Lydia Prieg is a researcher at the new economics foundation (nef). She wrote this on the Left Foot Forward blog yesterday:
A new report (pdf) by the new economics foundation (nef) estimates that the ‘Big Five' UK banks (Barclays, RBS, Lloyds, HSBC and Nationwide) enjoyed a £46 billion ‘too-big-to-fail' (TBTF) subsidy in 2010.
This subsidy arises because large banks are able to borrow at lower interest rates than they would be able to if they operated in a truly free market — a result of the implicit understanding in the market that the government will step in and bail out investors if a large bank defaults on its debt payments.
The report uses methodology developed by the Bank of England, and, for the first time, as Graph 1 shows, quantifies the TBTF subsidy for each individual bank.
Graph 1:
In addition to unfairly inflating banks' profits, these TBTF subsidies give large banks a huge competitive advantage (£) over their smaller counterparts. Moreover, even ignoring the financial value of this subsidy, while the market suspects the government will ultimately intervene if a bank gets into trouble, risks will not be fully shouldered by the risk-takers.
This undermines market discipline (£) and incentivises banks to engage in risky practices.
Finally, it is also important to recognise that while the TBTF subsidy does not involve the directtransfer of funds from the Treasury to the banks, it may involve an indirect transfer, as the interest rate at which investors will lend to the government may increase to reflect the additional risk the government is taking on board in effectively underwriting banks' balance sheets.
This upcoming Monday, the Independent Commission on Banking (ICB), otherwise known as the ‘Vickers Commission', will release its final report advising the government on how issues such as the TBTF problem should be addressed.
In its interim report, the Commission advocated ‘ring-fencing' the retail and investment banking subsidiaries within an investment bank. This is despite the Commission admitting that such an initiative will reduce but not eliminate the subsidy.
Furthermore, as ring-fencing will permit transfers between retail and investment banking up to a point, the taxpayer will still, to a certain extent, be underwriting investment banking activities.
So next time you hear the big banks cry foul of needless government interference, remember that government interference is worth billions to the industry. As long as the government offers such a subsidy, it is only fair that it set the banks the rules we need to avoid a repeat of the banking crisis, and insist that bankers contribute their fair share to society.
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The “free” market in action, eh? I despair…..I totally despair! 🙁
Things must be getting bad:
http://www.dailymail.co.uk/debate/article-2035795/DAILY-MAIL-COMMENT-Mr-Cameron-bring-banks-heel.html
Must be a spoof website, surely ?
More fun.
Looks like the electoral boundaries changes may be suspended for a while, or re-think:
http://www.politicshome.com/uk/story/20190/george_osborne_could_lose_his_seat.html
There is hope after all
But really it just means his seat will no longer exist and he will be given a shiny new one…and so the dismantling of the implicit social contract will continue. It’s rather ironic that Osborne’s the one who uses the line ‘we’re all in this together’ the most. Words being what they are most will hear social solidarity in that but he means the mess I’m creating in will fall on all your heads. Enjoy!
Robert Peston is now saying that the market is already treating the UK banks as if they are no longer supported by the taxpayer – do you agree?
http://www.bbc.co.uk/news/business-14851196
And if you do agree, why do you think the casino banks are so insistent that the will suffer immediate damage if they are rapidly cleaved from their high street anchors?
I agree only to the extent that this shows how unwise it was for these banks to have kept private status with the absurd vagaries that follow when it would have been so much better for them to have been brought into state ownership.
a) That would have let their casinos be killed or sold
b) Remutualisation of parts like the Halifax could have happened
c) Other elements could have become the new state investment bank we will not recover without
d) Some bits like insurers could have been sold
e) Their PFI assest could have been cancelled to help pay for the cost of the deal (if there was any)
f) Borrowing could have been provided
g) QE might have been managed in a very different way
But all we got instead was the crassness of the market that acts solely from fear – the worst motive of all
Oh, and if casino banks will suffer it’s because the market is pricing risk one way but the true cost of finance to casinos nis wrongly priced another way. They exploit wherever they go because arbitrage is their definition of entrepreneurship – and it’s about as far removed from that as it can be.
