Towards stable and competitive banking in the UK - evidence for the Independent Commission on Banking (ICB)

Abstract

In order to achieve all the goals aimed at by the ICB, two reforms are necessary that are of modest nature and that allow banks to continue to function largely as they do currently (specifically, they allow banks to continue their creation of credit).

These proposals are to

- impose direct regulation of the quantity and quality of bank credit

- change the structure of the banking sector in the UK to make it more similar to the
German banking sector.

The regulation of credit would take the form of restricting bank credit creation for transactions that are unsustainable – namely transactions that do not contribute to GDP, i.e. the financial transactions. Furthermore, the government (or central bank) should control the quantity of credit that banks are allowed to create, while closely monitoring the allocation (the use credit is put to). The ‘guidance’ of the quantity and allocation of credit towards productive purposes has been the single most important factor in the success of the ‘East Asian miracle’ economies Japan, China, Korea and Taiwan.

The reform of the banking sector would introduce a large, but currently virtually non-existing element of locally-owned banks. These would take the two competing forms of local cityowned banks and local credit unions (cooperative banks). In Germany, they account for about 70% of the banking sector, while in the UK currently for less than 1%. It is argued that this banking structure has been the single most important structural reason for the performance of the German economy, as well as other countries (such as Japan).

The proposed reforms would achieve the goals sought by the ICB, virtually without the need for any other reforms. The costs and disruption of introducing the reforms would be minimal, while the benefits would be significant. They would include the end of the boom-bust cycles and banking crises, while achieving a more stable banking sector and sustainable economic performance.

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