Taking the Temperature of Banking Stephen Regan Steve Today we are going to look at the state of health of the banking industry. Macaulay Joining me in the studio today is Stephen Regan. Now Stephen has made a special study of the industry. Stephen, we last met in the studio nearly six months ago; what has changed since then? Stephen Regan The main change has been the industry has now settled down to its new structure. The principle things, as far as I can see, are that we now have a small group of universal global banks. That group is largely dominated by European banks: HSBC, Barclays – which has survived the crisis rather well – and Santander – which is a large Spanish bank. There is also a group emerging of very powerful national players; Lloyds Banking Group for instance, with 30 million customers is now a very powerful but solely UK player. That appears to be the main consequence of the banking crisis so far. Steve Now banking has been almost universally condemned. What is your view Macaulay on what banking is up to; where is it going; how is the state of health of it? Stephen Regan What people fail to realise is that banking is an enormously high returns industry, but it’s extremely volatile. And banking is essential to any modern capitalist economy. When banks lend, economies grow; when banks stop lending, economies contract. So I am afraid, like it or not, banking is essential and the fact that banks need to be better run is also very important for someone like me who is involved in management education. Steve Can you see any signs of real change and reform? For instance, one of the Macaulay things is a call to return to what is called old fashioned banking; on the other side there are people saying the real trouble has been a cosy club at the top, what we need to do is break this up? Stephen Regan Well actually there has been a lot of criticism of non execs being rather too supine and there is some truth in that. The main crisis, the main thing I have learned from banking, is that there has been rather poor governance. Perhaps that is to do with the size of the institutions and the degree of lack of knowledge about just how complex and how risky these businesses really were. But it wasn’t just non execs; there were executive chairmen, there were regulators. There were executives on the boards of businesses, none of which have behaved particularly well. I think there are some very significant lessons to be learned here. Steve One of the things that has been almost unique really is the amount of Macaulay money that the government has pumped into this; many people are saying why shouldn’t we have our pound of flesh here? We actually own a lot of these banks or near own them, we should be exerting more influence. © Cranfield University July 2009 1 Stephen Regan
What is your view on this? Stephen Regan That would be a very bad idea. We will get our pound of flesh because these banks will return to profitability and the scale of the leverage, if you like, that the UK taxpayer now has – the average UK tax payer owns about £3,000 worth of a bank – that will return sign cant profits to them. It may take several years for that to happen, but there will be that return. One way of slowing it down would be if banks get too close to government or if government gets too close to banks. One thing that Gordon Brown has done rather well is that he has tried to separate powers as far as possible in order to try to allow banks to do what banks do. The problem is that the people who have been regulating the banking industry have not been close enough in terms of understanding the markets day to day. But that doesn’t necessarily mean to say that I would want a government minister sitting on the board of a bank. That would be a very bad idea, I think. Steve But people are saying, for instance, if there was more money available for Macaulay housing and lending generally, the economy would start to pick up, things would change. Stephen Regan That is almost the definition of a banana republic; that the government owns the banks and diverts money into special projects that suit its own political purpose. That would be an absolute disaster. Steve One of the things where government interference if you like, or government Macaulay influence, has been called for is the issue of large bonuses and people are now starting to say, look, here we go, we are back to large bonuses again; nothing has changed, people are pocketing millions. Stephen Regan What people fail to realise is just how important – and we are talking about investment banking particularly –investment banking, yes the salaries and the bonuses are – a word that has been used and it’s not inappropriate is obscene. But the key point is that certain banks have rules of thumb, for instance Goldman Sachs – they will routinely pay out 50% of their income. They will pay it in salaries because the only asset they really have are people and they compete for talented people. It is very hard for most people outside that industry to understand the degree to which you can get enormous returns on talented people and how few people are capable of doing some of these rather difficult, rather complex things. I am afraid if you want to have banks, and you want to have banks in London, you are probably going to have to compete at those global salaries. If you don’t want to have banks in London, then don’t pay those salaries. Steve So if I ask you in six months time to say what state is the banking industry in Macaulay now, or maybe 12 months time, what sort of things are you likely to see? And also, realistically, what would you like to see? © Cranfield University July 2009 2 Stephen Regan
Stephen Regan I think banks will still be under pressure. I think they will be getting the blame for all sorts of things like what’s happening in the gilts market, which we can see beginning to build up right now. So I think there will be a degree of unwelcome political exposure for some of the chief executives with those banks and they have got to realise how to play that game well because they have got businesses to run as well. There is a kind of holding pattern at the moment; there is not anything like the levels of lending that we would like to see, certainly from retail banking. And I don’t see that changing any time very quickly. The main thing I would like to see would be the beginnings of something that looks like a workable regulatory structure. And the danger here I would point to is nearly always the new regulatory regime replaces the mistakes that the last regime didn’t fix. And what we need to have is regulation that is forward looking. We need to have a very clear idea about where banking is going in the future and to design regulatory structures that allow banking then to start to move forward. Because a well designed regulatory system should take out risk and it should allow banking to start to do the thing that it’s meant to do, which is to allow economies to grow. Steve So Stephen, thank you. We will meet again in six months time and review Macaulay the situation then. © Cranfield University July 2009 3