20/01/2014 06:12 GMT | Updated 21/03/2014 05:59 GMT

Competition Won't Fix UK Banks

Chuka Umunna insists UK banks should be broken up, in order to make them - he says - more competitive. It is a surreal experience hearing a Labour spokesman arguing the virtues of competition while the coalition insists that concentrating UK banking into five banks is in no way problematic. But they are both wrong. U.K. banks are too big and do need to be broken up. But making them more competitive isn't the point - and, in itself, exacerbates problems instead of solving them.

The problem with British banks is that they are too big and too complex. RBS has a balance sheet the size of the British economy. The legacy of doomed acquisitions (NatWest and ABN/AMRO) means that the IT systems are still not integrated, customers still have to deal with multiple interfaces and transparency remains elusive. To have so large and important an institution fundamentally opaque constitutes a risk. As Frank Partnoy has so brilliantly demonstrated, bank balance sheets provide only a hint of what is going on inside these institutions. Even Don Young, a former director of the Financial Accounting Standards Board, say he no longer trusts financial accounting. The basic problem here is two-fold: huge banks are too complex for anyone to be confident they know what is going on inside of them. And their size means that, should they fail, only a government can rescue them - and must rescue them.

The solution of course is to create smaller banks: institutions small enough that, should they fail, they can be allowed to fail. This is the fundamental thinking underlying the engineering concept of robust systems. Airplanes are safe because they have multiple different systems on which they run - so that if one engine fails, the plane can continue to fly using other systems that use different software. They are designed with an appreciation that they could fail, not the hubristic confidence that they won't. These systems aren't safe because they compete with each other but because they are different. Think of it as a form of bio-diversity. We need smaller banks, pursuing a variety of strategies, in order to make the economy as a whole safer.

But this is not about competition. Competition is what drives people to devise broken products and mis-sell them to people who don't understand them. Indeed, the profound competitiveness between banks is part of what got us into this mess in the first place. Banks competing for customers and deals, attention and headlines, put everyone in them under greater pressure to take risks with acquisitions, products, pricing and interest rates. Just look back on Anthony Salz's investigation of Barclays: "Winning at all costs comes at a price: collateral issues of rivalry, arrogance, selfishness and a lack of humility and generosity." Banks competing more ferociously - as RBS competed with Barclays for the trophy of ABN/AMRO - is not what we should aim for.

If we have learned anything from this ongoing crisis, it is that the quest for scale in banking was insatiable. Competitiveness always is. It doesn't stop until it fails - and so it must fail.