What we may actually need remember is that the cost of lending increase further – by removing tax relief for it to encourage real investment through capital – the sources of which just need liberation, as I have argued often
As you would expect, the largest subsidy goes to the part-nationalised banks. It is hard to see that the markets are unreasonable in expecting the government to step in to rescue banks it part-owns. Question arises as to whether markets are reasonable in expecting government also to rescue banks it does not own. History suggests they are right.
I’m surprised by the inclusion of Nationwide, though – it is hardly a systemically-important bank. I can only assume that prior experience with Northern Rock and Bradford & Bingley leads markets to believe that Nationwide would also be bailed out.
The sooner living wills and structural changes are put in place to enable the implicit government guarantee to be lifted, the better. People do need to realise, though, that if large banks have to pay true market cost for their funding they are bound to pass on that increased cost in the form of higher borrowing costs. However, savers might do better if deposits start to look like a more attractive funding option!
However, we still have a capitalisation problem, particularly with Lloyds, Barclays and – especially – RBS. Lloyds and Barclays may be able to obtain capital from private investors. But RBS is 84% state-owned. The additional capital it desperately needs can realistically only come from the UK government. Despite my (famous!) opposition to full nationalisation, I fear that very soon this may be necessary for RBS.
You still make the fundamental mistake of thinking a) there is a functioning market out there b) that there are separate banks c) banks will ever survive in a modern economy without implicit guarantee when the very product that they are allowed to create at will – money – is solely dependent for its credibility on governments.
The living will idea is crazy: it assumes banks will fail through random chance whilst all around them will be sound. We know that’s just not true. None will fail until all are at risk of doing so, then they domino.
You also make the assumption that RBS and Lloyds are helped because they’re state owned. No. Wrong again. They’re state owned because they needed help and so far we have not radically transformed them.
It’s not just nationalisation we need: it’s a recognition that this is simply not a market as taught on blackboards that exists here. In that case all the logic you and market based economists are offering simply makes no sense: banks are just not in that space.
“You also make the assumption that RBS and Lloyds are helped because they’re state owned”
At the present time that is correct. Yes, they are state owned because they needed help. But the markets are now pricing in their part-nationalised status on the basis that the government will support them because it part owns them. It is also obvious that the markets still believe that the government will support entirely private banks as well. Whether this would in fact happen is a matter for politicians to decide. I am merely commenting on market behaviour.
Living wills are being prepared as we speak, and structural reforms are being considered (although there is considerable disagreement about the shape and form that these will take). We have in the past had failures of individual banks without contagion – the immediate one that springs to mind is BCCI of course. Where the activities of a bank are either commercially unsound (excessive risk-taking, high leverage and poor management, as with Northern Rock) or fraudulent (BCCI, probably HBOS) there is no particular reason to suppose that contagion to healthy banks would ensue unless there are general problems with the entire industry – as there were in the financial crisis. Which brings me to your main point.
Your main point is really that the entire industry is dysfunctional. On that we agree. It’s the solution we don’t agree on.
Note Peston argues the exact opposite of you on pricing
BCCI was a fraud
It was not a bank
This is the rotten apples argument you’re using in the wrong scenario
The problem with this analysis is that it ignores the real world actions of the market, i.e. any bank that may need the support of the government actually pay more for funding. Take RBS, it is already 85% owned by the government, so is the most likely one to be supported by the government, yet counter-intutively actually pays significantly more for wholesale funding than HSBC and Barclays. Also the analysis is based on credit rating spread differences, whcih can vary signicantly between companies despite ahving the same credit rating.
But of course the biggest argument against it, is that is products are priced to yield a specific return on equity, then the subsidy is effectively passed on to the customer in lower interest charges. Perhaps if the banks had been charged for the subsidy pre-2007, we wouldn’t have had the ridiculaous credit expansion we saw in the UK>