Unfinished business – too big to fail


Unfinished business – too big to fail

The former chair of the Treasury Select Committee and member of the Parliamentary Commission on Banking Standards argues that banks need cultural and behavioural change.

The financial crisis of 2007-8 and its aftermath continue to be the subject of policy debate.  Its contributing factors were examined by a number of parliamentary committees of both houses of Parliament. As parliamentarians, we had a particular responsibility for considering the elements that led to the crisis and how policy could prevent a recurrence. Despite eight years of reform, Britain’s big banks still remain too big to fail and too complex to manager, or regulate.

There was little disagreement across the Parliamentary and political spectrum about the consequences of the crisis and the failure of the banking sector.  Not only did taxpayers, customers and the economy suffer, but the reputation of the financial sector was damaged and trust in banking was seriously undermined.

Going to the heart of the different enquiries was the underlying question of what, fundamentally, was wrong with the system? How could a recurrence of such developments be prevented? How could the damage caused to the financial sector itself, to the economic life of the country and the people who contribute to it be avoided in the future?  Such questions continue to lie behind the discussion and policy debate.

Unless the events of 2008 are seen as part of a global crisis, it is hard to make sense of what happened or of the deep malaise in the world economy.  Although different emphases can be put on the role played by one factor or another, there is broad agreement that certain developments were particularly significant.  In particular, the lack of personal responsibility in the industry, including by senior people, and of an adequate system of accountability and sanctions is seen to have played a part.  There was a disconnection too between the risks and rewards in the banking sector, an absence of proportionality and not enough focus on the longer term benefits in the balance of incentives.  In all of these failings the actions of regulators and governments had contributed to the decline – they were one step behind the economy, and still appear to be.

 Taxpayer subsidies

The crisis exposed that banks were too-big-to-fail and received a variety of explicit and implicit subsidies from taxpayers. The Future of Banking Commission identified that the taxpayer subsidy had two particularly damaging effects. The subsidy encouraged banks to become as big as possible and to intertwine risky investment banking activity with essential retail banking services and the payment system. The subsidy is greater for larger banks and so distorts competition by weakening the ability of small or new entrants to become serious challengers.  Sir Martin Taylor, CEO of Barclays 1994-98, told us that investment banking activities were parasitic on the retail banking balance sheet and, when you combine these activities with an excess of leverage, then the whole system is put at risk.

The result was that taxpayers ended up shovelling over £120bn into the UK banks – £2,000 for every man, woman and child in the UK.  We also guaranteed RBS against losses it would make on loans to hedge funds based in the Cayman Islands and dodgy packages of derivatives that clever people at the bank thought they could trade for a profit.

 Structural change

Along with others, including Mervyn King, former Governor of the Bank of England, I have recommended that the banks be split between retail and investment units.  Not only would such a separation promote safe retail banks, which avoid the ‘casino’ activities that contributed to the crisis, giving people who only use banks’ retail services a different type of bank, it would be a more transparent, effective and efficient system and allow a workable framework for protecting retail banks without bailing out investment banks. It would, incidentally, deal with the conundrum of ‘too big to fail’.

Nonetheless there are significant gaps. The problem of separating different banking functions remains despite the ‘ring fence’; so does the problem of size and whether the structures have become ‘too big to manage’.

The separation of banking

The policy of separation has been much needed. Like others, I was prepared to go along with the concept of ring-fencing to give it a chance.  However, the evidence was and remains that it was impossible to separate retail from investment banking; that the two have different cultures. The retail bank must be customer focused whereas the investment bank is centred on trading and anonymity, a culture in which personal relationships with clients are much less important – a permanent distinction highlighted by the then Barclays Chairman, Sir David Walker. He had initially supported ring-fencing, but within a year he decided that it had had its day in 2015.

Paul Volcker, the former Chairman of the Federal Reserve (1979-1987), explained the problem of ring-fencing to our Committee: that there would be two boards, that the legal responsibility would be on the holding company directors and that it was unrealistic to expect these not to have an unremitting interest in responsibility for the retail arm.  Such questions, as well as those of independence, which continue to be highlighted by the banks’ lobbying of the Governor of the Bank of England, have still to be tackled.  They have not been dealt with by the Bank of England and Financial Services Bill, 2015.

