Feather-bedding Financial Services

Would banks be making any profit at all without billions in hidden subsidies from the British taxpayer and bank customers?

Increased scrutiny of the financial system in the wake of the banking crisis has shed light on a number of practices previously taken for granted, which now might be viewed in a different light. The sheer complexity of modern banking (itself one of the conditions that brought on the crisis) has worked to shield the sector from difficult questions. But, with the dust of public interventions now settling, a number of anomalies are emerging.

• The ​‘Too Big to Fail’ subsidy: Having concluded that our major banks are ​„too big to fail,‟ the government provides a public guarantee, effectively insurance against going bust. In business terms, this gives the banks a huge commercial advantage over other firms in a market system. It reduces their risk. This means that they can borrow money much more cheaply than if they were not ultimately underwritten by the public. Exchanges with leading auditors in front of the Treasury Select Committee confirm this. The hidden subsidy saves the banks a large amount of money – we estimate, conservatively, that it could be worth £30 billion annually– and helps them make unearned profits. It also means that when the banks pay bonuses to senior staff for ​„performance‟ and dividends to institutional investors, the rewards of that ​„insurance‟ provided by the taxpayer are going elsewhere, and not back to the taxpayer.
• The quantitative easing windfall subsidy: When it was decided that the economy needed more liquidity, the Bank of England pumped money in using the technique called ​„quantitative easing‟. To meet various, and sometimes self-imposed, requirements, it did this using a trading mechanism with several of the banks. As merely passive conduits for this ​„risk free‟ arrangement, the banks made more money, taking a cut of every trade. Here we find that they enjoyed a significant windfall, simply by being there, but that the failure to disclose sufficient information keeps the likely amount hidden.
• The ​‘make the customer pay’ subsidy: Looked at very sympathetically, the banks have been put in a difficult position. At the same time as being required to rebuild their capital, they are also under pressure to lend. It’s like being pulled in two directions at the same time. In response, the banks have tried to manage this by increasing the gap between what they have to pay to borrow money, and what they charge people to borrow from them. This is the so-called interest rate ​“spread”. But they do have alternatives. They can also recapitalise through reducing or eliminating bonus and dividend payments until their capital base is rebuilt. As it is, the taxpayer is subsidising the banks twice over: once through taxpayer funded public support to the banks, and secondly through paying much higher interest to borrow than the banks do. It‟s another hidden subsidy which in the retail and one part of the investment banking world amounts to at least another £2.5 billion per year.

There is yet another, very significant, but rarely discussed and poorly understood free benefit enjoyed by the banks. This is only mentioned in passing here to add context, and will be the subject of a future briefing. But it stems from the fact that banks are gifted by government, in effect, a licence to create money. Few appreciate that the vast majority of new money entering the economy is lent into existence by the banks when, for example, they make personal loans. The popular myth that banks merely lend out the savings left by depositors has never been the case in the modern Western world. Here‟s how Martin Wolf of The Financial Times put it recently:

“The essence of the contemporary monetary system is creation of money, out of nothing, by private banks’ often foolish lending. Why is such privatisation of a public function right and proper, but action by the central bank, to meet pressing public need, a road to catastrophe? When banks will not lend and the broad money supply is barely growing, that is just what it should be doing.”

Because the banks then get the benefit of the interest paid on the money they have been allowed to create, that can be seen as yet another subsidy. Its precise value to the banks annually is a subject of debate, but previously it has been estimated to be worth tens of billions.