Bank of England governor Mervyn King and Prime Minister Gordon Brown have clashed over whether banks should be split between utility banking operations and more risky trading activities.
Speaking to Scottish business organisations in Edinburgh last week, King warned that current UK Government and G20 policies of increased regulation and forcing institutions to hold more capital may not be enough to reform the sector and called for banks to be split into utility and trading operations.
But in Parliament last week, Brown rejected King’s proposals, arguing that splitting up the banks would not prevent them from collapsing and only global regulation would shore up both sides of the banking sector.
He said: “You must remember that Northern Rock was effectively a retail bank and it collapsed. Lehman Brothers was effectively an investment bank without a retail bank and it collapsed. The difference between retail and investment banks is not the cause of the problem.”
In a discussion paper last week, the FSA proposed increasing trading book capital requirements which differentiate more strongly between basic market making functions which support customer service and riskier trading activities. It says it is still considering whether or not deposit-taking and trading activities should be split along the lines of King’s suggestions.
King said it was hard to see how the existence of institutions that are “too important to fail” is consistent with firms being in the private sector. He said: “To paraphrase a great wartime leader, never in the field of financial endeavour has so much money been owed by so few to so many. And, one might add, so far with little real reform.”
King said increased capital requirements would only reduce, not eliminate, the need for taxpayers to provide catastrophe insurance.
He called for a clear distinction between the different activities that a bank undertakes.
“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,” said King.
He rejected suggestions that a clear split would be impractical and predicted that the current behaviour of the banks will make such a move inevitable.
He said: “The sheer creative imagination of the financial sector to think up new ways of taking risk will, in the end, I believe, force us to confront the too important to fail question. The belief that appropriate regulation can ensure that speculative activities do not result in failures is a delusion.”
But British Bankers’ Association chief executive Angela Knight insists that a mixed banking model must be retained. She says: “We believe the key issue is not one of breaking up banks but of financing the economy. Our mixed banking model provides choice. Big businesses may want big banks which offer a range of products and services while individuals may look to something smaller.”
Association of British Insurers director of investment affairs Peter Montagnon says: “We do not see a formal Glass-Steagall approach as practicable but it might be helpful if market pressures led to banks reorganising themselves into more manageable units, with either a utility or an investment ban- king focus. The application of more rigorous capital requirements to the trading book would promote such a market dev- elopment, which we would broadly support.”