One of the things I'm most pleased about in the reaction to the LIBOR fixing scandal is the attention that has followed for proposals for a British Industrial Bank, mostly due to Ed Miliband's speech today*, and the publication of Nick Tott's report into a British Investment Bank.
It's one of the ironies of modern British industry and politics that huge attention is now being paid to the German KfW bank, which was the invention of the British occupation of Germany as we looked to finance the industrial reconstruction of the occupied zone. So a revived British Industrial bank would not so much be another German export, but a rehoming.
The case for a UK industrial bank, or a similar institution like a US SBA or SBIR is strong. We have an issue with lending to small and medium size business for extended periods, our private sector investment levels are low, and the UK private sector doesn't invest in R&D to the same extent as our comparator countries. (This could be a consequence of our economic structure, as well as a cause).
Other people will know far more about the economics of a proposed UK investment Bank than I do, so I'm sure Duncan Weldon, Jonathan Portes and the like will be discussing it soon. Read their stuff.
I want to focus on the practical politics of establishing such a programme and ensuring it's success.
First, seeking to replicate an Eisenhower era initiative (SBA), or an Adenaeur programme (KfW) or a Reagan era programme (SBIR) does not make you an enemy of capitalism. Nor do I think what Labour is talking about would be horrifying to Vince Cable, or even Michael Heseltine.
This wide political spectrum makes sense when you consider what lies at the heart of such an initiative: It is a way for government to offer subsidy, support, and security to private sector companies, who will keep most of the return on their successes, and nationalise most of their losses.
We should go into this with our eyes open, we will offer such a subsidy because we want to encourage business formation, expansion and growth. Why is this a role for the state? Because we believe business provides a broader social benefit than it's own profit alone.
This is important, because establishing a national Investment Bank is not cost free and cannot be cost free.
The Tott report suggests using National Savings and Investment to fund a new bank. This is a smart move, but we should remember NS&I plays a role in reducing the cost of government borrowing already. Should NS&I funding be diverted to an Industrial Bank, this would be reduced.
If half of NS&I current support for govt were diverted to a bank, the Govt would need to pay an additional £400million to finance itself on the open market. Assuming we don't just add it to the deficit, that money has to come from somewhere, and that will likely mean extra public spending pressures. However such a bank is funded, there will be costs.
Similarly, introducing SBIR wholesale into the UK, would involve an 1-2% "tax" on all procurement spend, which could then be used to finance Small Business innovation. That would be a significant squeeze on suppliers, or on budgets.
Finally, there's the accounting treatment of such an institution. Most European style 'State Investment Banks' or loan guarantee/insurance schemes would lead to an increase in our Net Debt and borrowing figures. It might be possible to draw a distinction between "good" and "bad" borrowing when talking to the Bond markets, but this would create extra pressure to bear down on "bad" borrowing, which would mean pressure on welfare and public service expenditure.
Nor would such a bank always be an unqualified success. Germany's KfW earned the name "Germany's stupidest bank" after it sent money to Lehman Brothers on the eve of their collapse. Outraged politicians, a police raid and a criminal investigation followed
I mention all these negatives because we need to remember an Industrial Bank would represent a subsidy to the private sector from the state.
Second, such a programme never be a quick fix to the current crisis of the economy. It can't do that – it is a long term programme that has to be sustained for decades to have a significant impact. It will therefore require long term political support.
From this, the political strategy should flow. Rather than presenting our plans as fundamentally moral (or worse, anti-market) ones – we should regard them as fundamentally practical and purposeful (and pro-market).
The moral argument will be washed away when the pressure comes to reduce funding in some other area with an equally valid moral claim, or when the bank makes it's first really stupid investment, or when it is revealed that someone has wasted a loan made to them on a truly stupid business proposition (or committed a crime with public funds).
The practical, long-termist argument will stick as long as the purpose is agreed upon, and the objectives are being achieved.
This is a way for the state to make capitalism work- it can be supported for left of centre reasons – more job growth, higher living standards, better incomes. It can also be supported for right wing ones – a shift of resources from public to private, support for entrepreneurs. The political key is to employ both, to secure as broad a swathe of support as possible.
In my view, this would also have the useful short term political effect of casting Labour as a pro-Business party, though that is incidental to the long term gain for our economy.
* On some of the other proposals mentioned , I'm afraid I don't know enough about the structure of banking to understand why a system of small banks, like in Spain, or the old US Savings and Loans, is better than big banks, or less exposed to risk. It strikes me that is something is "small enough to fail" it probably will fail. I thought the reason we have big banks now seems to be that the small ones fell over in the crisis. I'm probably wrong though, and I look forward to being corrected.
“I look forward to being corrected.” No you don’t but your ignorance is …
The current integrated banks make vast losses in the ‘casino’ investment banks, but also provide the ‘critical ‘ retail banking and transactions (see RBS failure).
As part of the banks are critical therefore the (false) argument is made that the Government needs to save the banks and make them whole (cover the losses). Or the banking system collapses, including the critical elements.
Therefore the ‘critical policy’ is the complete separation of retail and investment banks. Something the Vickers report fails to do (ringfences are inadequate).
