Vince on reform of banking regulation

by Stephen Tall on July 20, 2009

Lib Dem shadow chancellor Vince Cable has been delivering a speech on reform of banking regulation to the London Stock Exchange, outlining the ways in which the current regulatory model could be improved. Here’s the skinny:

  • RBS and Lloyds to be broken up before they are returned to private ownership
  • Highly paid bankers to publish details of their remuneration and confirm they are resident and domiciled in the UK
  • The FSA to remain as a unitary regulator
  • A long-term role for state banking, rather than the quick sale of state-owned banks
  • The scrapping of the “woefully misconceived” Asset Protection Scheme

And here’s Vince’s customarily pithy sound-bite:

The Government has yet to grapple with the challenge posed by the Governor of the Bank of England: that if a bank is too big to fail it is too big. One approach is to make it easier for big institutions to fail.

“Some aspects of the financial services industry are simply too big for the British economy to manage safely. The large, failed, British banks are the financial equivalent of Chernobyl. Like the former Soviet Union, the UK became over reliant on dangerous financial reactors.

“Britain has the highest share of banking assets in GDP of any major country, four times as high as the US. To prevent Britain from becoming the next Iceland, radical safety measures, like ones I have set out, are required.

“My approach to the City is not one of hostility, or of obsequiousness. I recognise its importance. But it needs ‘tough love’, not the freedom to run amok.”

But for those who want to read Vince’s words of wisdom in greater detail, excerpts from the speech transcript follow:

