The Public Duties and Social Responsibilities of Big British Banks
Mullineux, Andy, International Advances in Economic Research
Abstract The implicit social compact between the big British banks and the U.K. government broke down in the 1980s. Since then, the banks have sought to maximize shareholder value by closing less profitable branches, thereby reducing access to finance and increasing risk taking. Post-1990, the big banks also substantially increased their dependency on wholesale funding and dramatically reduced their liquid asset holdings, which increased their leverage and risk exposure. The U.K. government's response to the financial crisis was to encourage mergers between banks, increasing concentration in the industry. The government bail-outs allowed the big banks to enjoy free insurance paid by taxpayers. The establishment of an autonomous retail banking (and insurance) utility regulator and a system for taxing the big banks fairly is recommended.
Keywords Bank regulation Corporate governance Corporate social responsibility
JEL H41 - G21 - G38
An implicit social compact between the big London clearing banks and the government broke down in the 1980s (see Mullineux 1987). Since then, the big British shareholder-owned banks have sought to maximize shareholder value by increasing their return on equity. This has involved reducing costs by closing less profitable branches, for example, and increasing risk taking; and yet retail depositors, not shareholders, traditionally supply the bulk of funds. Since the mid-1990s, however, the big banks have substantially increased their dependency on wholesale deposits and bond finance and dramatically reduced their holdings of liquid assets, thereby increasing their leverage (and risk exposure), as revealed by the Global Financial Crisis (GFC).
The British government's response to the crisis following the Northern Rock debacle has been to encourage mergers of weaker banks with stronger ones--increasing concentration in the banking industry and potentially reducing competition and aggravating the too big to fail (TBTF) moral hazard problem in banking. An Independent Commission Banking (ICB) was established by the government in 2010 to recommend a restructuring of British banking designed to assure competition and reduce the risk of another systemic banking crisis. It is due to report in September 2011. Major structural reform is, however, unlikely as the government is committed to maximizing the value of the bank shareholdings, by UKFI (including over 40 percent of Lloyds Banking Group and over 80 percent of RBS) it accumulated as part of the rescue package it launched to save the banks.
The British government thus faces a choice between meeting the short term goal of maximizing the returns to the taxpayer from selling UKFI's shares in banks, and increasing the long term benefit to the taxpayer from undertaking structural and taxation reforms. This thereby reduces the taxpayers' exposure to the risk of future banking crises and increasing consumer protection in retail banking. The big banks have thus been revealed by the government rescue package to enjoy insurance by taxpayers which they are not paying for in full. This reflects the collapse of a wider social contract between the British government and the big British banks that are over a century old (see Davies 2008). This involved the Bank of England, through its lender of last resort (to the major clearing banks) function underpinning bank money creation and thereby allowing them to profit from it. In return, the banks were supposed to maintain confidence in the payments system; which is essentially a natural monopoly in the sense that only a few providers are needed to achieve economies of scale.
In the GFC, the big banks clearly abused the trust placed in them and should either be made to pay in frill for taxpayers' insurance, or acknowledge their duty to the taxpaying public as a result of receiving it, perhaps by signing a new social contract. That seems unlikely, and instead the big banks tried (in late 2010/early 2011) to strike a deal with the government (Project Merlin), trading lower bonuses and more small and medium sized enterprise (SME's) lending for a lower regulatory burden and lower special taxes on big banks fairly. …