New UK Banking Act: A Missed Opportunity to Make Banks Socially Responsible

26/02/2014 09:56 | Updated 27 April 2014

Some six years after the banking crash, there is little sign of any major reform. The UK's Banking Reform Act is a disappointment and at one stage was described by the chair of the Parliamentary Commission on Banking Standards as "virtually useless".

To understand its inadequacies, we need to go back to the some of the reasons for the crisis. A major reason is the neoliberal revolution that encouraged mobility of capital and forms of regulation which emphasised light-touch regulation for financial markets. Neoliberalism not only informed the economic and social policies of governments, but also provided everyday understandings of what it means to be successful. It reconstructed individuals as competitive beings engaged in the endless pursuit of private wealth and consumption, which would somehow lead to vast increases affluence and happiness. A necessary condition for the operation of markets that work in the interest of society is that individuals need to be constrained in some way by social norms and regulatory structures. Such constraints induce stability, predictability and a sense of fairness that is so essential for any social system to work. However, this did not quite fit the neoliberal agenda. The state, neoliberals argued, had to be rolled-back because it was inefficient and got in the way of self-correcting markets.

The revolving door policies pursued by successive governments ensured that regulators came from the financial sector, or ended up their after their regulatory stint. They were too sympathetic to the demands of the industry and thus paid inadequate attention to welfare of consumers and the integrity of the financial system. In this environment, banks managed to persuade regulators that they needed low amounts of capital, but were permitted to engage in high-risk activities.

The banking crash finally galvanised some regulators, and showed that banks have been engaged in illegal cartels, manipulation of interest rates, selling abusive products, misleading investors and consumers, facilitating money laundering and engaged in insider trading, just to mention a few misdemeanours. The banks are also engaged in unprecedented speculation. The Bank of International Settlements (BIS) shows that the face notional/face value of Over-the-Counter (OTC) derivatives was about $693trillion. In addition, some derivatives are traded on recognised stock exchanges and may have a notional value of $70trillion, making a total of $763trillion. The economic exposure is hard to estimate and can run into billions, if not trillions. Derivatives are essentially a bet on the price of wheat, corn, copper, interest rates, currency rates and anything else. No one can always predict the outcomes of these financial races. Derivatives played a key role in the demise of Lehman Brothers, Bear Stearns, Northern Rock, Long Term Capital Management, MF Global, Countrywide, Merrill Lynch, Wachovia and Washington Mutual, just to mention a few. But no lessons have been learnt though executives gambling with other people's monies made vast personal fortunes. Banks continue to have a very low equity base and will not be able to deal with the derivatives tsunami. For example, shareholders' equity at Barclays is less that 5% of total capital and figures for HSBC, Lloyds Banking Group, Royal Bank of Scotland and Standard Chartered are about 7%, 5%, 5.5% and 7.25%.

The reward for reckless risk-taking and the sale of abusive products has been massive executive remuneration and a bailout. As at January 2014, the UK government is committed to £976billion of loans, guarantees and other forms of financial support. The government has also printed £375billion of money under its quantitative easing programme. No society can afford a repetition of the crash, but the UK reforms have not really addressed the fundamental problems as the government has caved-in to the banking lobby.

The reforms should have included a legally enforceable separation of retail and speculative banking, rather than a weak ring fence which may or may not be used,. However, merely separating the banking arms is not enough because speculators would continue to be funded by monies from savers, pension funds and insurance companies to finance their gambling habits. By enjoying the benefit of limited liability, they will be able to dump their losses onto the rest of society and affect innocent bystanders. This should be addressed by withdrawing the privilege of limited liability from speculative activities, and holding the owners of entities personally liable for the debts of their organisations.

The UK banking regulation has suffered from revolving doors whereby financial insiders become regulators and vice-versa. They have been too close to the values, vocabularies and agendas of the industry and have failed to attach proper weight to the interests of other stakeholders. This vicious circle needs to be broken. The main priority of any regulator should be to protect the financial system and the individual consumer and this cannot be done unless there is some ideological distance between the industry and the regulator. The regulator needs to be advised by a Board of Stakeholders, representing a plurality of interests. This Board should not be dominated by the finance industry. In fact, only a minority shall come from the industry, thus ensuring that other voices are heard and policies are made by consensus. Its meetings would be held in the open and its minutes and working papers would be publicly available.

For far too long, financial sector executive have enjoyed disproportionate financial rewards even when they inflict misery on ordinary people. This should be checked by democratising banks. For example, employees, borrowers and lenders at all licensed banks should be empowered to elect directors and have a binding vote on all aspects of executive remuneration.

The above is not some magic formula for arresting the ills of the financial sector. Rather it marks the beginning of urgent reforms to reform banks to limit the damage to society and to the industry itself.

Prem Sikka is the author of "Banking in the public interest: Progressive reform of the financial sector", published by the Centre for Labour and Social Studies (Class), a think tank established by Unite the Union, GMB and the Institute of Employment Rights to act as a centre for left debate and discussion