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Osborne Urges UK Banking Sector Reform

by Robin Pilgrim, LawAndTax-News.com, London

17 June 2011


While the UK's economy is 'on the mend', its financial sector is slowing the recovery, meaning a major shift in the regulatory culture is required, Chancellor of the Exchequer George Osborne has said.

During his annual Mansion House speech in the City of London on June 15, Osborne urged the need for the UK to "avoid that now well trodden path from banking crisis to sovereign debt crisis". He stressed that the economy is, in fact, recovering, with output growing, a rebalancing taking place, job creation on the up, unemployment falling, the deficit decreasing, and stability returning. In his words, "Britain is on the mend".

Nonetheless, Osborne also noted that, while in the past six quarters, the economy as a whole has grown by 4%, the financial sector has shrunk by 4%. He said: "Our banking sector fuelled the boom. Now it is slowing the recovery from the bust". He argued that "unsustainable borrowing in our banks must not lead to unsustainable borrowing by the government". Thus, the government is, according to Osborne, taking steps to resolve regulatory uncertainty and encourage new capital investment in the banking system. He pledged to hold banks to the published lending commitments they have made, using every tool available to him.

Most importantly, the Chancellor argued, the banks cannot be underwritten by the taxpayer. He said he believes that a consensus is emerging on how best to achieve both successful and competitive financial services, and a healthy, balanced economy. Previously, Osborne feels, the UK had the "worst of both worlds", a system where no one was in charge, but which also perpetuated "endless box ticking".

The government's remedy is to drive home a sea change in regulatory attitudes. A permanent Financial Policy Committee is to be established within the Bank of England. It will monitor risks, identify problems and dangers, and deal with excessive levels of leverage before it is too late. A new Financial Conduct Authority will be created to deal with the operation of markets and ensure the protection of consumers. Above all, its primary duty will be to promote competition. Osborne's goal is clear. "We want to move away from the tick-box mentality of the current system, where there's no shortage of costly regulation, but too little room for invaluable judgement".

The Chancellor then went on to reference the conclusions drawn by the Independent Commission on Banking, which made two fundamental recommendations. In the first instance, there should be a principle of "bail-in", rather than "bail-out", with private investors expected to foot any such bills, not the tax payer. Secondly, the UK should see its high street banks "ring fenced", "to make them safer, and to protect their vital services to the economy if things go wrong". Osborne stated the government's endorsement of both proposals, but promised that, until the Commission's final proposals are made, he will not pre-empt their conclusions.

Lastly, the nationalised bank Northern Rock is to be sold off. This is part of Osborne's plan to rebuild the UK's international reputation and he believes it would be a sign of confidence, and has the potential to foster competition in high street banking. Northern Rock Asset Management is to remain in government ownership, but its assets are being wound down over time.

Osborne's comments on the potential ring fencing of the UK's high street banks were largely expected. In advance of the speech, PwC warned of the dangers this could bring. Steve Davies, UK retail banking leader, said: "There is no compelling evidence that universal banking contributed to the financial crisis so forcing banks to ring-fence their retail banking business could prove a costly exercise with unproven benefits for both the banking industry and consumers. The government needs to be mindful of the unintended consequences and consider what the benefits of ring-fencing are for the consumer, as they are likely to be left facing higher mortgage, loan and credit card costs. The increase in banks’ costs and capital requirements will also have a knock-on effect on economic growth, reduce dividends for UK pension funds and could promote heavier risk taking within the banks".

Davies added: "The most pronounced banking failures would not have benefitted from ring-fencing. Robust recovery and resolution plans for individual banks, together with carefully calibrated capital requirements, would be a far more appropriate response than structural reform. The government needs to provide clear rules on how the ring-fencing will work in practice to protect against any unintended consequences."

Osborne is to publish a White Paper and detailed draft legislation on proposed regulatory changes this week.

TAGS: tax | investment | economics | business | law | banking | financial services | capital markets | United Kingdom | enforcement | legislation | standards | regulation | services

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