What was the main cause of the financial crisis, and what should be done about it? Some blame irresponsible lending and trading at the banks; they say the major banks should be broken up to separate wholesale market risk-taking from retail market service-provision. Others blame the regulators; they say the regulatory system should be reformed to become tougher and more proactive.
George Osborne has chosen to hedge his bets, taking on both the banks and the regulators. In his Mansion House speech on Wednesday night he said: “When a system of regulation fails so spectacularly, people are going to ask what replaces it. When the failure of certain banks have cost the country so much, people are rightly going to ask how to stop it happening again.” He went on to announce the abolition of the Financial Services Authority and the creation a new prudential regulator as a subsidiary of the Bank of England. At the same time, he promised an independent commission to review the future of the banking industry, paying particular attention to the state of competition in the industry “and how customers and taxpayers can be sure of the best deal.”
Granted, there are advantages in tackling both the financial regulatory regime and the structure of the banking industry together. For a start, it avoids the difficult question of where ultimate blame for the financial crisis should be placed. Second, it allows the coalition government to appease key policymakers in both coalition parties: Osborne has made clear his desire to abolish the FSA and Vince Cable his desire to break up the large banks. Why worry about either/or when you can do both?
But the radical restructuring of the regulatory system will be costly and time consuming. Anyone who has worked in a newly merged private company, or a public sector organisation created by the merger of two or more antecedent bodies, will know just how much energy is expended on internal matters, from deciding who will run which department and how the various technology systems are to be integrated, right down to the design of the letterhead and the staff policy on rail travel. In times of institutional uncertainty, employees tend to focus inwards—right from the top of the new organisation down to the bottom.
And this process—scheduled to last two years—could not be worse timed: it will occur while economic recovery remains uncertain, and the strength of bank balance sheets remains weak. The major banks, no doubt fearful of the restructuring that might be imposed upon them by the banking commission, have an incentive to shift their financial capital—and their best human capital—to where it will be most productive in the longer term: and that is not the boring utility-banking services beloved by their critics.
Given the current fragility of the financial system, one might think that this is not the optimal moment to embark upon a major structural reform of the banking sector. To consider doing so while the financial regulator is wholly self-absorbed in institutional change looks hugely ambitious. There are times when it makes sense to hedge one’s bets; at others, focusing on one task at a time looks to be the more prudent course.