Mervyn King is right about casino banking

Dr Stephen Spratt is Director of nef‘s Centre for the Future Economy.

Mervyn King has annoyed Gordon Brown and Alistair Darling again with his call for UK banks to be split into smaller groups focusing on either retail or investment banking, but not both. King does not share the government’s belief that stricter regulation would prevent banks heading straight back to the casino, describing such thinking as a “delusion“.

He is almost certainly right. Banks like being big, and they particularly like being too big too fail. With the backing of the taxpayer, should their gambles go wrong, they can borrow cheaply and make huge bets in the market, safe in the knowledge that they will capture any gains but be protected from losses.

It is not surprising then that the banks also oppose King’s idea. Of course, they say that this is because of the enormous complexity, or “practical difficulties”, that implementing it would involve. Another reason is more likely. Simply, they are able to make a lot of money from leveraging their depositor base to support speculative activities elsewhere.

But this creates strong incentives to focus on the more “exciting”, and highly lucrative, gambling activities at the expense of the “boring” business of providing banking services to individuals, families and small businesses. This is nothing new in the UK, where financial exclusion remains a huge problem and small businesses struggle to access finance at all. The closure of branch after branch, particularly in disadvantaged areas, is just the most brazen example.

It seems very hard for banks to concentrate on providing a good service to these parts of their customer base when the global casino beckons. If some banks want to roll the dice in the markets, fine – they just shouldn’t be allowed to gamble our money to do so, and they certainly should not have these bets underwritten by the taxpayer.

For banks to serve their retail customers well, they should be dedicated to this essential function, and only this. By cutting banks down to size we could bring them closer to the communities they should be serving, and so better able to meet local needs.

At nef we would go further. Will Hutton on this site rightly calls for root and branch reform. Here are a couple of ideas of how that process might start. Most “investment” banks don’t really do any real investing. They are trading banks. But we do need real investment banks that focus on long-term needs, and nowhere is this more obvious than with green energy and transport infrastructure.

As well as separating out retail banking, why not also restructure the investment side? The government, on our behalf, retains its stake in the banking system, and it could use this as the means to form a green investment bank, charged with financing these long-term investments. And why stop there? A national housing bank to underpin a more stable housing market that meets people’s needs is an idea whose time has come.

For a while not so very long ago, people remembered that the purpose of banking was not to feather its own nest, but to provide the vital financial services and long-term investments that underpin our economy and society. King seems capable of seeing through the hard sell of the financial lobby to recall this. It would be good if the chancellor and prime minister could do likewise.

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