Howard Flight: How we should regulate the UK's financial services industry

Howard Flight is a former Shadow Chief Secretary to the Treasury and chairman of Flight & Partners Recovery Fund.

The stern criticism of the top management and Boards of some of our major banks, which have had to be bailed out by the tax payer – particularly RBS and HBOS – have in my judgement been wholly justified. Failed management should have been fired and not incentivised to leave by a huge pension.

The bonuses which some employees of large banks have been paid have been unjustified as well as damaging, when these individuals have been exploiting the “fire power” of the large organisations for which they have worked, as opposed to being successful entrepreneurs, building businesses.

Having said this, the underlying cause of the banking boom and bust was failed monetary policy – causing excessive monetary and credit creation; failed economic policy – not to have recognised 5 years ago that lending, debt and house prices were increasing too much; and failed regulatory policy – with over-concentration on the minutiae of retail regulation while ignoring the need to oversee and supervise large financial institutions and especially the banking system.  All of these failures were the responsibility of the Labour Government.

Also, as history has shown, when money is too loose, banks, like sheep, invariably act incautiously.

There are approximately one million people working in the UK financial services industry – the overwhelming majority of whom are not paid huge salaries or bonuses, and indeed who frequently earn some 20% less than individuals of a similar employment level in the public sector. 

Many of these have already lost their jobs, and even more face losing their jobs over the next year or two, and do not have generous, defined benefit pensions. Most bank employees have been loyal and conscientious in the face of difficult times, and have not been responsible for the calamitous mistakes of their senior management. At the least they deserve sympathy.

Large banks are only part of the UK’s financial services industry, which overall, has been a great success story over the last forty years. London has regained its pre-1914 position as the financial capital of the world, providing major employment, a major source of tax revenues and a major source of international earnings.

Government policy should be focused on ensuring that the UK retains a successful, international financial services industry, in the interests of all of the nation. It would be wantonly stupid for government to add to the problems currently faced by the industry when, in the main, it has been developed successfully since the time when Harold Wilson as Prime Minister and Lord Cromer as Governor of the Bank of England initiated the tax reforms which enabled London to compete globally.

This is why the right regulatory reforms are so important. Unmerited as it has turned out, the UK had the reputation of leading the world in financial regulation. What is now needed is a new and successful UK model, executed well, which will lead the world in financial regulation, as well as help restore the health and success of our largest industry. 

Here the dangers are both international and domestic.

The EU's de Larosière Report calls for the creation of 2 new pan-EU regulatory bodies, effectively empowered to dictate pan-EU financial regulation for national implementation. The UK has already lost too much of its regulatory independence – witnessed by the imposition of the unhelpful EU, MIFID regime. 

What I suggest is needed is a clear division between retail regulation, designed to help and protect the consumer and which is the natural (and historic) responsibility of the FSA; and institutional, more supervisory orientated regulation, of all the financial institutions with large balance sheets and liabilities – (including, for example, Life Insurance companies) as well as the non-retail activities of banks – and the markets in which they deal.

This should be the responsibility of a reformed and adequately resourced Bank of England. Moreover, when large banking groups wish to engage in investment banking activities, this should be carried out via a separate subsidiary with its own balance sheet and without the ability to put at risk the assets of the parent, commercial bank.