Banking after Cruickshank - impact of Cruickshank report on British banking industry
Are banks special, or is it time to make them work harder for a living? David Lascelles examines the recommendations of a damning report
When did your bank last go bust? Unless you were unlucky enough to be with the most fraudulent bank in history, BCCI, the only possible answer is never. And there are two reasons for that. First, British banks are enormously profitable, so they have enough fat to handle hard times. Second, the government is there to prop them up. Or was.
Although the politics of banking are now dominated by the Cruickshank report, the big question looming behind that rather technical document is more historic: are banks special and, if not, is it time to make them work harder for a living?
It's not as easy a question as it looks. The instinctive answer is yes. Banks are fat cats, they treat their customers with disdain, they shut down rural branches, and they charge us the earth for handling our money. So let's make them sweat.
But hold on. We also want them to lend more to small businesses. We want them to scrap charges for cash machines. We want them to run the national payments system. And if they can spare the time to keep rural branches open as well, that would be very nice. Actually, we'd quite like to tell them exactly how to run their affairs.
This is the problem with banks. When you examine the position they occupy in the economy, it's hard to leave them to their own devices. They are a bit like the electricity grid, Railtrack and the sewage system: vital to public service, they can deliver social objectives. And they can't possibly be allowed to go bust -- imagine a large chunk of the railway system vanishing overnight.
How do you strike the balance? In a way, it was easier for the Tories. Even though the interests of the Tories and the City often merged, the case for making life harder for banks tended to win the day. There was some movement in the 1980s and 1990s towards removing the "special" tag from the sector: letting in more competition, breaking open the motherly relationship between the Bank of England and its chicks.
But even the Tories ran up against the basic problem: where do you draw the line? You can't have a clearing bank with 20 per cent of the market charging about, doing what it likes. It has to mind the china, and keep the flow of credit going not just to good borrowers, but also to "the industries of the future".
This dilemma is more acute for Labour, even in its new guise, because it has inherited the Tories' appetite for competition, but retains social and compassionate objectives over which the banks have some control.
What all this boils down to is that each government has to write some kind of compact with the banking industry. You do this for us, and we'll let you do that. Behave, and we'll help you if you get into trouble. What is Labour's compact? It started outtough, but it's getting softer, in spite of Cruickshank.
Almost the first thing that Gordon Brown did when Labour came into power was shake up the whole financial regulatory apparatus to take supervision away from the Bank of England. This was a very bracing move. Although the Bank did a passable job, it suffered from the fatal flaw that no one knew whose side it was on: protecting the financial houses, or their customers. When it came down to it, the winners were usually the banks because they were "too big to fail", even when they were tiddlers such as Johnson Matthey Bankers, which hardly anyone had ever heard of. The Bank was too close to the City, and too far from customers.
With the Financial Services Authority now in charge, that balance should swing more towards customers. The FSA has a strong customer protection mandate, and is more distanced from the City (being down in Canary Wharf probably helps). There has also been a cultural shift. In the old days, it was bad form to question the Bank of England's role too closely. Now it is fashionable to talk openly about "moral hazard" -- the encouragement that protection gives to bad behaviour.
The FSA has not been put to the test, so we don't really know which way it will veer. But the expectation is that, in times of trouble, it will leave failing banks to go bust, and focus its resources on limiting the damage.
Unfortunately, this has left the compact a little muddled. The banks, accustomed to a balanced deal, read it as the government saying: "We're going to do less for you, so go off and do what you like." What Brown was really saying was: "We're going to do less for you, but you can't go off and do what you like." That's not the sort of deal banks like, so they read it their own way.
Hence all the trouble we've had: banks doing hard and heartless things with their tariffs and branch networks in the name of "competition" and "cutting costs" -- and doing very well out of it. If you no longer have to worry about keeping uneconomic small town branches open or lending to struggling businesses that will never pay you back, you can start making a lot of money. In recent years, UK banks have made the largest profits in their history.
It took Brown a year or so to realise that the compact wasn't working. Which is when he called in Don Cruickshank and gave him a brief to find out how good a job the banks were doing, and whether there needed to be any changes.
First, a word about Cruickshank, the inscrutable Scot. Cruickshank came from the telephone regulator Oftel and knew little about banks. But he knew where to start: networks. The banks' payments system was a bit like the telephones: lots of wires conveying messages, all owned by a potential monopoly. It was obvious that this was where he would concentrate his efforts, although he would also have to look at service for the personal customer and small businesses.
What he found was an incomplete revolution. The Tories had opened up competition and made the banks more accountable, but they hadn't finished the job. The big banks still dominated the scene; prices for banking services were still high -- and capricious. The Banking Code, introduced in the 1990s to give customers some comeback, had terms of reference that had been designed by the banks for the banks.
Altogether, it wasn't exactly a cartel: the banks actually compete with each other quite vigorously. When the Centre for the Study of Financial Innovation conducted a survey of banking competition in the European Union last year, it found far more new entrants battling for a place in the UK market than anywhere else: all those Eggs and Sainsbury's Banks. But it didn't encourage much innovation, or lead to noticeable improvements in service, because the newcomers are still tiny and targeting only selected segments of the market. Brian Pitman, the outgoing chairman of Lloyds TSB, made a name for himself by increasing the value of his bank thirtyfold in 15 years. But the other side of the coin was that the quality of service to customers was pared down, and charges were pushed up to increase margins.
As expected, Cruickshank delivered his biggest broadside against the payments system, where he found "profound competition problems and inefficiencies" -- that is to say, slow cheque clearing and high charges for cash withdrawals. His solution was to propose a regulator, PayCom, to make it a bit more like the phone system. He also thought that the regulation of competition in general in banking should be gingered up -- in effect, removing special treatment for banks. His third set of recommendations covered services to private individuals and small business, which he thought would be improved through a combination of more rigorous regulation and government-sponsored Cat (cost, access, terms) labels to make it easier for customers to compare the prices of bank products.
A part from the PayCom proposal, it was all fairly predictable, and the only serious challenge to Gordon Brown was whether to set up yet another regulator. It now looks as if he won't, or at the very most has stuck it on a back burner. Initially, Cats will apply only to credit cards, so they won't have much effect on accounts and loans. Is this because he, too, has turned soft on the banks to get that compact going again: no PayCom in return for less nonsense on rural branches and cash machines? Possibly. If the banks have any sense, they'll play ball and everything will go away.
But there's also a real-world consideration: things may be changing of their own accord. More banks are coming into the market; new payment systems are opening up on the internet; the whole banking structure could be on the verge of tremendous upheaval. So there's no point in launching a great exercise to break it up if it is about to fragment by itself.