From Lombard Street to Easy Street

The old adage about how to succeed in banking was the formula of ‘3-6-3’: borrow at 3%, lend at 6% and get onto the golf course by 3 o’clock. Oh how quaint and distant such times feel to us now, with the economy still suffering from the fall-out of a banking crisis for which no-one involved seems particularly willing to accept responsibility.

What would be the modern banking formula? It seems more like 0-15-7 – get money for almost nothing, lend it at double-digit rates (in all probability with nasty conditions attached) and trouser your 7-figure “performance-related” bonus at the end of the year. To those of us who have attempted at any point to earn a crust entirely off our own bat, the self-delusion of senior bankers who describe themselves as ‘entrepreneurs’, ‘risk-takers’ and ‘wealth-creators’ would be laughable if it were not so costly to the real enterprise economy. Reward and risk are supposed to go hand in hand – this is at the heart of capitalism. Banks reap the profits but are protected from losses by the broad shoulders of the taxpayer.

But then banking is anything but a normal and competitive free market. The bailout demonstrated this to dramatic effect – Woolworths can disappear from the high street almost overnight, but RBS cannot. But the problem runs deeper than the damage inflicted on taxpayers by the bailout and the impact businesses and workers by the credit crunch and recession.

Banks make too much money. Banks need to earn a reasonable return on capital, but in a recent report ‘Featherbedding Financial Services’ we at nef (the New Economics Foundation) set out several ways in which banks profit excessively at the expense of taxpayers, customers, investors and corporate clients. This allows them to be relaxed on costs, indifferent about customer satisfaction and yet still enjoy margins that would make a manufacturer or a retailer blush. This is bad news for the broader economy. Banks’ profitability has more than doubled and has outstripped non-financial sectors since the 1970s. Why?

To start with, being “too big to fail” is profitable. Based on calculations by Andrew Haldane, the executive director of financial stability at the Bank of England, we estimate the value of this subsidy to UK banks to be around £30bn a year. The subsidy arises because banks, effectively guaranteed by the government, are able to access much cheaper funds than would otherwise be the case.

But this is far from the end of the matter. We also identified windfall profits to banks from the additional trading in gilts required by the Bank of England’s programme of quantitative easing. This is ironic to say the least, as QE was brought in to revive the economy after the banking crash.

Customers are proving a good source of extra profits, too. The interest spread – the difference between the interest rate that banks pay for funds and how much they charge us – has widened dramatically since 2008. Although perhaps too narrow before the crash for some forms of consumer credit, this suggests that the burden of rebuilding banks’ balance sheets is falling disproportionately on customers instead of shareholders, executives and bondholders. SMEs are all but priced out of the market for credit – no wonder many do not even bother applying for a loan.

Investment banking is also something of a cosy club of financial returns wildly out of kilter with real economic contribution. Institutional investors and corporate customers are getting a raw deal. For example, in the case of rights issues we identify a near trebling of investment banking fees since 2000, having been at a steady level for decades. This has reaped an additional £1bn in fees just through a rise in commission rates.

Reform is desperately needed. Until we see genuine competition, and some customer power, in retail and investment banking, and until incompetent and failing banking institutions and executives are guaranteed to suffer the same fate as they would in any other sector of the economy, our banking industry will be a drag on the UK’s prosperity.