Drape ourselves in black and don the funeral weeds. The “permanent loss” of Edinburgh’s “leading position in the banking industry” is a “tragedy”. Scotland’s capital is “never going to recover the position that we had for centuries in banking”. So declares Professor John Kay, a former member of the First Minister’s Council of Economic Advisers and a visiting Professor of Economics at the LSE.
Well might we grieve the loss of our reputation for prudent banking and the loss of some 10,000 jobs as RBS and HBOS, now part of Lloyds Banking Group, savagely curtailed their operations. The collapse of RBS and HBOS scythed through the professional services sector in Scotland. At least eight prominent law firms either collapsed or merged in the wake of the crisis.
But we should not weep long. On any objective consideration, the near collapse of these two banking giants and their subsequent curtailment was a direct consequence of grievous errors and misjudgements, an unsustainable, helter-skelter pace of expansion and an all-too necessary purgative. In some respects we were fortunate that the collapse was not worse. The ascendancy of Edinburgh as a capital of warped banking did the rest of Scotland’s economy few favours. Even within the capital itself, it tended to obscure the other financial sector activities such as pensions, insurance, fund management and asset servicing where Edinburgh continues to do well.
On a broader view it was often assumed that the acquisition-fuelled expansion of RBS and the appearance of the RBS name and logo around the world’s financial capitals was an acceptable compensation for stagnation and decline elsewhere. Our economy became ever more unbalanced – and remains so despite government exhortations. The retreat of RBS back into a retail service function with renewed attention to small business lending and shorn of its global investment banking operations will be welcomed by many. Indeed, it is a necessary condition of its survival and recovery.
Professor Kay is certainly right about the continuing malaise in banking. Almost eight years on from the debacle the global banking industry is still wrestling with proposals for “ring-fencing” banks’ retail operations to protect them in the event of serious stress in their other activities. Policymakers have placed enormous emphasis on ring-fencing strategies and measures to boost capital.
That emphasis on capital adequacy is understandable. Banks’ capital ratios had, by 2007, fallen to levels that left very little margin for error in their business decisions. But is the enforcement of much higher capital requirements on banks an adequate response to the problems revealed during the 2007-9 global financial crisis?
As the economist Stephen Lewis argues, banking institutions incurred losses which, even had they held capital sufficient to meet the requirements that regulators now plan to impose, would still have rendered them insolvent several times over. Some bank activities in derivative markets – much of them of dubious economic or social benefit – could have proved so toxic that no capital requirements are ever likely to be enough to cover potential losses. Culture change still needs to be pursued, and measures to minimise the chances of fresh troubles occurring in financial markets given higher priority.
So much for “emergency” low interest rates. After the Bank of England’s Inflation Report last week we look set for ultra-low interest rates to persist well into next year, with some predicting no increase until 2017.
There is a fundamental “weirdness” about this nine-year emergency – both for the real economy and for savers. It will encourage even the cautious to push out along the risk curve to obtain any meaningful yield on long term investments.
And the risks are rising. It’s all very well to chase higher yielding equities. But how secure are the dividend yields on offer? We have recently seen dividend pay-outs from giants such as Royal Dutch Shell, BP and HSBC. But HSBC has announced a 14 per cent drop in adjusted profits, BP unveiled a $5.8 billion loss, and Shell reported a Q3 loss of $7.4bn.
Ironically, rather than those global corporate behemoths providing “safe” returns to shareholders, better prospects are likely to lie in the mid-cap FTSE 250 sector. UK companies trading in consumer-facing sectors stand to be the beneficiaries of continuing low interest rates.
The worry for those saving for retirement is that the continuing low interest rate regime – more a reflection of global uncertainties than any weakness in the UK domestic economy – encourages a greater exposure to equities than would normally be tolerable. Such is the unnerving result of ongoing “savers’ repression”.