Vince Cable: Our obsession with competitiveness risks another crash

In trying to understand the flaws and hubris that led the financial community into this disaster, I remember two seemingly innocent words that bankers used to explain their behavior. One was ‘innovation’, which turned out to involve the making up of complex, mathematically ingenious financial products that the bankers themselves did not understand.

The second was “competitiveness”, which essentially involved undertaking high-risk activities with extreme leverage – which was considered necessary because overseas or domestic competitors did, and bank shareholders had to be sure that the maximum return was achieved.

It also entailed massive bonuses for senior executives and traders needed to operate in a competitive transatlantic talent market.

Those who cleaned up the mess after the party ended – in my case in the coalition government – insisted on fundamental reforms to ensure that the same mistakes were not repeated. The Bank of England and overseas regulators agreed on stricter reserve requirements to minimize systemic risk.

Our government – aware that in the crisis the UK had some of the world’s largest banks measured by the balance sheet – insisted that banks should not, as far as possible, be considered too large to go bankrupt. If the taxpayer remained on the hook to save financial institutions, the banks would have to pay insurance in the form of a tax on the bank balances.

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A further reform, which was sufficiently critical that it was a condition for me and my party to join the coalition, was that risky investment banking activities should be clearly separated from mainstream banking, so that if something went wrong in the ‘casinos’, it is not cross-subsidized by banking activities that are vital to businesses and households.

Following the Vickers report and a lengthy implementation process, the necessary changes – ring-fencing – were implemented three years ago. Costs were complained about, although banks were spared the radical possibility of complete separation under the so-called Glass-Steagall reforms based on post-depression security measures in the United States.

Those who have studied the history of financial crises have often wondered why they occur with monotonous regularity. The simple reason is that the experiences of the previous ones have been forgotten. Greed or memory loss erodes restraint and discipline. A new generation is entering the industry, which has no recollection of past disasters, but which finds the rules of disaster prevention cumbersome and expensive.

Or new forms of risky activities are emerging – currently crypto markets – which are happily assumed to be of little systemic danger.

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We can see these forces working right now. The Chancellor has already listened to those who demanded a reduction in the insurance premium – the tax on bank balances – although there is no confidence that the test ‘not too big to fail’ has been met. What’s worse, banks have agitated to dilute the ring fence system.

It is reassuring that banks find ring-fence inconvenient and unprofitable; it suggests that it is doing its job. It is less reassuring that the Treasury seems to be listening to industry complaints.

We will know how far the government has been seduced by the lobbyists when we look at the details of the financial services bill that will be announced in the Queen’s speech on 10 May. It is widely expected that the Financial Conduct Authority and the Prudential Regulation Authority will have a statutory responsibility to promote international competitiveness in the financial sector along with pre-existing objectives of promoting consumer protection and competition between companies.

The importance of adding international competitiveness is well understood by those responsible for overseeing it. Andrew Bailey, who was the regulator at the FCA before becoming governor of the Bank of England, noted that during the pre-crisis regime “the regulator was obliged to consider Britain’s competitiveness and it did not end well for anyone.” .

The extensive autopsy of the crisis by the coalition government and by parliament found that the duty of the pre-crisis regulator Financial Services Authority to “take into account” international competitiveness contributed to the crisis, and the Ministry of Finance removed it.

Despite this recent history and the long and grim history of financial crises following the same cycle of carelessness, lax regulation and market abundance that led to a crash, nothing seems to have been learned.

These seemingly harmless words “international competitiveness” contain a lot of danger, and if the Financial Services Bill promotes them, I hope wiser councils in Parliament will prevail.