The FSA
I start with the topical issue of the Tripartite system. Actually this is a secondary issue. But it has dominated the recent news and it needs to be dealt with sensibly. So far it is being dealt with very foolishly in the form of an old fashioned bureaucratic turf-dispute between the Bank of England and the FSA with Mr Darling and Mr Osborne egging on the two sides, like two schoolboys cheering on their heroes in a playground punch-up.
The Chancellor, who has evidently fallen out with the Governor and backs the FSA, appears to have set up a Financial Stability Committee based at the Bank of England in the Banking Act 2009, and then a Financial Stability Committee at the FSA and also a Council for Financial Stability, chaired by the Chancellor, in the White Paper. This is like setting up three Competition Commissions to investigate monopoly. There should be one Financial Stability Committee, led and chaired by the Governor of the Bank of England and with representation from the FSA and from the Bank.
Mr Osborne’s proposal is even more disruptive: moving the bank supervisors back from Canary Wharf to the Bank of England. City institutions which straddle bank and non-bank financial services despair at the idea of going back to separate, competing, regulators and at the prospect of endless office politics as desks are moved and jobs are reallocated after this quango war. Of course the Governor must have overall responsibility for systemic stability but he doesn’t need to oversee the accounts of Little Tidbury Building society. I would leave the FSA as a unitary regulator.
I won’t dwell on the structural issues since they are a side issue: the harness rather than the horse. My worry is that we are being deflected from the substance of what sensible regulation means. My party and I encouraged, indeed anticipated, the creative use of capital adequacy requirements to offset booms and busts and I note that this approach is being extended to manage risk across institutions as well as over time. But there is a danger of regulators becoming one club golfers albeit with a very adaptable club. Clever bankers will always be looking for ways round the rules. A number of investment banks have already been reported as engaging in the practise of securitising bank balance sheets on order to evade regulatory capital requirements. This type of innovative side stepping of regulations will have to be penalised heavily, other wise the promised revolution in regulation will be still born.
Remuneration and Bonuses
I proceed to another issue which dominates the headlines perhaps disproportionately – though since I appear frequently as Disgusted of Twickenham perhaps I shouldn’t complain about the headlines. Just as politicians were very slow to grasp the public reaction to duck islands, moats and house ‘flipping’, the financial community has been extraordinarily obtuse in failing to appreciate why the public is angry about bankers. Without the taxpayer, many bankers would be without a job let alone the huge bonuses that they are enjoying. It could be argued that pay for top footballers is similarly disproportionate but Chelsea and Manchester City do not depend on British taxpayer guarantees. And we know both from experience and economic research that remuneration structures in banking have given incentives to excessive risk taking leading to financial collapse.
What should be done? We can’t do much about Goldman Sachs beyond noting that it was rescued by the American taxpayer a few months ago and is growing fat on the semi-monopoly in investment banking following the collapse it helped to create. But the British authorities can and should do something about financial institutions which are their responsibility. The principles were clearly set out in Lord Turner’s excellent report in March. The problem is that we are getting a lot of talk and no action.
Remuneration policy of regulated financial institutions must be approved by the FSA as a check to ensure that short term risks are not being incentivised that may affect long term stability. The FSA should make publicly available the outcome of assessments made of banks’ remuneration policy and the action taken. Increasing capital requirements could be one tool to enforce this but a fine would send a more powerful message and would provide greater transparency. It should start with the big institutions which incubate systemic risk, not the small fry.
The issue of remuneration in relation to the nationalised or semi-nationalised banks should be more straightforward. The UKFI has direct responsibility and it should exercise it whilst showing an understanding of the need for qualified staff as well as restraint. Despite all of its protestations its role seems largely passive.
Transparency is a minimum requirement. We have argued for highly paid staff, not just Directors, in regulated institutions with a compensation package – say – in excess of the Prime Minister’s £200,000 to publish details of their remuneration. They would also have to confirm that they are normally resident and domiciled in the UK for tax purposes. I see that the Walker Report is adopting a very similar approach to ours, but it is too timid. A voluntary code is pointless. Unless disclosure is mandatory it won’t happen. And we will be back to where we started.
Ultimately, however, regulators can’t and shouldn’t try to manipulate pay like 1970s incomes policy. Progressive taxation has to address the issue of fairness in rewards. The government’s flag waving approach to top tax rates is not a serious approach to this problem. As long as there are huge disparities between top tax rates in earned income and capital gains any half competent tax accountant will arrange for big bonuses to pay 18% on stock rather than 40% or 50% tax on income. Leading tax firms are already drawing up plans to facilitate large scale tax avoidance. We have made it clear that we support a return to the policy of the last Conservative government of taxing income and capital gains at the same rate.
Breaking up RBS and Lloyds
The government has yet to grapple with the challenge posed by the Governor of the Bank of England: that if a bank (or other institution) is too big to fail it is too big. One approach is to make it easier for big institutions to fail. Resolution powers could be put in place such that large and complex financial institutions can be wound down in an orderly manner. The key assets required to continue the operation or provision of the ‘public service’ would be easily and quickly extractable from the organisations that currently supply the service. Banks would be required to operate in such a way that this separation is possible. Importantly these plans for orderly wind down and separation must be produced by the institutions themselves and subject to approval by the regulator. This will dramatically strengthen the position of the regulator in the event of failure. Sharing information across borders where the bank is operating internationally is vital to ensure that large cross-border banks could be wound down. This approach is however untested and long term at best.
Another approach is to break up the existing big banks so that large scale systemic risk is removed; banks become small enough to fail; and more competition is restored. One version of this argument is that investment banks should be split off from what is called ‘utility’ banking. Various counter arguments, often self serving, are advanced in reply. It is said that small banks (like Northern Rock) as well as big banks (like RBS) collapsed in the latest crisis: true. Also that risk is not necessarily correlated with structure: some investment banking is low risk; some small business and mortgage lending is high risk. Also true. But size matters; if Barclays Capital continue their ambition to be the world’s largest investment bank the British taxpayer will be left footing the bill for any future collapse. This is wholly unacceptable.
We believe big banks must be split up but are open minded about the mechanisms involved. The essential point is that within a realistic time frame the British taxpayer has to be totally disengaged from the risks involved in global investment banking. For existing publicly owned institutions, RBS and Lloyds they should be broken up before they are returned to private ownership. The European Trade Commissioner has already warned of over concentration in the UK market for – for example – mortgages. The Lloyds-HBOS merger should be unscrambled as part of this process and RBS should also be split with its investment banking operations floated off.

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Doesn’t go anywhere near what is really needed: Fraa Banking.

Probably a once in a lifetime opportunity, and nobody has the cojones to tell the truth: central, fiat banking has been an absolute disaster for everyone except governments. Until it goes we cannot build a long term sustainable economy. And, come to think of it, we cannot build an aconomy that does not encourage the sort of excessive growth than many have held responsible for climate change.

If we could have a mantra that Central Banking is Killing the Planet we’d have people out on the streets yelling for the alternative. But as it is, these two are simply maintaining as much power as possible for governments to continue manipulating currencies and whole economies (and never for the better in the long term), whilst tinkering around the dges with more regulation that will one day be broken and we’ll have to do this all over again.

by Jock on July 20, 2009 at 2:28 pm. Reply #

Oops – that should of course be “Free Banking” – damn this no preview thing!

by Jock on July 20, 2009 at 2:29 pm. Reply #

As Joseph Stiglitz points out, the Obama administration in the US is having similar problems. Bank are not only too big to fail, they appear (after some intensive lobbying by the banks) to be too big to restructure as well;
http://www.project-syndicate.org/commentary/stiglitz113

by Geoffrey Payne on July 20, 2009 at 2:53 pm. Reply #

I though the FSA failed very lamentably in the banking crisis, especially regarding not seeing the crisis coming at Northern Rock, lax lending oversight etc. Vince was also saying so at the time. What has changed since then, and why does he now want to keep a reformed FSA? I remain unclear from his speech.
Therefore I am also disappointed.

by Biodiesel on July 20, 2009 at 5:13 pm. Reply #

gargantuan edit by the BBC Tory supporting editorial team again, on this and the by-election coverage.

