fail” on its own.  Global institutions like HSBC and Goldman Sachs maintain operations throughout the world’s major financial centres and are subject to regulation in dozens of countries, the most important of which generally are the UK and the rest of the EU, the US and major Asian markets such as Japan.  The UK, acting in isolation, can’t protect the global economy from the systemic risk of global banks that are “too big to fail” because if the UK acts alone then the systemic risk will remain in the other markets where the banks operate.  Furthermore, if the UK goes too far on its own then the banks may simply move much of the operations in question to other markets like the US or other EU countries (which would be easy enough, as the largest banks already have major operations there).

A Labour government may also press for progressive measures like curbs on the “bonus culture” and a financial transactions tax.  But again, the risk is that if the UK goes too far on its own that the banks will simply move their operations to other countries.  This would cost the UK much needed jobs and tax revenue.

For the regulation that progressives want to be effective, it must be done in cooperation with other major markets.  The place for the UK to start is with the EU.  EU law is already a major source of financial regulation for the British financial services industry.  When EU law tackles issues like systemic risk or other progressive reforms, the risk of banks abandoning the UK in favour of other EU markets will be addressed.  Coordination with major regulators such as in the US is also critical, and this is much more achievable when the EU negotiates with other regulators on behalf of 27 countries, as opposed to 27 nations going it alone.

Any UK withdrawal from the EU would therefore be a disaster for progressive efforts to regulate the banking sector whilst retaining it as a source of jobs, tax revenue and capital.  Not only would the UK become a less attractive destination for financial services because of increased complication of trade with other EU nations, any major unilateral action that a UK government takes for progressive regulation could result in banks simply moving their operations to other countries.  A scaled-down membership in the EU, with the UK subject to certain regulations but without the power to influence the rules, would also be a disaster for the British banking industry and for progressives’ efforts to regulate it.

Ed Miliband has it right when he says that Labour shouldn’t be too sanguine about the consequences of rampant free markets, and that those at the top must be held accountable for their actions.  Britain’s continued membership in the EU is an essential tool in getting the regulations that we need to implement this progressive point of view.

This article is the first in a three part series on banking and financial services regulation.