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It’s no use trying to change the banks’ behaviour – we must have the power to break them up

Felix Martin's "Real Money" column.

The financial crisis of 2008-2009 exposed huge flaws in the UK’s banking system: but what should we do to fix them? One conventional answer to that has been in the news over the past three weeks. Since the crisis, the Basel Committee – the main forum for the international co-ordination of financial regulation – has been busy refining a new set of global banking standards. And in the UK, a Financial Policy Committee (FPC) has been set up at the Bank of England with a mandate of “protecting and enhancing the resilience of the UK financial system”.

Early this month, the Basel Committee reaffirmed new global rules under which banks will have to keep more of their assets in safe and liquid securities such as government bonds, and fewer in risky and illiquid securities of the sort that turned toxic during the crisis. And on 14 January, the FPC announced that banks will in future be required to keep larger buffers of loss-absorbing capital when their loan books are growing rapidly or when they are financing bubble-prone sectors.

The rationale for these measures is clear enough. Banks provide essential financial services – the operation of the payments system, deposit-taking for savers, lending for businesses and mortgages for individuals. But banks can also engage in activities that look suspiciously like gambling – from speculative lending to trading equities and bonds on their own accounts.

Fixing the banking sector is about discouraging banks from gambling while stimulating their useful activities. Requiring banks to hold more loss-absorbing capital makes it more expensive for them to go to the casino. Requiring them to devote a higher proportion of their portfolio to highly liquid assets limits the tables they can play at. Doing both at once is the best way to avoid another financial meltdown.

It’s a sensible-sounding answer to the ques - tion of what it will take to fix the banks. It is also, unfortunately, wrong.

I first understood why, and what a better answer is, last October, when I went to see Paul Volcker – the ex-chairman of the US Federal Reserve and architect of America’s current banking reform efforts – testify to the Commission on Banking Standards that parliament established to scrutinise the government’s current banking reform plans.

Watching the commission members file in to Portcullis House was not wholly reassuring. It was the sort of roll-call that only Britain can produce. First in line came a hereditary peer, Viscount Thurso, the fifth generation of his family to represent the constituency of Caithness as MP. Then came the Bishop of Durham – as he then was – Justin Welby. Both he and Thurso sounded curiously plummy. No wonder: they were both at Eton. In fact, they were both at Eton at the same time.

In the chairman’s seat was Andrew Tyrie, the backbench Tory MP and thorn in George Osborne’s side – a sure sign that the commission’s recommendations would be ignored. And to cap it all, there was Nigel Lawson. At first I thought I wasn’t seeing straight. Could the man who turned the Square Mile into Las Vegas in the first place and presided over the last great crash in 1987 really have been given responsibility for sorting out the banks?

What on earth, I wondered, was the greatest American central banker of the 20th century going to make of this cross between Kind Hearts and Coronets and Nineteen Eighty-Four? The whole thing, I thought, was clearly a waste of time.

I could not have been more wrong.

Volcker explained that the problem with modern banking is not in the details; it is in the structure. The regulators’ efforts are important, he explained, but banks have always found ways to circumvent controls and always will. If they really want to play at the tables, they will find a back door where entry is free.

In any case, there’s nothing wrong with gambling – as long as you do it with your own money. The problem with the present set-up is that the bill for the banking sector’s gambling debts comes to us. When banks go bust the taxpayer has to step in, because the government has to protect the essential services that they provide.

So the solution is not to change behaviour within the structure: it is to change the structure so that bad behaviour doesn’t matter. Financial institutions that take deposits from customers, make loans to businesses and allow you to pay someone in London from your bank account in Liverpool should be separated legally from financial institutions that shoot for profits by trading on their own account. The former should enjoy a government guarantee; the latter should not.

The good news, Volcker concluded, is that the government’s own adviser, Sir John Vickers, made many of these points in his 2011 report. The bad news is that the Vickers recommendations don’t go far enough. Vickers advised only the “ring-fencing” of separate business units within existing conglomerates. Volcker warned that nothing short of full legal separation of utility banks from casino institutions will do.

