Weaknesses in the UK banking system

Weaknesses in the UK banking system

Weaknesses in the UK banking system

Introduction

Banking is unlike any other industry; this has been made abundantly clear in the current crisis. Banks have two major privileges that are not enjoyed by normal commercial businesses. The first is the ability to create credit - a fundamental function that underpins the health of the whole economy, and closely connected is the second privilege arising from the implicit and explicit government guarantees of banks solvency.

Discussion and analysis

The phrasing of this criterion in the Terms of Reference seems to contain implicit assumptions that the UK sector's international standing equates to domestic competitiveness, and secondly that the international competitiveness of the UK?s financial and professional services sectors is synonymous, or at least consistent, with the competitiveness of the wider UK economy. These assertions would need to be tested in our view, as there are prima facie reasons to suggest that the two objectives of international competiveness of individual UK financial services firms and the international competitiveness of the UK economy overall might conflict. It is beneficial for an individual UK-based firm to achieve maximum scale and scope to compete internationally, particularly with a profitable domestic market providing a bedrock to its international expansion plans. But there is no inherent reason why the positive benefits of overseas earnings from global UK banks will necessarily outweigh the potential raised costs to domestic industry of an oligopolistic banking sector. The Government's own focus on ending over-dependence on financial services implies that such conflicts might exist. The UK may have been suffering from a form of financial „Dutch disease?, where a single dominant sector of an economy can inadvertently distort general economic conditions to such an extent that other sectors are undermined. This famously occurred in the Netherlands upon the discovery of natural gas deposits. This valuable export sector drove up the value of the Dutch currency, making exporters and manufacturers in other sectors less competitive, and worsening the general balance of trade. Even if there is no causal link between the expansion of financial services and the decline of other industry sectors, the relative decline of non-financial sectors has been easier to view as non-problematic as long as the City continued to grow. (Gola, 2009)

There are two sources of risk to the government's fiscal position: the deterioration in the public sector borrowing requirement that results from sharp recessions associated with banking booms and busts, and the additional cash (i.e. bail-outs) and notional (i.e. value of free insurance) costs of guaranteeing banks? solvency. We believe that any reforms must seek to reduce both of these risks both from the point of view of the primary objective of stability, but also from the point of view of the broader economic, social and environmental definition of the purpose of banking that we take as our starting point. (Prentice, 2011)

The fact that banks create credit in this fashion means that the money supply is endogenous to the economy; the most likely ...