Letting a good financial crisis go to waste
We agree that access to finance is a precondition to participating in fully society, and so we oblige banks to provide free-free basic bank accounts. But lending to businesses - especially smaller firms with growth ambitions - remains scant, and so public policy has intervened by creating other channels like the British Business Bank. Meanwhile, UK authorities have failed to win some high-profile enforcement actions that might send a message to those who create risk in the system - the “London Whale” who lost JPMorgan $6.2bn, slipped the net. Nearly a decade on from the financial crisis, have we missed the opportunity to ask what we want finance to do for us?
This month, Iceland’s finance ministry announced that it would lift the remaining capital controls it had imposed after the 2008 financial crisis. Benedikt Jóhannesson, Iceland's minister of finance and economic affairs, said that this approach had focussed on defending the currency, addressing Iceland’s balance of payments issues, and avoiding economic shocks. In 2015, the IMF’s Mission Chief gave Iceland his approval, noting its “steady fiscal adjustment” and “quick restoration of the domestic banking system”: all achieved “while carefully preserving its Nordic welfare model” and with “limited government absorption of private financial sector debt”.
In a magisterial article, the freelance Icelandic journalist Sigrún Davíðsdóttir notes that contrary to myth, Iceland did impose austerity and it did bail out banks. The largest, Glitnir, Kaupthing and Landsbanki, were allowed to fail, but two smaller banks were supported in a move with no obvious policy rationale. Furthermore, the Central Bank of Iceland lent €500m to Kaupthing to meet its obligations to UK authorities - documented only by a phone call. These irregularities led to criminal investigations, prosecutions for senior bankers, even the trial of former prime minister Geir Haarde. A fascinating episode of the BBC’s Inquiry spoke to the Special Prosecutor investigating the collapsed banks. He was joined by Jay Cullen, a specialist in bank governance. He argues that despite “substantial market manipulation” there was little evidence of systemic fraud related to the crisis in larger financial systems like the UK’s - criminal investigations relating to the crash have not been pursued here. However, has the UK’s response managed to address the systemic risks caused by bank behaviour?
Tomorrow, the Bank of England will publish how it plans to stress test the banks this year. Last year, its scenario included a crash in house prices, a severe domestic recession and turbulence in the global economy. RBS, in which the public own a 73 per cent stake, fared worst - largely due to the need to set aside cash to pay fines for previous misconduct. To cover costs, it cut 1500 jobs and closed 34 branches last year. This raised eyebrows and rankled trade unions. But some of the fines it will pay will cover systematic mistreatment of business customers, as revealed by the Tomlinson Report, which finally prompted an apology from the bank last year.
An investigation by Buzzfeed and BBC Newsnight details how as the financial crisis began to bite, RBS was getting worryingly close to insolvency. Its head of property for the south region, Rhydian Davies, realised that cash fees would be the only way to meet targets and proposed a project he nicknamed ‘Dash for Cash’. To do this required renegotiating loans, most of them secured against real estate. A fall in property values would invalidate covenants that specified that a customer’s borrowing must not exceed 70-80% of the value of their assets: this would allow the bank to charge restructuring and exit fees.
It didn’t solve the bank’s problems. Famously, Tom McKillop, the chairman of RBS, called Alistair Darling on the morning of October 7, 2008 to tell him that the bank was hours from collapse. He asked the Chancellor what he was going to do about it, and the answer was a £45 billion bailout.
In the wake of the crisis,16,000 companies worth £65 billion were pushed into RBS’ Global Restructuring Group. Internal memos show that property exposure of the type favoured by Davies was one reason for referral - but deciding to go elsewhere or litigation against RBS could also trigger it. By 2011, GRG was making £1.2 billion a year. By 2013, regulators were starting to take notice. The Financial Services Authority began to be concerned about the “philosophical approach” of the group, and the “reputational risks” associated with how it handled repossessed assets. By 2013, not only had the profits of the group reduced to a tenth of its former size, it had created “£10 billion of regulatory headwinds” for RBS. That’s five times the amount of money needed to put social care back on track this year.
Are ordinary people feeling the benefit of rescuing the financial system? According to a recent Demos report, 1.5 million adults in the UK do not have a bank account, and this imposes a ‘poverty premium’ on each of £1300 per year. Financial exclusion also affects those who are not able to access affordable credit, cannot track income and spending, and are unable to build up a savings buffer. This has not escaped the attention of policymakers, particularly on the latter - with the Lifetime ISA and Help to Save scheme the latest steps forward. However, most people without a bank account do not want one due to a lack of trust in providers of finance and financial advice.
In the age of referendums, a public conversation about what we want from financial services is conspicuously absent. While Iceland may have only limited lessons for the UK, our approach has in important ways bound us to bank profitability. The pursuit of profitability at whatever cost has, in the RBS case, actually led to worse outcomes for UK companies. Bafflingly, the money now being used to defray regulatory action seems to be undermining fiscal stability, and it is sorely needed for other public goods. If given the opportunity to redesign the financial system - say, by an unprecedented crisis - would anyone choose to do it like this?
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