There’s no need to break up the banks

By Allister Heath, July 23, 2009

A few weeks ago, the received wisdom was that a good way to ensure financial stability would be to forcibly separate investment banks from retail and commercial banks. There was also discussion about imposing limits on bank sizes. Yet the Labour Party in its White Paper and the Tories in George Osborne’s response have now largely rejected those ideas.

The new consensus focuses on making all banks hold more capital, with giant firms forced to hold the most. Institutions which operate investment banks as well as retail banks may have to hold much greater reserves to insure against some activities, such as proprietary trading, that are deemed higher-risk. The thinking is that this would indirectly limit bank sizes and dangerous activities by making them too costly. While some of these proposals are imperfect, this move away from arbitrary break-ups and size restrictions is welcome.

Remember who went bust. Northern Rock, Bradford and Bingley and other bailed-out lenders were they were deemed “too big to fail” and even a banking industry populated with corporate midgets would still be in line for a bail-out next time things go wrong. A belief that small is good makes no sense. Imagine how bad customer service would be if all banks were limited to 100,000 customers. There would be no competition. The 100,001th customer would be turned down and the rest treated like dirt.

Forcibly separating investment and retail banks would not have prevented a single bail-out anywhere. Governments stepped in to help both kinds of banks from going bust, arranging shotgun marriages in some cases. Literature shows that unified banking is less prone to collapse than artificially segmented institutions. America’s Glass-Steagall Act was the product of an attempt by the Rockefellers to raise the costs of their rivals, the House of Morgan, and made little sense even in the 1930s. Not all the new proposals are good. A small building society that lends vast amounts to volatile commercial property firms is riskier than a well-managed investment bank that does not engage in highly-leveraged trading. And even most proprietary traders pose less of a systemic risk than the average stodgy lender. But some common sense is now prevailing in the banking debate — and for such small mercies we should be grateful.

Allister Heath is Editor of City A.M.

Last updated: 10:08am, July 23 2009