Breaking up the Banks

The little UK bank reporting season is over. £15Bn profits have been reported. Bonuses are being calculated. The time they took us all over the brink is becoming a distant memory, along with the ‘too big to fail’ mantra. Sir John Vickers’ commission on banking regulation won’t report for another twelve months and by then the boot will be firmly on the other foot. Government will need the bank’s profits to push share prices up so the public holdings can be disposed of at a profit, or at least at not too big a loss. It will be business as usual, at least till the next time.

Despite the £15Bn profit, banks are still not lending to industry at a level which would ensure we avoid a double dip recession. This failure is accompanied by many mixed messages. Stories abound of small businesses being refused loan financing, existing facilities not being rolled over as previously and some being called in with considerable urgency, causing many business closures. Asked why they aren’t lending more to real economy businesses, the bankers offer various explanations. There is no demand for more debt capital; businesses are reluctant to take on more debt because of the uncertain future; banks have to rebuild their balance sheets after the credit crunch; banks have to be prudent and cannot afford to take undue risks and many businesses look extremely risky. These are all rationalising sound bites which deny the real position.

You’re in charge of this bank which has a traditional High Street operation, and an investment trading business. Your job is to decide where you put any discretionary funding. The High Street business, which invests in traditional industry, returns around 6% per annum gross and is not risk free. The trading operation can return up to 40% on deals which are mostly short term, if not overnight. They are also not risk free, but it is likely to be at least another year before the proverbial hits the fan. You are being pressed by government, the media and your shareholders, to improve performance. What do you do?

The obvious answer is to focus your investment as far as possible on the trading operation rather than funding industrial projects. While ever you have the two businesses to choose between, that is the direction you will be pressed to take. Your logical course of action will be to take money out of High Street banking and put it into the high return trading and hope the high risk, which is intrinsic to that business, doesn’t happen any time soon. And that you will have the foresight to get out before it does.

Removing that option from banks, so that they resume their tradional function supporting industry, will only be achieved by separating the two operations, ie breaking up the banks.

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