Banks must be made safe and competitive

It is more important than ever that the banking sector and the Government have a constructive working relationship.

Towards the end of this year, Britain’s banks will learn what regulatory measures the Government is proposing to prevent a repeat of their annus horribilis of 2008. The Independent Commission on Banking, chaired by Sir John Vickers, will set out its proposals in late summer, and they are likely to provide the template for new banking laws.

In a weekend speech, Sir John offered some of his early thoughts, and they do not make comfortable reading for the banks. Pointing out that the failure of the banking sector to manage risk efficiently had been “spectacular”, he said the sub-prime lending crisis “should not have caused havoc on anything like the scale experienced”. But it is not such chiding over their incompetence that the banks will find most disconcerting. It is the refusal by Sir John to rule out the seismic option of splitting retail and investment banking that will cause the greatest alarm. He said that the investment arms of the big banks effectively had a state guarantee against failure, which could lead to excessive risk-taking, while stand-alone investment banks had no such safety net. While Sir John made clear the commission has reached no conclusions, Nick Clegg, the Deputy Prime Minister, was quick to spell out his personal support for such a split. He said he was “attracted” to the notion of separate retail and investment businesses that would “insulate” the taxpayer and the wider economy from such enormous liabilities.

In these testing circumstances, one would expect the banks to be bending over backwards to be helpful to the Government over bonuses and lending targets. Not a bit of it. Talks to moderate the size of bonus pots while at the same time increasing the amount of credit available to business have become bogged down. While the view in Whitehall appears to be that some sort of deal will eventually be agreed, the tardiness of the process does not augur well.

For it is more important than ever that the banking sector and the Government have a constructive working relationship. We report today on what can happen when the political and regulatory heat becomes too intense. There are early signs of an exodus of senior bankers from Europe, where the downward pressure on cash bonuses is now intense, to the US, where it is not. This underscores the delicate nature of the challenge facing Sir John and his commission. They must propose regulations that are not so onerous that they undermine the competitiveness of the banks, for successful banks are essential to a successful economy, while putting in place effective fail-safe measures to prevent another meltdown. It will not be easy.