Too big to manage

A policy of separation would also go some way to tackling the other problem of ‘too big to manage’. Although the focus since 2007/8 has been on ‘too big to fail’ because big bank failure can damage the economy and governments therefore turn to taxpayers to bail out the banks, there is another side to the matter.  Are big institutions ‘too big and too complex to manage’?

Size is a serious factor. The combined total of assets of the 28 global systemically important banks, which was c. US$38tn in 2006 (an average of 1.35 trillion per bank) had grown to c. US$50tn in 2013 (an average of $1.76 trillion for each bank).[1]  If one recalls that one trillion seconds amount to just under 32,000 years, one gets a sense that US$50tn really is a great deal of money.  It is no surprise that many of those in charge of the banks fail to understand the issues for individual institutions.

Are the banks therefore too big to manage? HSBC chairman, Douglas Flint, responded to my query whether HSBC too big to manage: ‘That is a good question’ – leaving the answer in the air.

Insufficient capital

But what about all of the extra equity capital that regulators have forced banks to raise?  As the Stanford economist Anat Admati told a New City Agenda event last year – ‘Banks say that they doubled or tripled their capital.  They fed us a good line.  But tripling almost nothing still gives you a very small number.’  Banks will still be able to have leverage of around 30 times their equity capital.  This a tiny sliver of capital supporting banks’ risky activities – equivalent to buying a £1m property with a £30,000 deposit.

We are also assured that ‘living wills’ and bail-in will allow banks to fail safely, with bondholders instead of taxpayers taking the pain. Whilst these may be workable for smaller banks and may be valuable, they have yet to be tested for larger banks and are being resisted by the banking industry. It also remains to be seen whether politicians will ever be comfortable with exposing depositors – even those with over £75,000 in liquid assets – to losses.

Too complex to regulate

The Financial Services Authority had only small teams of people dedicated to supervising the banks and, following the crisis, there has now been a significant increase in resources.  We are told that regulators will be clever and clairvoyant enough to spot potential risks.  There are many talented individuals working in the Prudential Regulation Authority, the Financial Conduct Authority and the Bank of England, but few are the cross between Einstein and Mystic Meg needed to prevent bank failure.  We continue to place far too much confidence in the ability of detailed and complicated regulation to keep banks on the straight and narrow.  It is complicated and ineffective regulation.


In the UK what we have managed to do is restore the same system that prevailed pre-crisis, but with a few bells added. Moreover, the Government’s decision to secure all private debts of the banks has imposed a burden of unknown magnitude on future generations of tax payers. The response to the crisis has also caused political populism to take hold globally.  If we fail to apply ourselves to fully fixing the systematic failures within the current system that populist reaction may prove fatal for the cohesion of the social fabric.  The next time the UK’s banks get into trouble they may even be ‘too big to bail’ as their size will overwhelm the public finances – as happened in Ireland and Cyprus.

To minimise this risk we need further reform.  We need higher and simpler capital requirements, which even after recent increases still remain too low.  Structural separation of banks and greater controls on banks overall size and complexity are the only way we will make more progress on eliminating too-big-to-fail.

Most of all, however, we need cultural and behavioural change in our banks. Today, and for the foreseeable future, we will all be paying the price for the toxic banking culture.  One which the Parliamentary Commission on Banking Standards characterised as emanating from the very top of these organisations:

‘Top bankers dodged accountability for failings on their watch by claiming ignorance or hiding behind collective decision-making. They then faced little realistic prospect of financial penalties or more serious sanctions commensurate with the severity of the failures with which they were associated.’

Until strict liability is made mandatory for those in charge of banks, such as a duty of care, the implications of too complex to manage and too big to fail will not be tackled with the urgency or seriousness required. A sign stating ‘The buck stops with me’ needs to be a permanent feature on every bank chief executive’s desk.

John McFall is a Labour peer.  He will become Senior Deputy Speaker of the House of Lords on 1st September.



Feb/Mar 2020

In June 2019 Open House held a conference exploring possible new directions for the Catholic Church in Scotland. See conference papers.

Open House also held a conference on the role of lay people in the governance of the Catholic Church in November 2013. See conference papers.