In his article in yesterday’s Financial Times,“’Too big to fail’ is still a threat to the financial system”, Bob Diamond justly calls for international, coordinated, consistent action on bank resolution regimes, and a moratorium on incoherent domestic proposals. He gets it; but does our government? In a few weeks’ time, the Financial Services (Banking Reform) Bill reaches committee stage in the Lords with clause 9 intact. This outrageously proposes that in a winding up, other banks that have had to dip into their pockets to compensate small depositors will have their claims preferred over those of anyone with more than £85,000 at risk.
Written evidence before parliament since April points out that such a provision effectively serves to subordinate bank deposits, which are not however commensurately rewarded.
While it is politically bizarre to prefer banks to the claims of individuals and businesses, this is not just a matter of fairness. The proposal ensures that the most basic function of banking can only take place under the aegis of the implicit guarantee the government is trying to remove, and means that in a crisis every such depositor would be mad not to run at the first opportunity. Once on the statute book multinational companies may realise that their short term surplus funds cannot be safely managed in London, and this measure will drive such deposits to Frankfurt or New York, with grave implications for the banking industry.
At the time the legislation (and the written evidence) was drafted, there was some uncertainty regarding the impact of the European Commission’s impending rules on state support for banks. In fact in a communication released in July, the Commission, perfectly sensibly, makes it clear that the burden of failure should be shared by equity and the holders of hybrid capital and subordinated debt; but it will not require senior debt holders, including uninsured depositors, to contribute. As the accompanying memo puts it, “The ultimate aim of the proposal is to make sure that the financial sector pays for its own failings.”
Clause 9 proposes to insulate the financial sector from its failings. It is a proposal which can only weaken the stability of banks in a crisis once depositors understand its implications, and it is now seen to be both unnecessary for European compliance and contrary to international principles of bank resolution. I hope the government will follow Bob Diamond’s advice in relation to it.