Iain Cornish: Give the banks time and set clear standards

The ICB was set up by the coalition Government in the aftermath of the financial crisis to come up with ways to make the financial system safer and to promote competition.

What the Chancellor does in response to the commission’s recommendations will have far-reaching implications, not just for the banks and for their shareholders (which includes all of us as taxpayer owners of large parts of the banking sector), but very directly for the economy as a whole. The judgments to be made are both complex and fundamental, with little consensus so far on the best way forward.

The background to the ICB’s work is, of course, a global financial crisis of almost unimaginable proportions, followed by a recession which has had a devastating impact on nations’ finances, businesses and individual households around the world, with the UK very close to the centre of events.

Although many factors contributed to the crisis, the international banking sector, including many of our own banks, was at its heart.

We have seen very vividly how dramatic the impact of a financial crisis can be, and how the previous system allowed a build-up of risk culminating in a scale of potential loss and economic damage which many individual financial institutions (and some countries) could not have withstood without unprecedented public support.

We have also seen how much of the upside in the good times went to shareholders and management, while much of the downside has been borne by taxpayers.

The banking sector is already a lot safer than it was in 2007, but all of us involved in the activity of banking have to recognise that the case for a fundamental overhaul of the system remains inarguable, and that the nature of the “implicit contract” between society and its banks has to change.

But putting aside the public perception and politics of banking, it is also undeniable that a healthy and prosperous banking system is an essential component of a vibrant economy.

At the moment, according to recent Bank of England figures, the major UK banks are receiving more money back from UK businesses in the form of loan repayments than they are making available in the form of new loans. This despite the fact that default rates on loans to large and small businesses are reported by the banks to have fallen, and demand by small and medium-sized businesses to have risen.

Ultimately, unless this situation can be reversed, and sound businesses can access credit at reasonable rates of interest, it is difficult to see how a sustainable economic recovery can be guaranteed.

We should also not ignore the fact that for the UK, financial services has been one of our most successful exports. It is estimated that financial services contributed more than £40bn to our balance of payments in 2009, and that the financial services industry accounts directly for around 10 per cent of our annual economic output. It may be desirable to build up other industries as well, but to “re-balance” the economy in this way will take many years.

From the ICB’s interim report it is widely expected that proposals will be forthcoming which, if accepted, would require the major banks to “ring fence” their retail and investment banking activities, so that the investment banking parts of an institution could (theoretically at least) be allowed to fail without jeopardising savers’ money or disrupting the wider banking system.

It is also likely that the ICB will support calls for the major banks to be required to hold more capital to give them a greater financial buffer against unforeseen losses. Overlaid on this the ICB is also expected to make proposals which would stimulate greater competition so that consumers get a better deal.

In the end, a balance will have to be struck between the conflicting objectives of greater resilience and a desire for increased lending. The only way of resolving this is to give banks time to adjust and also using this time to press for international consensus.

While the glide path has to be a measured one, my own view is that the process must start now by setting clear standards which the banks must continue the process of getting to, or we risk losing the momentum for change, possibly until there is another crisis.

There has been far less focus on the ICB’s thinking on promoting competition. Virtually every survey shows that customers are not satisfied with the service which they get from most of the major banks.

Yet the stranglehold which they have on the market, and the difficulties of changing suppliers (some real and some perceived), put a great many customers off shopping around – giving the major banks less incentive to raise their game and making it harder for new entrants and smaller competitors to provide an alternative.

The ICB has proposed beefing up the required Lloyds branch sell-off, which barely scratches at the surface of the issue, but has otherwise largely passed the competition reform agenda onto others. And in my view this is a wasted opportunity.

• Iain Cornish is chief executive of Yorkshire Building Society.