Cameron must be really pleased to have such friends in high places!

by JohnM on July 20, 2009 at 6:47 pm. Reply #

Poor old Vince only managed a 30 second slot in the BBC, whilst the wholly inadequate Osbourne got close to 4 1/2 minutes. The BBC is becoming the replacement for the CofE, the Tory Party at prayer.

by Roger Shade on July 20, 2009 at 8:00 pm. Reply #

@Roger
I agree, And if Vince had not been addressing the LSE today then Robert Peston would have ignored him completely like he usually does.

by simonsez on July 20, 2009 at 11:55 pm. Reply #

By far the best of the policies of the main three parties, but there’s still a few misses here even from Vince for me.

“RBS and Lloyds to be broken up before they are returned to private ownership”

Absolutely agree. Banks need to both smaller in size, and have their commercial, investment and insurance parts kept separate with a Glass-Steagall type Act, and from the look of Vince’s speech, that seems to be what he’s proposing.

“The scrapping of the “woefully misconceived” Asset Protection Scheme”

Yes it was misconceived, but there does need to be something put in its place.

“There should be one Financial Stability Committee, led and chaired by the Governor of the Bank of England and with representation from the FSA and from the Bank.”

I’d like to add “and from the Treasury” as I don’t think financial stability should be as independent as (say) monetary policy. But otherwise agree with this sentiment.

“Mr Osborne’s proposal is even more disruptive: moving the bank supervisors back from Canary Wharf to the Bank of England. City institutions which straddle bank and non-bank financial services despair at the idea of going back to separate, competing, regulators and at the prospect of endless office politics as desks are moved and jobs are reallocated after this quango war. Of course the Governor must have overall responsibility for systemic stability but he doesn’t need to oversee the accounts of Little Tidbury Building society. I would leave the FSA as a unitary regulator.”

Agree. The Tory proposal would create the mother of all quangos in the Bank of England. We don’t want a UK version of the US Federal Reserve, as it would have far to much power. Keeping watch as a unitary regulator, monetary policy, and overall stability are all very different things, and as such should be overseen by very different bodies. Vince has it right here.

“A long-term role for state banking, rather than the quick sale of state-owned banks”

Yes absolutely. Make sure taxpayers come out of this in the best possible shape. We didn’t want to nationalize the banks but it was necessary to do so, now don’t treat them like hot potatoes.

“Highly paid bankers to publish details of their remuneration and confirm they are resident and domiciled in the UK”

This summary of what Vince has said on this issue doesn’t quite suffice. And Vince’s statement itself is confusing on this. I’ll go through it step by step:

“Remuneration policy of regulated financial institutions must be approved by the FSA as a check to ensure that short term risks are not being incentivised that may affect long term stability. The FSA should make publicly available the outcome of assessments made of banks’ remuneration policy and the action taken.”

This part disagrees with that summary. The summary said that he just wanted the remuneration details published. But the statement says that not only should they be published (I guess a kind of “name and shame” idea), but action should be taken (and this also published), and remuneration policy should be approved by the FSA. So a bit more tough than the summary implies.

Now what exactly should the FSA do? It is quite obvious that the incentives are all wrong in banking: you can get someone like Fred Goodwin turn RBS into the largest bank in the world but built on a house of cards which then subsequently crashes, yet since the remuneration is based on short term gains, people like him walk away with a packet, and the taxpayers lose out. That kind of moral hazard has to stop. Link pay of the directors, executives etc to the long term health of the company. There are a wide range of values and securities in banks that can be used and pay should be linked to some of these.

“Increasing capital requirements could be one tool to enforce this but a fine would send a more powerful message and would provide greater transparency.”

Well capital requirements should be increased (and decreased if necessary) as a counter-cyclical measure, not really as a method of punishing over-zealous remuneration policy. Fines may be most appropriate, but the fines have to be proportional to the size of the over-remuneration.

“It should start with the big institutions which incubate systemic risk, not the small fry.”

