Well, what a surprise. As anticipated here on several occasions, a major Anglo government has announced that it will establish a ‘People’s Bank’ as part of its pre-election campaign strategy. This time around it is the ALP’s big sister, the British Labour Party, which, given the wholesale implosion and subsequent nationalisation of much of the UK banking system, does not have to make a great logical step to arrive at such a conclusion. In Australia there has been growing speculation that Ahmed Fahour will do something similar (refer to this Banking Review article for the latest summary). The UK developments were brought to my attention by Bernard Keane, who referred me to the following article in the Guardian newspaper:
“The manifesto will also set out proposals for a new model of banking built round a People's Bank, drawing on the post office network…
The energy and climate change secretary likens the introduction of a People's Bank, in the wake of the banking crisis, to the creation of the Sure Start network of children's centres – an institutional reform that meets new demands in society and brings together poor and middle-class people. Built round the 12,000-strong network of post offices, the bank would provide capital for the hundreds of credit unions in the UK, he disclosed.
He argued: "Institutions are the things that define governments. The 1945 government was defined by its relationship with the NHS. The 1997 government was defined around rebuilding the fabric of communities through institutions like Sure Start. I think the idea of the People's Bank … is one of those ideas."
Ministers are completing talks with the Post Office on the range of banking services to be provided, and the scale of its initial capitalisation.
Miliband said: "Frankly banks have let down low-income consumers. The People's Bank can be a very serious financial institution and a competitor to the conventional private sector. One of the exciting ideas is for the People's Bank to provide the network of credit unions access to funds, but it can also become a banking alternative for a significantly wider group than just the low-income consumers. It is part of a bigger reform we need in the relationship between individuals and financial institutions.”
The Bank of England’s Governor, Mervyn King (the UK equivalent to the RBA’s Glenn Stevens), has been arguably the most courageous of all developed economy central bankers in confronting the rarely spoken frailties that undermine the foundations of private banking systems, including Australia’s. Since most central banks regulate private banks, they are typically uncomfortable destabilising pubic confidence in them, which would only exacerbate the asset-liability mismatches that plague their business models. King was able to do so because the private (now mostly public) UK banking system was eviscerated by the GFC.
I have previously argued in an article co-authored with Sharan Burrow of the ACTU last year that there was essentially no material difference between the Australian and UK banking systems, aside from one of relative development (we were more backward and hence less reliant on securitisation and more innovative non-conforming finance), and the critical economic advantages afforded to Australia via our endowments of natural resources and rapidly growing population. The popular thesis that Australia's bankers and regulators are smarter than those around the rest of the world is just baloney. Indeed, it is precisely this school of thought that will likely lead to serious institutional failures in the future, especially if our major banks further divert their attention from the domestic market that protected them during the GFC and try to become 'pan-Asian' entities (notwithstanding that they have zero comparative advantage in Asian countries). As I have suggested elsewhere, the next financial calamity will likely originate out of Asia and be heavily influenced by the nebulous sovereign, economic, and rule of law risks that characterise the region, and China in particular.
In a key speech King highlighted the utility-like nature of private banks and the fact that many of the moral hazard problems that caused the GFC have actually been made much worse by the responses to the crisis. He then considered the ‘narrow-banking’ solutions I have canvassed here before and concluded that they have a lot of merit. It is worthwhile excerpting his thoughts in detail:
“It is hard to see how the existence of institutions that are “too important to fail” is consistent with their being in the private sector. Encouraging banks to take risks that result in large dividend and remuneration payouts when things go well, and losses for taxpayers when they don’t, distorts the allocation of resources and management of risk…
That is what economists mean by “moral hazard”. The massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history. The “too important to fail” problem is too important to ignore…
The banking system provides two crucial services to the rest of the economy: providing companies and households a ready means by which they can make payments for goods and services and intermediating flows of savings to finance investment. Those are the utility aspects of banking where we all have a common interest in ensuring continuity of service. And for this reason they are quite different in nature from some of the riskier financial activities that banks undertake, such as proprietary trading…
In other industries we separate those functions that are utility in nature – and are regulated – from those that can safely be left to the discipline of the market. [A] second approach adapts those insights to the regulation of banking. At one end of the spectrum is the proposal for “narrow banks”…which would separate totally the provision of payments services from the creation of risky assets. In that way deposits are guaranteed. At the other is the proposal in the G30 report by Paul Volcker, former Chairman of the Federal Reserve, to separate proprietary trading from retail banking. The common element is the aim of restricting government guarantees to utility banking.
There are those who claim that such proposals are impractical. It is hard to see why. Existing prudential regulation makes distinctions between different types of banking activities when determining capital requirements. What does seem impractical, however, are the current arrangements. Anyone who proposed giving government guarantees to retail depositors and other creditors, and then suggested that such funding could be used to finance highly risky and speculative activities, would be thought rather unworldly. But that is where we now are.”
