Finance sector growth brings collateral damage
The biggest question is whether ever-increasing financial deepening and cross-border integration are good things
Mark Carney, governor of the Bank of England: believes that that “organised properly, a vibrant financial sector brings substantial benefits”. Photographer: Chris Ratcliffe/Bloomberg
Last week, Mark Carney, governor of the Bank of England, brought cheer to the City of London. His robust defence of finance and declaration that “we are open for business” mark an abrupt change from the regime of Lord King, his predecessor. The financial sector will certainly love him. His views are refreshingly clear. But they are also a gamble.
In the speech celebrating the 125th anniversary of the Financial Times, Carney’s central point was that “organised properly, a vibrant financial sector brings substantial benefits”.
Carney pointed to the scale of the London markets, with almost four times as many foreign banks as in 1913. The assets of UK banks have grown from 40 per cent of gross domestic product to more than 400 per cent. But, he added, suppose: “UK-owned banks’ share of global financial activity remains the same and that financial deepening in foreign economies increases in line with historical norms. By 2050, UK banks’ assets could exceed nine times GDP, and that is to say nothing of the potentially rapid growth of foreign banking and shadow banking based in London.” He continued: “Some would react to this prospect with horror.”
He was right, since this would turn the UK into the Iceland of 2007. He responded that “a vibrant financial sector brings substantial benefits”. This is true, he asserted, not only for the UK, but for the world: “The UK’s financial sector can be both a global and a national asset – if it is resilient.”
Carney outlined the measures taken, and soon to be taken, to make banking more resilient. These include rules on bank capital and liquidity and, above all, procedures for the “resolution” of failing cross-border banks without need for taxpayer-funded bailouts. He noted that “the UK state cannot stand behind a banking system that is already many times the size of the economy”. In addition, he discussed new rules for markets, stressing the way changes in the value of collateral generate instability. But he insisted these weaknesses, which caused the markets to freeze in 2008, are being rectified.
Carney stressed the supportive role of the Bank of England while arguing that “our job is to ensure that [the financial sector] is safe”. He emphasised the forthcoming approach of the central bank to supplying money and high-quality collateral to banks: “The range of assets we will accept in exchange will be wider, extending to raw loans and, in fact, any asset of which we are capable of assessing the risks. And using our facilities will be cheaper. In some cases, the fees are being more than halved.”
This then is a new Bank of England. Is it also a sensible one? First, are the new liquidity rules wise? A central bank can, in principle, create domestic money without limit. But if it uses that power more freely, it will encourage banks and markets to generate more maturity transformation, making themselves and the economy more vulnerable to panic. The Victorian commentator Walter Bagehot thought central bank lending at a penalty rate would curb the danger. The lower the penalties, the more important are the new regulations on liquidity management. Will these work? We do not yet know.