Just before Christmas, the parliamentary commission published its answer to the question of how to fix the banks. It has taken Volcker’s view that fundamental reform is needed. Any “ring fence”, it explains, needs to be electrified: the Bank of England should have the statutory power to break up banks properly if required. Better still would be to break them up to begin with.

It is a bold answer – and it is the right one. The reforms that have been announced this month by the regulators are useful, but insufficient. And if it takes a quaint British combination of lords, bishops and poachersturned- gamekeepers to speak this truth to the Treasury, let’s have more of them.

Felix Martin is a macroeconomist and bond investor. His book, “Money: the Unauthorised Biography”, will be published by the Bodley Head in June

Macroeconomist, bond trader and author of Money

This article first appeared in the 28 January 2013 issue of the New Statesman, After Chavez

Photo: Getty Images
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What's to be done about racial inequality?

David Cameron's words on equal opportunities are to be welcomed - now for some action, says Sunder Katwala.

David Cameron made the strongest, clearest and most high profile statement about ethnic inequalities and the need to tackle discrimination ever yet offered by a British Prime Minister in his leader’s speech to the Conservative Party conference in Manchester.
“Picture this. You’ve graduated with a good degree. You send out your CV far and wide. But you get rejection after rejection. What’s wrong? It’s not the qualifications or the previous experience. It’s just two words at the top: first name, surname. Do you know that in our country today: even if they have exactly the same qualifications, people with white-sounding names are nearly twice as likely to get call backs for jobs than people with ethnic-sounding names? … That, in 21st century Britain, is disgraceful. We can talk all we want about opportunity, but it’s meaningless unless people are really judged equally”, said Cameron.
While the proof of the pudding will be in the eating, this was a powerfully argued Prime Ministerial intervention – and a particularly well-timed one, for three reasons.

Firstly, the Prime Minister was able to root his case in an all-but-universally accepted appeal for equal opportunities. It will always prove more difficult in practice to put political energy and resources behind efforts to remedy discrimination against a minority of the population unless a convincing fairness case is made that values cherished across our whole society are at stake. Cameron’s argument, that any party which tells itself that it is the party of the ‘fair chance’ and ‘the equal shot’ must have a response when there is such clear evidence of discrimination, should prove persuasive to a Conservative Party that has not seen race inequalities as its natural territory. Cameron argued that the same principles should animate responses to discrimination when it comes to race, gender and social class. Put like that, wanting job interviews to be fair – by eradicating conscious and unconscious patterns of bias wherever possible – would strike most Britons as offering as clear a case of the values of fair play as wanting the best baker to win the Great British Bake-Off on television.
Secondly, Cameron’s intervention comes at a potential "tipping point" moment for fair opportunities across ethnic groups. Traditionally, ethnic discrimination has been discussed primarily through the lens of its impact on the most marginalised. Certainly, persistent gaps in the criminal justice system, mental health provision and unemployment rates remain stark for some minority groups. What has been less noticed is the emergence of a much more complex pattern of opportunity and disadvantage – not least as a consequence of significant ethnic minority progress.

Most strikingly of all, in educational outcomes, historic attainment gaps between ethnic minorities and their white British peers have disappeared over the last decade. In the aggregate, ethnic minorities get better GCSE results on average. Ethnic minority Britons are more likely, not less likely, to be university graduates than their fellow citizens. 

As a result of that progress, Cameron’s intervention comes at a moment of significant potential – but significant risk too. Britain’s ethnic minorities are the youngest and fastest-growing sections of British society. If that educational progress translates into economic success, it will make a significant contribution to the "Great British Take-Off" that the Prime Minister envisions. But if that does not happen, with educational convergence combined with current ‘ethnic penalties’ in employment and income persisting, then that potential could well curdle into frustration that the British promise of equal opportunities is not being kept.  Cameron also mirrored his own language in committing himself to both a ‘fight against extremism’ and a ‘fight against discrimination’: while those are distinct challenges and causes, actively pursuing both tracks simultaneously has the potential, at least, depolarise some debates about responses to extremism  - and so to help deepen the broad social coalitions we need for a more cohesive society too.

