Friday, 24 June 2011

The hole in the fence

It looks as if Osborne's decision to jump the gun and ringfence UK retail banking ahead of formal release of the Independent Commission on Banking may have been a good call. Not because ringfencing retail resolves the issues with UK banking - I stand by my remarks in my previous post - but because it protects high street banking from possible catastrophic losses arising from the European debt crisis.

The thinking seems to be that if the savings and borrowings of ordinary British people are protected, then investment banking - which everyone knows is the rich people's gambling den, isn't it - can be allowed to fail. And there is some merit in this view. Protecting ordinary British people from the consequences of profligate lending and spending by banks and countries alike in the Eurozone is an appropriate action for the UK government to take.

The trouble is, it's wrong. We are no longer in the banking of the 1950s, when ordinary people had their life savings in high street banks and building societies, and the only people with stock market investments were stockbrokers, who were "expert users" so could be expected to know how to manage their risks.  These days few ordinary people keep their life savings in bank and building society accounts. They have them in stock & share ISA accounts, long-term endowment policies linked to life insurance, and above all in personal and company pensions.  Although most of these are covered by FSCS insurance, none of them fall within the retail ringfence.  They are a major source of money for INVESTMENT banking.  Yes, that's right - the investment banking that is left exposed to the Eurozone debt crisis in the expectation that it doesn't matter if it is hit by catastrophic losses. 

Well, I don't know about you, but my pensions, my ISA, my long-term savings matter to me. I don't want them to disappear into a bottomless pit of Greek (or Irish, or Portuguese) debt.  But there is little protection for these forms of savings - the vast majority of the savings of ordinary British people: the FSCS compensation limit is currently £85k, which doesn't go very far towards replacing a lifetime of pension contributions.  And there is no doubt that investment banking, as a whole, is seriously exposed to Eurozone sovereign debt.

The ICB's comment was that institutional investors - are "better able to protect themselves" from losses due to failure of investments. That's the 1950s thinking again. Ordinary savers need protection from rapacious bankers. Professional investors should be able to take care of themselves.

The sheer illogicality of this is breathtaking. Both high street banks and institutional investors accept deposits from ordinary people which they invest on their behalf and pay them a return.  High street banks traditionally use savers' money to lend out to borrowers, although these days they are just as likely to lend that money to other banks or buy securities with it. Institutional investors either use savers' money to purchase securities themselves, or they lend savers' money to financial intermediaries - "shadow banks" - who use that money for trading on international financial markets.  In short, both high street banks and institutional investors are professional investors. And both of them are managing the savings of ordinary people.

It is reasonable to expect that all professional investors would demonstrate a prudent attitude to investment with the intention of providing the best possible return to savers for the lowest risk.  But the history of the last few years has shown that institutional investors have been (and still are) seeking for high returns without regard to risk - not in order to give a good return to savers, but in order to enrich themselves. And high street banks have lent out money in the most irresponsible manner, again not to benefit savers but to enrich themselves. Savers have been comprehensively failed by professional investors across the board.  There seems no reason to distinguish between retail deposits and other forms of savings when it comes to the need for protection from bad management and external risks - but that is what is being done.

So if the retail ringfence doesn't protect the majority of people's savings, what does it protect?

The most significant difference between bank deposits and institutional investments is that savers (including current account holders) can withdraw bank deposits with little or no notice, whereas all other forms of savings are tied up in such a way that either considerable notice of withdrawal has to be given (so the institution has plenty of time to find the money) or the money can't be removed at all without considerable penalty.  Because banks lend out deposits, they are always at risk of not having sufficient money available to meet withdrawal demands from savers.  When a lot of depositors try to remove their money at the same time (a "bank run"), banks can literally run out of money. This is what happened when Northern Rock failed and had to be bailed out by the taxpayer. 

Now, if depositors can be convinced that their money is not at risk even when the whole world is collapsing around them, they aren't going to remove their money, are they? So I think that real purpose of the retail ringfence is to improve depositor confidence and therefore prevent bank runs.

In other words, the retail ringfence is not to protect people, but to protect banks. 

And from the savers' point of view, there is a massive hole in that fence, through which most of their savings have escaped.


  1. A nice informative post, Francis - thank you.

  2. So if the IMF gets more taxpayer money will my pension savings be at even greater risk?