For a given definition of “big”, yes. This definition should include banks like Northern Rock etc.

“We have argued for highly paid staff, not just Directors, in regulated institutions with a compensation package – say – in excess of the Prime Minister’s £200,000 to publish details of their remuneration. They would also have to confirm that they are normally resident and domiciled in the UK for tax purposes. I see that the Walker Report is adopting a very similar approach to ours, but it is too timid. A voluntary code is pointless. Unless disclosure is mandatory it won’t happen. And we will be back to where we started.”

This seems to be where the conclusion in the summary lies. Vince is not proposing that “Highly paid bankers to publish details of their remuneration and confirm they are resident and domiciled in the UK” but details of their compensatory packages i.e. bonuses.

But this part doesn’t go far enough. So pay is regulated by the FSA, but bonuses aren’t? They’ll just move the incentives onto the bonuses if there’s no regulation. Yes shame them by revealing how much they’re getting, but some people are beyond shame, and this won’t be enough. Would naming and shaming antisocial youths work? No because plenty know no shame.

So bonuses have to regulated in the same way as pay: link to long term stability of the company.

“Ultimately, however, regulators can’t and shouldn’t try to manipulate pay like 1970s incomes policy.”

This is where I get confused. In the previous paragraph he said he wanted the FSA to take action and regulate bankers pay, but now he says we can’t do it in a 1970s incomes policy. I’m not old enough to know exactly what means. Can anyone explain this to me?

“Progressive taxation has to address the issue of fairness in rewards.”

Yes, but the issue with bankers’ pay and bonuses is not about “fairness” (which as Vince rightly says, can be addressed by progressive taxation) although that does seem to the sentiment out in the public and in the media, it’s about moral hazard.

Now there were a few topics missed out here e.g. sub-prime mortgages, credit default swaps etc etc, but I hope this is because this wasn’t specifically about those topics, or because he agrees with the government’s policy on these things, whatever that may be, I’ve forgotten.

Something else I’ve not heard of from ANY party, is some of the changes we need on an international level. UK policy should be promote reforms such as those that Keynes proposed at Bretton Woods but the Americans rejected, like an International Clearing Union. This would be particularly useful for sorting out the lopsided trade and debt/surplus balances (e.g. Germany/China etc are massive exporters, and have large surpluses, whereas us and the US etc are mainly importers with large private debt), one of the major causes of this crisis.

Also, stability needs to be looked at internationally in a joint effort, and it would make sense to search for some agreement on what happens if a global institution like RBS has to be bailed out in future again (god forbid), so that UK taxpayers aren’t saddled with rescuing these global companies alone just because they’re from the UK. These banks were bigger than the UK. Obviously politically even if we called from it, the US and the Chinese etc are never going to go for it, so I appreciate that, but I still think this idea should at least be verbalized some people know what the ideal financial system would look like.

Anyway, I’ll stop waffling now.

by Alex on July 21, 2009 at 12:42 am. Reply #

“This seems to be where the conclusion in the summary lies. Vince is not proposing that “Highly paid bankers to publish details of their remuneration and confirm they are resident and domiciled in the UK” but details of their compensatory packages i.e. bonuses.”

Actually no I was wrong too. In that paragraph, Vince was proposing that those bankers with large bonuses should publish details of their salaries, which seems a bit bizarre. Surely it should be that they publish details of their bonuses since that is the measure they’re being judged on in this paragraph? And surely these bankers would’ve already published their salaries, since Vince said, “The FSA should make publicly available the outcome of assessments made of banks’ remuneration policy”? Or is that FSA statement only talking in a general sense, and not about individuals having their details published?

Now I’m really confused.

by Alex on July 21, 2009 at 12:53 am. Reply #

Vince has it wrong on the FSA. The problem there is its ‘New Labour’ culture, which remains unchanged. It can’t be reformed and really should go – having failed as badly as any regulator can, it has no business continuing to exist.

The tories have clearly been ignoring the FSA spin machine – rightly so. So should Vince, who I thinks need to look a lot more closely at the internal culture of the FSA since it was set up.

by dave on July 21, 2009 at 3:17 pm. Reply #

I can recall when I worked in the City that the B of E was run by a bunch of Toffs who new little about the activities of the Barrow boys (like me) and understood even less. If we really intend to smarten up the regulation of the City we need to use the poachers as Gamekeepers. I have to say that Unis do not produce the smart cookies who ran the FSA ragged, we need streetwise guys who have done the job and have probably got the T shirt.

by Roger Shade on July 21, 2009 at 7:12 pm. Reply #

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