Editorial: Rein in banks and end the financial crisis

Opinion

New Year celebrations can never entirely erase problems unsolved the previous year.

The most serious of them, by a long way, has been with us for the past two years and remains no closer to a solution. It dates from late 2008. It is the global financial crisis.

The immediate crisis was alleviated by huge injections of public money into national banking systems, taxpayer guarantees of their deposits and fiscal stimulants to offset the consequences of banking failure for business and jobs in national economies.

The costs of those measures will weigh on the United States and Europe for many years whatever their success, and success is not yet assured. Economic recovery is uncertain, high unemployment persists in the US, currency tensions continue in the euro zone. The crisis is far from over.

It is a crisis in the role of finance and banking in a modern economy. The financial sector used to be a service industry for the real economy, a repository of cash, a conduit for payments, a provider of working capital. These functions are essential to the daily operation of the economy. They are the reason governments cannot let their banking systems fail.

The problem is that banks have become much more than a service industry. Slowly over the past five decades, finance has become an industry in its own right with a range of products that can generate far more wealth than most other goods and services.

The Governor of the Bank of England, Mervyn King, has noted that bank balance sheets now exceed Britain's annual GDP by five times.

While the business of banking has expanded, so have the risks banks carry. Their credit and loans have been allowed to exceed their capital assets by much larger ratios than before.

They and fringe financial institutions have manufactured debt instruments that they trade in a way that leaves them mutually dependent.

Before the crisis they had become so confident of these securities that they measured them as added value, as though an insurance company was to count its premiums as profits without accounting for the risk of a claim.

The simplest of banking is high risk. It borrows short from term depositors and lends long on home mortgages and the like. Yet just about everyone regards banks as secure. The reason for that is the implicit support of the taxpayer. Banks are too important to fail, and they know it.

They know that if things go well, they will reap the rewards; if things go wrong, the public will foot the bill. They knew it in the decades before the crisis came in 2008, and they know it still. The public is footing their bill.

The public in turn has every right to impose its solutions on the sector. Several remedies have been ventured - higher capital ratio requirements, separation of functions, taxes and levies to match risks placed on the public. In September a new international standard of capital requirements, Basel III, was agreed. But it is probably not enough.

Mervyn King believes the levels of capital in Basel III are insufficient to avert another crisis and the risk weighting of assets is based on previous assessments that proved to be wrong.

He prefers more drastic proposals such as a rule that every pool of bank investment must be backed by funds with a similar maturity, or a strict separation of risk lending from the payments system and other basic financial services.

Some such steps must be taken if periodic failures are to be avoided. The global financial crisis has destroyed much more wealth in the US and Europe than the 1987 stockmarket crash or the dotcom collapse did. Financial failures are crippling. This crisis will not be over until banking is on a much tighter public leash.