Our friends in the city

Our banking system is still dangerously dysfunctional. Post-crisis reforms failed to fully address the risks posed by the City of London, and with banks back in the driving seat, these reforms are already being rolled back. We cannot afford a return to business as usual.

The UK has one of the biggest, most concentrated, risky, complex, and interconnected banking systems in the developed world. It leaves us uniquely exposed to global financial turmoil.

If post-2008 promises to reform our financial system had been kept, the dangers we face now would not be so acute. Instead, UK banks have fast-tracked a return to business as usual. Contrary to recent claims by policymakers, post-crisis reforms did not fix the structural problems with our banks. Recent concessions to the City are already rolling back the limited progress made:

• Banks are still at risk of failing. Measures to increase banks’ capital do not go far enough, and in any case they misdiagnose the problem: financial crises are created within the financial system. More must be done to change the business models behind our banks’ risky behaviour.
• UK taxpayers remain on the hook. Banks remain too big to fail, and as a result, continue to receive £5.8bn a year in implicit government subsidies. The ring fence between retail and investment banking – intended to insulate the taxpayer from losses caused by risky activities – is also being rolled back.
• The UK banking sector still lacks competition and diversity. The UK has the second most concentrated banking sector in the G7 – its top 3 banks own over half of all bank assets – and is uniquely dependent on shareholder-owned banks. Recent changes to the bank levy actually undermine competition, as they benefit big, international banks like HSBC at the expense of smaller challengers.

Image credit: theboybg via Flickr

Recent concessions to big banks have been justified by claims that international investment banking is vital to our economy. These claims are grossly exaggerated: our status as an international banking hub is as much of a liability as an asset:

• The City’s contribution to UK growth is outweighed by the damage from financial instability: Banks’ contribution to Gross Value Added (GVA) has consistently fallen since 2008. Financial instability does long-term harm to economies: the losses to UK GDP from the crisis of 2008 have been estimated at up to £7.4 trillion.
• The City is a weak and unbalanced provider of jobs: Wholesale banking accounts for just 120,000 jobs, and only 15,000 of those are outside London. UK banks only created 36,000 new jobs in the pre-2008 boom years and have been cutting jobs consistently since 2006.
• Banks pay even less corporation tax than they did before the financial crisis: Corporation tax paid by banks has fallen from £8.8bn in 2008 to £3.8bn in 2014, despite a new levy which promised to recoup the costs of bailing out the banks (£289bn in direct costs alone). This fails to cover even the interest payments (estimated at £5bn a year) on these costs.
• The City is still failing to serve the real economy: only a small proportion of banks’ balance sheets (less than 10%) supports non-financial businesses – the majority is fuelling an unsustainable housing boom in the South East of England. Small business lending is still severely lacking, and the credit banks do provide is regionally unbalanced.

Despite this questionable record, banks continue to threaten to move elsewhere if regulation is designed against their interests. HSBC’s recent threat to quit the UK and relocate its headquarters abroad is only the most recent example of such tactics.

This is not a credible threat:

• London remains an attractive proposition to banks for a whole host of reasons that have little to do with tax or regulation and are difficult to replicate elsewhere, from the time zone to the global language.
• Even if banks’ threats were followed through, the impact would not be as disastrous as we are led to believe. Only a fraction of the jobs and taxes provided by UK banks would actually need to move given a relocation of headquarters – and there would be benefits as well as costs, most obviously a reduced exposure to global financial shocks.

We cannot afford a return to business as usual. Given their overstated contributions to the UK economy, and the real liabilities the City of London represents, threats to leave unless given concessions can and should be faced down. The interests of big banks should not come before those of the rest of the economy.

We recommend:

• The Bank of England should significantly strengthen the lightweight ring-fencing regime.  An urgent clamp down is needed on ring-fenced banks’ economic links with the rest of their banking group. If banks continue seeking to water down and ​‘game’ the regulation, full structural separation between retail and investment banking must be reconsidered.
• The Financial Policy Committee should consider more active credit guidance policies. More active intervention could stimulate real economy lending and dampen down both mortgage lending and lending to other financial corporations.
• The Treasury should urgently review options for addressing the lack of diversity in the UK banking system, and for promoting a more vibrant local stakeholder banking sector. This should include examination of the full range of options for the public’s majority stake in the Royal Bank of Scotland (RBS).