Selling of branches etc, is a different problem, Lloyds/HBOS merger has resulted in Lloyds having a dominant, scale monopoly (22 million current a/c, 21 million saving a/c out of a 60 million population) of retail accounts.
I appreciate the vickers point, but that's really not what being proposed- the creation of new challenger banks is intended to encourage more competition in the retail banking sector. Is there much evidence that smaller banks are less likely to fail/require bailouts etc? If so, why did we basically push through the Lloyds/hbos merger, and if so why is history littered with the bodies of dead small banks?
As David suggests, selling off branches has sound rationale behind it on competition basis, but the moral/social function argt for it as a way to change the culture of banking seems less convincing- if indeed is even related.
Hopi
Don’t tell anybody but the universal banks RBS and Lloyds are in effective Government ownership and Barclays were rescued by money from the Middle East.
i.e. Megabanks failed but are ‘too big to fail’ and therefore must be rescued by Governments.
Small banks are allowed to fail, and absorbed by the survivors/new entrants.
Investment and Retail banks have different cultures, in the case of Investment Banks think the ‘Vegas’ casinos when operated by the mob.
David:
The deposit base moves with the branches.
Where to start ?
Margret Thatcher (following S&L example) facilitated the demutalisation of building societies, and deregulation of the banks (and former Building Societies).
Most of the Universal Banks and former Building Societies (like Northern Rock) adopted a business model (more profitable model, from the US) based on liquidity in the overnight market.
Financial Innovation and contagion (losses) spread from US Investment Banks to UK based Universal Banks and demutualised Building Societies producing huge losses and collapsed the banking industry, which was rescued by Government.
The liquidity/capital crisis was precipitated by Investment Banks (like Lehmans), resulted in the collapse of the business model used by UK institutions (that had adopted the US model) and/or purchased securities from US Investment Banks.
Papers and books have been written on this subject, and will be written on the solution.
Strict regulation (i.e prescribing the business model) and separation of Retail Banks (from Investment Banks (with a different culture)) would prevent financial innovation (aka Fraud) in this sector, and prevent contagion from Investment Banks.
http://www.guardian.co.uk/business/2011/sep/12/vickers-report-key-points
https://en.wikipedia.org/wiki/Savings_and_loan_crisis
Key question here is what do you want to achieve? More sme equity investments in small businesses (which is a) v risky and b) consumes large amounts of banks' risk capital to provides, more retail banks on the high street, more investment banks, recreate per big bang city structure? There is a difference between considering what banks are currently being criticised (rightly) for and the policy objectives that are being sought from the sector. Given there are more bank chains than supermarket chains and still dozens of other retail bank alternatives, I doubt lack of competition here is an issue. Certainly selling branches won't help unless you move the deposit base with them. However as sure as eggs are eggs, more high street banks will have an extremely limited effect on the investment banking side of large univesal banks. I can't see nationwide/co-op et al being viewed by JPM or MS or Goldman as competitors.those banks would barely touch the sme end of the market – it's simply not economic for them to do so.
Aragon – Northern Rock had no investment bank. Nor did Bradford and Bingley. These were largely pure retail banks that failed because their lending policieswere too aggressive (driven by competition on the high street) and their funding sources were not not sufficiently diversified. Don't forget the worst of the crisis occurred when Lehman (no retail bank) went under. Why do you see separation as a panacea? To work, as you suggest, you would have to restrict your banks ability to transact with I banks. Not as simple as you suggest.
For the record, I don't disagree with reducing lloyds market share – I just don't see how that addresses an of the other issues raised in the sector recently
Would the creation of such a bank be something which a British government could get cleared by the European Commission? It would certainly require approval under the State Aid rules and these would also constrain its ability once approved to offer significant subsidies in its lending to SMEs (the current Commission rules require even subsidised lending to SMEs with impaired credit and little collateral to be at 100-150 basis points above the real national interest rate (something analogous to LIBOR)).
On the assumption that the BIB would not be established until some time after 2015 I suspect that the regulatory burden of clearing it would be substantial in any scenario. In the best case generally, the euro will have by then stabilised and the rescues of Spanish, UK and other banks succeeded robustly. The conditions attached to those bailouts include taking out excess capacity (which is why eg Northern Rock aggressively had to discourage even its best customers from seeking new deals on mortgages) and increasing their general solvency. A new subsidised competitor might damage the bailed out banks, particularly where they have significant SME business (eg the Bank of Scotland's SME banking business was part of the attraction for Halifax when they merged). At the very least it would have been designed to have some chilling effect on SME lending by commercial banks. In worsening case scenarios the creation of a BIB would easily be arguable to be undermining the stability of the whole sector and in a way inconsistent with the approvals already granted for bailing out other banks.
The best bet for the BIB would have been to have established it in 2008 as a compensating measure for allowing the failure of HBOS (instead of merging with Lloyds) and perhaps RBS. In 2015 it would be most achievable were there to have been a sufficient eurozone collapse (and consequential adverse impact on the EU and UK) to change the general UK consensus towards EU exit.