The Finance Innovation Lab held a joint seminar earlier in the month, with the leading centre-left think tank, IPPR.
The event looked at questions of banking reform through the lens of our Disruptive Finance Policy project.
Chaired by IPPR’s Chief Economist, Tony Dolphin, who has just published a report calling for a British Investment Bank, the other speakers were Baroness Susan Kramer, from the Liberal Democrats, and Professor Richard Werner of Southampton University. I led of the event with an updated version of the Prezi on disruptive finance policy options, particularly focusing on the policies relating to banking.
Richard Werner presented fascinating evidence that the main assumptions of economics simply do not hold for the economy of money supply. His presentation, well worth reading in full, first showed how cutting interest rates is not a driver of economic growth, but the causation is in fact the other way round.
Where as the received economic wisdom is that high interest rates lead to low growth and low interest rates lead to high growth, the economic data actually shows that high growth leads to high interest rates and low growth leads to low interest rates.
The reason for this lies in the fact that banks can use credit for three broad purposes: lending for consumption, financial speculation or investment. Lending for consumption and speculation both lead to inflation, where as lending for investment helps create growth but not inflation.
At the heart of the crisis is that too much credit is used to fund consumption and speculation. Simply increasing the capital requirements of banks fails to address this because the risk weightings applied through the Basel rules encourages banks to lend higher proportions of their balance sheets to property and speculation as the risks (to the banks) of lending to productive businesses are higher.
Werner’s solution is that central banks should use credit controls, or guidance, to force banks to ration the lending that goes towards unproductive and inflationary activities. This could be a role for the Bank of England’s Financial Stability Committee (FSC).
Alongside this ‘top down’ solution, Baroness Kramer, a front bench spokesperson for the Lib Dems on the Financial Service Bill, spoke about the ‘bottom up’ barriers to new entrants in banking and also alternative finance providers such as peer to peer lenders.
She was absolutely clear that the big banks are no longer fit for purpose to provide sufficient lending to UK businesses and urgent reforms are needed to correct this market failure. Susan is on the Joint Parliamentary Inquiry into Banking, which was set in the wake of the LIBOR scandal, and gave an upbeat perspective on the power that Inquiry will have to call for changes.
It is better resourced than any other Parliamentary Inquiry has been and the members are taking the task very seriously. On policy she had several recommendations that would help break down barriers for new entrants.
Peer to peer finance platforms need some form of proportionate regulation and the right secondary legislation could give the new regulator, the Financial Conduct Authority (FCA) the right framework.
There were signs that the government is becoming more engaged with these issues than in the past, although still holding out against any new regulation. The Finance Innovation Lab will be hosting a Peer-to-Peer Policy Summit on December 7 where these issues will be examined in more detail with the P2P industry, politicians and officials from HM Treasury, BIS and European Commission.
The other new regulatory body, the Prudential Regulatory Authority (PRA) will have responsibility for issuing new banking licences.
Susan believes that the PRA should be given specific responsibility to deal with market failure in the banking system, which would mean greater focus on bringing new entrants, particularly small banks, into the system.
This debate will happen as part of the Banking Reform Bill, due to come to Parliament in January. There is a risk that these issues may get overshadowed by the debate around splitting retail and investment banks, where as both issues are critical.