A progressive’s wish list for bank regulation

Written by: Todd Foreman on 21 January, 2013
Filed under Economy

Labour Party leader Ed Miliband has rightly said that 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”. This certainly is true with respect to the banking and financial services industries.  Too little regulation and oversight led to a taxpayer bail-out of the banks. This has been used by the Tory-led coalition to justify cuts in public services, while banks like Goldman Sachs continue to look for schemes to ensure that as little as possible of their bonus pot is taxed. A progressive wish list for banking regulation should seek to minimise the risk that taxpayers will again be asked to pay for the mistakes of the banks, and also ensure that the financial services industry is taxed fairly and held accountable for its actions. There are a number of measures that progressives can push for to achieve these goals.

The biggest risk to taxpayers comes from the banks that are “too big to fail”. 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.  This risk can be greatly reduced by splitting up the commercial and investment activities of banks. Commercial banking activities comprise of what are normally thought of as traditional “high street” banking and are often aimed at ordinary consumers; taking deposits, lending for home mortgages and lending money to businesses. Investment banking services are typically aimed at much more sophisticated customers, and include activities like underwriting share offerings, mergers and acquisitions and the creation of ever-more complex derivative products. Whilst many such investment banking activities are entirely legitimate, some of them are tools for casino capitalism. Splitting investment banking activities from commercial banking will greatly reduce the risk that taxpayers will need to bail out a bank because it has placed bad bets in the casino.

For those at the top, responsibility means that bankers should not expect to be bailed out by the taxpayer when they get into difficulty.  When banks are no longer too big to fail without major damage to the wider economy, they should indeed be allowed to fail when they become insolvent. Ordinary depositors are protected up to £85,000 by the Financial Services Compensation Scheme, and anyone fortunate to have more than that amount to deposit can protect themselves fully by opening accounts at more than one bank.

Aside from not expecting to be bailed out when they fail, bankers should expect to be prosecuted when they break the law (just like everyone else). Historically, the UK’s record in this area is poor. The problem isn’t so much that there aren’t laws on the books—fraud and market manipulation are already crimes; what has been missing is the criminal prosecution. However, the FSA has recently made some encouraging noises about prosecuting wrongdoers in the LIBOR manipulation scandal, and the Serious Fraud Office arrested three people in December in connection with their investigation into LIBOR.  Much more action is needed on this front and criminal prosecution of market manipulation should be a high priority.

Fairness and accountability means that those at the top should expect to pay their fair share in tax.  The Tory-led coalition has made exactly the wrong move by cutting income tax for those few taxpayers earning over £150,000 per year. The recent attempt by Goldman Sachs to delay bonus payments until the new tax year to take advantage of this Tory tax cut is highly cynical and frankly disgusting. The Goldman Sachs scheme also highlights the problem of the bonus culture. Bankers’ bonuses are typically tied to their performance over just one year. It is all too easy for bankers to work for the short-term, trouser a large bonus and move on to a new bank with little regard for the long-term health of their employer (never mind the wider economy). Progressives should push for solutions to this problem, such as tax disincentives for large bonus payments, longer service requirements for bonuses, and clawing back or prohibiting bonuses when banks are bailed out by the taxpayer.

A progressive wish list should include tax reform to ensure that the financial services industry is taxed fairly and contributing to the funding of public services. Don’t look to the Tories to take any special action on this issue. Tory Chancellor George Osborne floated the idea of a “bank tax”, which would have prohibited banks from offsetting losses in the financial crisis against later earnings, and promptly shelved the idea after coming under pressure from the City. Another proposal is a financial transactions tax, a small levy on transactions such as trades in currencies, bonds, shares and derivatives. Not only will such a tax raise money, it will discourage casino-type trading. 11 EU countries (including France, Germany, Italy and Spain) are moving forward with plans for a financial transactions tax, but once again the Tory-led government has blocked the tax for the UK.

Many of the measures described above have a much greater chance of success if we can convince other major market participants, such as our EU partners and the United States, to implement similar measures. The goal for progressives should not be to shut down the financial services industry or drive it from the UK. It should be to create the regulatory framework for a financial services industry that pays its fair share of taxes, is held accountable for its actions when things go wrong and poses as small a risk as possible to taxpayers and the wider economy.

This article is the second in a three part series on financial services regulation.