July 24, 2012 7:10 pm

Reforming British banking after Libor

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Only incisive measures can restore confidence in the City

The ripples from the Libor scandal are still spreading through Britain’s financial system. Following the forced resignation of Bob Diamond, Barclays chief executive, the regulators – and in particular, the Bank of England – are under growing pressure to explain why they did not spot the misconduct that was happening on their collective watch.

The reputation of the City of London has been dented – both domestically and abroad. Americans in particular have once again been quick to cast London as some sort of financial wild frontier.

Disillusion with the banks also remains high. Much of the public believes that financial liberalisation has brought little or no benefit at all to the ordinary citizen. The banks are seen as having taken little interest in the real economy, preferring to exploit consumers for their own narrow financial benefit.

But all these accusations, while strongly felt, are at least partly undeserved. If British regulators were asleep while Libor was manipulated, American watchdogs were scarcely alert. Not all investment banking activity was damaging, and the profits and overseas earnings it generated helped to finance public services. There is a danger that in the current mood of revulsion, these considerations are forgotten.

This does not mean, however, that Britain can avoid a detailed re-examination of what went wrong in the City. Lord Turner, chairman of the Financial Authority, has given a speech on how he would like the British banking system to change that offers a useful jumping-off point for such an analysis.

The speech, it should be admitted, was not necessarily a wholly selfless exercise. This autumn, the government has to decide who to choose to replace Sir Mervyn King as the next governor of the Bank of England. Lord Turner’s speech – alongside another one he gave this month on the future of monetary policy – are widely seen as a way of throwing his hat in the ring for the succession.

Lord Turner may have addressed the grand sweep of the reforms that are necessary – from prudential policy, industry structure and conduct supervision to the culture and values of the banks. But many of the practical changes he proposed were hardly revolutionary. While willing to entertain changes to the structure of the industry along the lines proposed by the Independent Commission on Banking, he showed little interest in the full-fledged separation of retail and investment banking that this newspaper has advocated.

He had more to say on the future of supervision. For example, his suggestion that Britain should regulate more heavily the wholesale selling of financial products makes sense. While it is true that in wholesale transactions both parties are typically quite sophisticated, when a pension fund is mis-sold a product the final victim is a less knowledgeable policyholder. For this reason it is right that the regulators should be given the powers to ban products for the wholesale market, just as they will in the case of retail investors.

On questions of culture and enforcement, it would have been good to hear Lord Turner call for a more muscular approach. If the UK is to restore confidence in the City of London as a national asset, policy makers must take a tougher line on enforcement.

Where critics are right is in claiming that the British system lacks sufficiently severe penalties for wrongdoing. It is simply absurd that no one of any significance has been prosecuted for any of the scandals that have been uncovered since the crisis. When organisations are unwilling to reform themselves, then the penalties of wrongdoing need to be stiffened to the point where bankers conclude that it is no longer in their interest to break the rules.

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