Martin Flanagan: Mervyn King lays out his radical reforms for bank system

Published on Tuesday 26 January 2010 20:05

BANK of England Governor Mervyn King took a break from the day job yesterday – judging interest rates and economic stimulus measures – to reflect on the means of making the banking system safer.

• Mervyn King

Merv told the Treasury committee there was no "silver bullet" to solve the banking sector's problems (the day a central banker says there is a silver bullet for our troubles will be worth the admission money).

Instead, King, like his central bank counterparts, is renowned for placing shoot and hip as far from each other as possible.

You can't blame them. Hostages to fortune and all that.

So King told the MPs that Barack Obama's plan to constrain deposit-taking banks from owning hedge funds or private equity groups and playing the casino (the latter "proprietary trading" for the genteel) would not fully solve the too-big-to-fail problem.

Instead, King said, the American president's action and tough talk showed radical change was on the table.

There were no simple answers, the Governor said, as previous generations would have probably come up with them if they were so simple. Common sense suggests this is true.

King suggested a triple-pronged strategy of putting banking's house in order while leaving open the question of whether banking leviathans should be broken up or not.

First, capital and liquidity levels should be raised, but gradually in the case of capital so as not to choke off the nascent economic recovery.

Second, "living wills" could be introduced to allow the orderly winding down of troubled banks, Adair Turner's brainchild at the Financial Services Authority (although the idea of anyone getting round to making a will after they have already died suggests a perverse tendency to procrastination).

And, third, King suggested a debate about how the structure of banks could be changed over time.

The BoE chief also backed away from previous speeches in which he had appeared to back breaking up big banks, perhaps having suffered a nosebleed earlier from going north of central-banker nuancing in the overtaking lane.

Now the Governor feels it should just be an option and a robust banking system could potentially be based on smaller business models, or not.

The one area where King seemed most definite was that the so-called "Tobin tax" on financial transactions was way down the list of radical banking reforms as it did not go to the heart of the too-big-to-fail issues like Obama's levy on banks has done.

Another leading British banker has said privately to journalists that Obama's bombshell "levy" has grasped the nettle in a way the British authorities have signally failed to do.

Now the spotlight swings to next week when King returns with the rest of the BoE Monetary Policy Committee to the more specific issues of what to do with interest rates and whether to bump up quantitative easing (electronically printing new money to help stimulate the economy) or allow the 200 billion current programme to now peter out.

These are somewhat more tactical problems for the BoE compared with yesterday's strategic head-scratching of whither the banking sector.

Even with the renewed spectre of inflation, it is unlikely the Bank is ready to raise interest rates from their current historic low of 0.5 per cent, where they have been since last March.

As mentioned above, King is fretful of choking bank lending to get the economy going again through raising banks' required capital levels too quickly.

The committee is also mindful of the need not to choke off that recovery by the alternative route of lifting rates.

And quantitative easing? The extremely limp move out of recession just confirmed makes the call harder on whether the BoE extends the programme.

But the City consensus remains that King and co will not add to the current QE programme.

Next week's MPC outcome will have less blue-sky thinking around it than yesterday's debate at the Treasury committee about the future of banking.

But, in the short term, the MPC's decisions could be profound for the economy.

My instinct is we will see nothing new on rates and nothing new on quantitative easing.