Vince Cable on ongoing banking scandals: 'the rot was widespread, the corruption endemic'

In a Guardian column, UK Business Secretary Vince Cable calls for urgent action to be taken to reform the UK banking system.

Regular readers know that real reform of the UK banking system requires the adoption of ultra transparency.  When banks are required to disclose on an on-going basis their current asset, liability and off-balance sheet exposures, they don't engage in activities like manipulating the Libor interest rate or taking proprietary bets.

Sunlight is the best disinfectant for these types of activities.

Instead, Mr. Cable wants a number of reforms passed that would not have prevented the financial crisis or the Libor Scandal.

Last week's banking scandals demolished a convenient myth: that the banking crash was all the fault of a few colourful rogues like Fred the Shred of RBS and Adam Applegarth of Northern Rock. We have been reminded, instead, that the rot was far more widespread. Incompetence, corruption and greed have been endemic in British banking....

The same can be said of the EU and US banking systems.

The Libor scandal demonstrated deeply corrupt practices at the heart of Barclays Capital, our leading investment bank, and at others too. The public cannot understand how a corporate fine – which will be passed on to customers and shareholders – begins to address the problem.

 The fine does not address the problem.  It is a cost of doing business for the banks.

Then there is the greed: the bonus-driven mis-selling of complex financial derivatives (in the wake of payment protection insurance and other scandals). Tens of thousands of small businesses were told that they could have a bank loan only if they also bought products that neither they nor the bank salesmen understood....

Faced with a moral quagmire of almost biblical proportions, what should be done? 

One of the suggestions from Labour is a costly Leveson-style public inquiry. It would certainly be enlivened by Ed Balls explaining why, in government, he allowed the regulatory mess to occur in the first place.

A costly public inquiry could in fact be a very good thing.

In Ireland, they spent some money investigating the causes of their financial crisis and the result was the Nyberg Report.  This report showed that the politicians and regulators were also at fault in supporting the bad behavior by the banks that lead to the financial crisis.

There is not a single shred of evidence to suggest that a costly public inquiry in the UK would not come to exactly the same conclusion.

Instead we have announced an urgent independent review into the operation of Libor and professional standards for bankers, to enable us to make changes via bills currently going through parliament. And this week we will launch a consultation on criminal sanctions for directors of failed banks, following the recommendations of the FSA report into RBS.

Mr. Cable's solution suggests that the UK policymakers and regulators know what is the solution for cleaning up the banking system.

Sorting out the mess involves several steps. First, the banks have to be made safe so that there is no risk of further collapse.

As regular readers know, modern banks are designed not to collapse as they are supported by both deposit insurance and access to liquidity from a central bank.  As a result, they can have massive negative book capital levels and still operate and support the real economy.

This the present government has done by toughening regulation. 

The problem is that safer banks have become zombie banks, incapable of maintaining a sufficient supply of affordable credit to small businesses and householders to support a growing economy. 

The government and the Bank of England are together ensuring that banks have capital and liquidity; the challenge now is to ensure that highly paid bankers use them and are rewarded for sensible banking rather than the present combination of hoarding and speculative trading.

It is the very policies being pursued by the government and the Bank of England that have turned the banks into zombie banks with a focus on hoarding and speculative trading.

First, nobody believes that bank book capital levels reflect reality.  This was confirmed this week when the Bank for International Settlements, the central bankers' bank, called for regulators to require banks to recognize all of their losses.  At a minimum, this uncertainty about the losses on other bank balance sheets causes hoarding as banks don't want to lend to each other if they might not get repaid.

Second, by calling for higher book capital levels, the government and BoE give bankers an incentive to cut back on lending.  The fastest way for a bank to improve its capital ratio is to let a loan mature and replace it with a government bond.  So the government and BoE call for more capital is a call for less lending.

The second step is to carry out the government's agreed Vickers reforms, which stop contamination between casino-style investment banking and traditional retail and business banking. Putting investment bankers in charge of high-street banks is like putting mice in charge of cheese supplies. The wisdom of clearly separating investment banking and traditional banking, through ring-fencing, has been reinforced by this week's events and it is now down to parliament to expedite the reforms.

The simple fact is that the Vickers reforms would not have prevented the financial crisis that began almost 5 years ago or the current Libor scandal.  At best, they are like eating chicken soup when one is sick, they cannot hurt.

However, when it comes to cleaning up the banking system and changing the culture of the banks, they will have minimal impact.

Third, there has to be accountability. Regulators are a backstop: they don't own banks. 

The governance at the top of our leading banks has been lamentably weak. No one at the top of Barclays will take responsibility for systemic abuse. Shareholders, the owners, have a major responsibility here. I am bringing in legislation to strengthen their control over pay and bonuses, through binding votes, but shareholders have to get a stronger grip on weak boards and out-of-control executives. And our range of criminal sanctions is currently narrow compared with tough jurisdictions like the US.

There is a reason that governance has been lamentably weak.  That is because Regulators are an impediment to market discipline.  Regulators have an information monopoly on each bank's current asset, liability and off-balance sheet exposure details that they jealously protect.

This is the data that market participants need if they are to independently assess each bank and exert discipline on its management.

If Vince Cable and his government are serious about reforming the UK banking system and changing the culture that gave us the financial crisis, Libor scandal, and derivative mis-selling, they will require the banks to provide ultra transparency.