The banking system has been on the verge of collapse for a frighteningly long time. The arithmetic is awesome. “All told, taxpayers are on the hook for about £500bn. To put that in context that is fine times the entire health budget or a penny on income tax for 125 years,” reported Patrick Hosking in The Times on 9 May 2009 in relation to Royal Bank of Scotland. This could be a crisis of epic proportions, forcing future generations to bear the cost of present financial indiscretion. In the words of Launcelot in The Merchant of Venice, it now seems that “the sins of the father are to be laid upon the children”. Just as there is no such thing as a free lunch, so the concept of ‘free banking’ upon which much of the financial system was based may cost this and future generations dear.
Just how the new system will arise out of the embers of the old is under much discussion and is of course the subject of Lord Turner’s Review.
I am neither an economist nor a banker. However, like most solicitors, I have a contribution to make to this debate since I manage clients’ money in accordance with the Solicitors’ Accounts Rules 1998: the new system could do a lot worse than study these rules and consider their application to retail banking.
It seems to me that the accounts rules are a model instrument for the storage and ‘ring-fencing’ of money. Rule 22 deals with “withdrawals from a client account” as follows:
Rule 22(1): “Client money may only be withdrawn from a client account when it is:
1) Properly required for a payment to or on behalf of the client;
2) properly required for a payment of a disbursement on behalf of the client; or
3) properly required in full or partial reimbursement of money spent…on behalf of the client.”
Rule 22(2) imposes similar obligations concerning controlled trust money.
The overriding principle is contained in Rule 22(7) that “money held for a client or controlled trust in a separate designated client account must not be used for payments for another client or controlled trust”.
Such is the importance of this rule that nothing other than strict compliance is required. Indeed any solicitor who breaches or infringes these rules in any way is likely to have his/her practising certificate withdrawn or continued on stringent terms.
Why is it that this model is not being considered? Is it because the banking system is based upon fundamental flaws which are immediately apparent? The position is that credits on ordinary ‘checking’ accounts remain unsecured and indeed ‘title’ passes to the relevant bank. The accounts rules recognise this: “Once money has been paid into an account set up under 16(1)(b), it ceases to be client money” [nb(i)]. It seems that, under the present system, the only matter which stands between a solvent and an insolvent client account is the taxpayer’s guarantee, but only to the extent of £50,000 for each such account.
There is a paradox between the strict application of the accounts rules while they are accounted for by solicitors and the relaxed rules which apply when they are accounted for by banks. There is also an inherent contradiction in this system. Ordinarily, clients borrowing from banks do so on ‘secured’ terms, yet banks ‘borrowing from clients’ do so principally on unsecured terms. This contradiction appears so normal that it does not seem to attract any criticism at all.
A critical analysis of the banking system ought to consider whether banks should be ordered to store money, ‘right-fence’ it or offer security in ordinary course. A system ‘propped-up’ by the taxpayer is simply unsatisfactory. To revert to Patrick Hosking’s article: “In essence, for a fee, the government is guaranteeing RBS against 90 per cent of the losses in excess of the £19.5bn on a gargantuan portfolio of £325bn of problem loans.” Ominously this article reports that RBS’ “…loans and investments are turning sour at the rate of £41m-a-day, even worse than the £26m-a-day deterioration [recently] reported by Barclays”.
A modest attempt in the form of a clamor ex inculta was introduced in the House of Lords in April 2009 by Earl Caithness-the Safety Deposit Current Accounts Bill 2008. This Bill would force all banks and building societies to “…make available safety deposit current accounts” In which legal and equitable title to any money deposited would remain fully vested in the customer. Additionally it would require financial institutions to hold such money “…separately from the general or other assets” held by the debtor bank. Although the Bill failed to obtain parliamentary time in the last session, it is likely to be reintroduced.
Banks must consider offering to store money following the model set out in the accounts rules. This might offer one means of avoiding future economic meltdown, which will result if the system is not effectively reconstructed.