If you think, as many still do, that the core activity of banks is gathering savings to oil the wheels of industry, then you are sadly out of date. Large businesses, overall, generate more than enough cash internally to cover their investment needs. Small and medium-size businesses badly need access to bank finance. They have been woefully short of it since the credit crunch. But the amounts they need are very small relative to the current scale of financial activity.
The assets – and liabilities – of British banks exceed £6,000bn, four times the country’s income. Lending to UK businesses – to manufacturers and retailers, construction companies and road hauliers, accountants and farmers – accounts for about £200bn of that, about 3 per cent of the total.
Banks contribute to the real economy in other ways. They make consumer loans, they finance property development and investment, they lend more than £1,000bn in residential mortgages. But most of the £6,000bn total of UK banks’ assets and liabilities represents financial institutions trading with each other.
From the 1980s, banks grew their balance sheets to a size that dwarfed their core activities of deposit taking and lending for productive investment. Initially this explosion of intra-market activity had little impact on the core business of banking because trade between financial institutions was assumed to be conducted in liquid markets and more or less free of credit risk.
In 2007-08, we discovered that the assumptions of assured liquidity and security were false. Governments – Britain’s in the lead – were forced to bail out the banking system to avert a credible threat that its collapse would bring the global economy to a halt. The capital and liquidity that the British government provided to keep the banking system afloat was more – far more – than was needed to finance the whole of bank lending to non-financial businesses.
Even though politicians were motivated by the needs of the real economy, the priority of the banks that had built these balance sheets was to resume business as usual. However, the conglomerate banking structure that had emerged by 2007 can be viable only with far greater capital than banks traditionally held – or can raise. Investors will not subscribe new equity for banks on anything like the scale required, and banks claim that such equity capital as is available is very costly.
This is not surprising since the experience of the past decade has been that shareholders in banks lost most of their money while the individuals who ran these banks became very rich. The outcome is that companies in the real economy – those factories, shops and service businesses – find that capital to support their activities is scarce, and the banks that service them have been able to raise lending margins sharply in order to increase their own capital through retained earnings.
Only if traditional retail banking is ringfenced can taxpayer guarantees be limited to personal and business depositors, and government funding of the banking system be directed to the needs of the businesses that create jobs and growth. That is the irrefutable case for the Vickers Commission recommendations. The principal argument the banks have raised against ringfencing is that the cost of capital to investment banking would be higher if retail deposits and the associated taxpayer guarantee could not be used as collateral for its borrowings.
That argument is correct, but more compelling to investment bankers than to depositors or taxpayers. The jobs and growth the bankers claim will be in jeopardy are their own: the pressing needs of the real economy point not to delaying change, but to implementing it as speedily as possible. We need to get back to banking as usual: not banking as it was in 2007, but banking focused on the needs of depositors for a haven for their cash and on the needs of business for funding productive investment.