Six tests for the Banking Commission


This article was first published on the Guardian on 12 May 2011.

 As the chancellor at the time, Alistair Darling, said last month, "We were at the stage where -- in a very short period of time -- one of the world's biggest banks would have to shut the door and switch off the electricity."

He was talking about the Royal Bank of Scotland which, had it fallen, would most likely have brought down a whole pack of cards given the panic and contagion that would have followed. Yes, Britain stepped right up to the precipice, stared in and at the last moment pulled back thanks to a £50bn lifeline from the last Labour government.

It is worth remembering this as we digest the interim report of the Independent Commission on Banking (ICB) today. Established by the coalition government last summer, the ICB is tasked with examining structural and non-structural measures to promote stability and competition in UK banking.

The report will identify the leading reform options under consideration -- a final staging post before the publication of the final report in September. Here are six tests I would apply to the ICB's proposals:

1. Do they protect the social utility function of banks?

Banks provide payment systems, core deposit and lending facilities that enable us to manage our day to day affairs. These were jeopardised during the crash and it is essential they are insulated from future shocks to the system.

2. Do the proposals prevent banks from becoming "too systemically important" to fail?

As the governor of the Bank of England has argued, we have to find a way to allow banks to fail without bringing down the rest of the system. Today the promise of government capital at times of stress amounts to an implicit subsidy by the British taxpayer to the banks calculated to have been equivalent to an astonishing £100bn in 2009 alone.

3. Do they help promote jobs and growth in the economy?

The structure and behaviour of the banking sector shapes the rest of the economy, so the recommendations need to support economic recovery and investment in other sectors so as to reduce our over-reliance on the financial services sector.

4. Do the proposals better democratise financial services, for example, through the promotion of financial mutuals?

Mutuals are traditionally more risk-averse and generally emerged from the crisis in better shape than the banks. Democratic, long-termist and grounded in the communities they serve, they must play a greater role in the post-crisis economy. What the ICB says on the future of Northern Rock, an ideal candidate for a return to mutual status, will be an important touchstone.

5. Do they increase competition in the sector?

As our recent Treasury select committee report found, there is insufficient competition in the retail banking sector. The financial crisis precipitated consolidation in the sector leaving the "big four" banks (HSBC, RBS, Barclays and Lloyds) with unprecedented dominance; in the interests of customers and the economy as a whole, this high level of market concentration needs to be addressed.

6. Do the recommendations enable the City to remain competitive internationally?

The above tests coexist with the need to sustain the international competitiveness of Britain's financial services sector (which before the crash rendered a huge amount of money to fund public sector investment). We must ask of each of the recommendations whether any cost to the City's standing is genuinely outweighed by the benefits of their implementation.

The status quo is clearly not an option. In its original form, the word krisis referred to the "turning point" in the plot of an ancient Greek drama; today the financial and economic crisis puts the onus on regulators and politicians to enact "pivotal change" that not only prevents a repeat of the last crash but helps prevent a new and different one from occurring.