Thirdly, Cameron’s challenge could mark an important deepening in the political competition between the major parties on race issues. Many have been struck by the increase in political attention on the centre-right to race issues over the last five to ten years. The focus has been on the politics of representation. By increasing the number of non-white Conservative MPs from two to seventeen since 2005, Cameron has sent a powerful signal that Labour’s traditional claim to be ‘the party of ethnic minorities’ would now be contested. Cameron was again able to celebrate in Manchester several ways in which his Cabinet and Parliamentary benches demonstrate many successful journeys of migrant and minority integration in British society. That might perhaps help to ease the fears, about integration being impossible in an era of higher immigration, which the Home Secretary had articulated the previous day.

So symbolism can matter. But facial diversity is not enough. The politics of ethnic minority opportunity needs to be about more than visits to gurdwaras, diversity nights at the party conference fringes and unveiling statues of Mahatma Gandhi in Parliament Square. Jeremy Corbyn’s first speech as Labour leader did include one brief celebratory reference to Britain’s ethnic diversity – “as I travelled the country during the leadership campaign it was wonderful to see the diversity of all the people in our country” – and to Labour bringing in more black, Asian and ethnic minority members - but it did not include any substantial content on discrimination. Tim Farron acknowledged during his leadership campaign that the Liberal Democrats have struggled to get to the starting-line on race and diversity at all. The opposition parties too will no doubt now be challenged to match not just the Prime Minister’s rhetorical commitment to challenging inequalities but also to propose how it could be done in practice.

Non-white Britons expect substance, not just symbolism from all of the parties on race inequalites.  Survation’s large survey of ethnic minority voters for British Future showed the Conservatives winning more ethnic minority support than ever before – but just 29 per cent of non-white respondents were confident that the Conservatives are committed to treating people of every ethnic background equally, while 54 per cent said this of Labour. Respondents were twice as likely to say that the Conservatives needto do more to reach out – and the Prime Minister would seem to be committed to showing that he has got that message.  Moreover, there is evidence that ethnic inclusion could be important in broadening a party’s appeal to other younger, urban and more liberal white voters too – which is why it made sense for this issue to form part of a broader attempt by David Cameron to colonise the broad centre of British politics in his Manchester speech.

But the case for caution is that there has been limited policy attention to ethnic inequalities under the last two governments. Restaurateur Iqbal Wahhab decided to give up his role chairing an ethnic minority taskforce for successive governments, unconvinced there was a political commitment to do much more than convene a talking shop. Lib Dem equalities minister Lynne Featherstone did push the CV discrimination issue – but many Conservatives were sceptical. Cameron’s new commitment may face similar challenges from those whose instinct is to worry that more attention to discrimination or bias in the jobs market will mean more red tape for business.

Labour had a separate race inequalities manifesto in 2015, outside of its main election manifesto, while the Conservative manifesto did not contain significant commitments to racial inequality. The mid-campaign launch in Croydon of a series of race equality pledges showed an increasing awareness of the growing importance of ethnic minority votes - though the fact that they all involved aiming for increases of 20 per cent by 2020 gave them a slightly back-of-the-envelope feel. 

Prime Ministerial commitments have an important agenda-setting function. A generation ago the Stephen Lawrence case opened the eyes of middle England to racist violence and police failures, particularly through the Daily Mail’s persistent challenging of those injustices. A Conservative Prime Minister’s words could similarly make a big difference in the mainstreaming of the issue of inequalities of opportunity. What action should follow words? Between now and next year’s party conference season, that must will now be the test for this Conservative government – and for their political opponents too. 

Sunder Katwala is director of British Future and former general secretary of the Fabian Society.