27/5/2010

By Neil Ainger: News analysis

As the nation slowly comes to terms with a new coalition government, many have been wondering what policies will survive the coupling of the Lib Dems and the Tories. Already the much trumpeted plan by the new Prime Minister, David Cameron, to get rid of the FSA seems to be unclear as the Bank of England takes back regulatory powers but no mention is made of the watchdog's future. A year-long commission is also to investigate breaking up the banks and how to reintroduce more competition on the High Street. Neil Ainger looks at our new government's plans for the financial services sector

The people have spoken and ..well, they weren't quite sure. The UK awoke to a hung Parliament on 7 May, the day after the general election, and immediately everyone started wondering what would happen. Would Gordon Brown and Nick Clegg form a progressive coalition as many on the left wanted; how would the financial markets react, especially as the Eurozone crisis kicked in pre-empted by Greece's ballooning public sector debt; would the UK deficit be cut if too many compromises had to be made to form a government? What about the Conservative party's plan to re-instate the Bank of England as the regulator of all financial matters, superseding the Financial Services Authority (FSA), or Vince Cable's long cherished idea of splitting up retail and investment banks, so that such institutions would no longer require taxpayer bailouts if they speculated too wildly and imperilled their High Street customers' savings?

Fevered speculation inevitably ensued post-election and, of course, a coalition government was eventually formed, consisting of members of the Conservative and Liberal Democrat parties, with, respectively, George Osborne as the Chancellor and Vince Cable as Business and Banking Secretary in the shared Cabinet. As we go to press, the first indications of the new government's plans for the financial services sector in what it hopes will be a five-year fixed term Parliament (an early innovation here), were just starting to come out and they are pretty far reaching.

The FSA's future, for a start, is unclear. Will it be used as a checking body in future years to actively ensure that banks, insurers and others are complying with all necessary regulations, while the Bank of England takes over sole responsibility for ensuring wider financial stability and the lead role generally? The Financial Reform Bill unveiled by the coalition government in the Queen's Speech on 25 May asserted that the tripartite system that Labour introduced back in 1997 will be ended with the Bank regaining its former pre-eminence, but what role the watchdog will have, if any, was left unspecified.

It is expected a new bank tax levy will also be introduced, although no details have as yet been forthcoming. This is probably because the EU is planning its own bank tax and global plans for one are also being laid out by the International Monetary Fund (see HERE). Arguments still rage over whether to use the levy to fund battered government finances from the first bailout or use it to build up a reserve for any future rescue packages, with the UK favouring the former. Until this is resolved detailed proposals for the levy are unlikely. In addition, as yet unspecified, measures will be taken to tackle "unacceptable" bonuses in the City of London, says the coalition. The new government also stated that it intends to end 'unfair' bank charges, reopening a case that the Office of Fair Trading has already lost, and reduce 'excessive' interest rates on credit and store cards, as part of a wider championing of the consumer - for instance, court orders for the sale of properties have been banned where the unsecured debt is below £25,000.

Responding to the resuscitation of the furore over 'unfair' overdraft charges and the like, the British Bankers' Association pointed out that the OFT had already looked at this and "in March this year, reported that real progress is being made in making current accounts work well for customers". Naturally, others were egging the new coalition on with Martin Lewis of the Money SavingExpert.com website saying that he "expects to see pressure, especially on the state-owned banks, to reduce the amount of unfair charges". He also wants to see people allowed to opt out of them and a shift from per transaction, to per day charges. "If that doesn't work, expect to see legislation," he adds. Many banks have, of course, changed their policies as this long-running argument dragged its way through the courts over the last couple of years, but further stipulations seem to be on the way.

Banking commission
An independent commission, charged with investigating whether to break up the banks, separating out investment and retail banks to reduce risk, and how to introduce more competition to the High Street, was also unveiled as the new coalition outlined its combined policy programme on 20 May and subsequently on 25 May in the Queen's Speech as the new Parliament opened for business. The horse trading involved in merging the manifestoes of the two separate parties was clear from the number of commissions and enquiries that have been set up, with the banking commission being one of the most obvious fudges here. The body will also look at how to promote mutuals as part of its overview of the sector, a move warmly welcomed by the Building Societies Association, whose head, Adrian Coles, said: "Mutuals bring competition, diversity, democracy, a lower appetite for risk and a higher appetite for service and trust, to a banking market suffering from a deficit of all these things in recent years."

The coalition government is yet to name the chair of the banking commission or provide any more detail about the competition investigation into the retail banking segment, which has come to be dominated by Lloyds Banking Group, and a select few others, after it swallowed HBOS at the height of the 2008 meltdown. Santander, of course, also absorbed Alliance+Leicester and Bradford Bingley, along with its earlier acquisition of Abbey; and the building societies sector contracted sharply as the Britannia and others were rescued. Introducing more competition back into the sector post-crunch was a key aim for all of the parties going into the election, not least because the European Commission is demanding it as a quid pro quo for the state aid handed out to support failing institutions back in 2008 - hence the requirement for RBS to sell off its 318-strong Williams & Glyn branch network. The banking commission will be given a year to report and be overseen by a cabinet sub-committee chaired by the Chancellor.

Bank sell-off scrapped
One thing seems for sure and that is that the year-long banking commission unveiled by the new government spells the end for any plans to sell off the taxpayers' stake in RBS and Lloyds Banking Group. There had been speculation that an incoming government would embark on a quick sale of the publicly owned shares to try and plug the gaping hole in the public finances and defer savage spending cuts. The new Chancellor, George Osborne, is thought to have been keen on an 80s-style privatisation with preferential shares and options for the public a lá British Gas when it was sold off by Margaret Thatcher. The Tory idea obviously clashes with the new Business Secretary's stated wish, however, to see the 'state owned' banks, including Northern Rock, retained in the public sector for now, in order to lend more credit to small businesses and support the real economy.

The Eurozone crisis means that there is no chance the banks will be privatised yet anyway as the low share prices of both currently means the taxpayer would make a loss. RBS, for instance, needs to be worth at least 50p per share for the taxpayer to break even and is currently trading below this. Similarly, Lloyds Banking Group's approximately 43 per cent public stake was brought at an average price of 63p and is currently below this level. A £9 billion paper profit in April has been reversed into a £6 billion paper loss during May in the wake of Greece's debt rescue package from the EU and IMF and ongoing concerns about the huge deficits in Spain, Portugal, and Italy.

The UK, saddled with the huge bill for bailing out the banks here, has its own deficit worries of course. The new coalition government announced £6 billion worth of immediate spending cuts this year in the public purse, a clear win for the Conservatives here, in the negotiations with the Lib Dems to form the coalition. There will also be an emergency budget on 22 June setting out the full details of planned spending cuts. The technology sector can expect to lose out as the government plans to cancel big ticket programmes like the national ID card scheme and scale back technology spending generally. A comprehensive spending review will then be held in the autumn of 2010 to lay out planned cuts over the next few years to try and eliminate the UK structural deficit.

This task will largely fall to David Laws, the Liberal Democrat who has joined the government as Chief Secretary to the Treasury. He'll be responsible for carrying out the savage cuts needed to get the deficit down, which will no doubt make him unpopular in the country at large. The City will be pleased to have got 'one of its own' into the Treasury however, as Laws started out at JP Morgan as a graduate trainee and had a very successful career in the wholesale arena. Whether this means a sympathetic ear remains to be seen.

Conclusions
The challenges awaiting David Cameron, are numerous and pressing. Cutting the deficit and reviving growth is of course paramount, but there will also be calls for the incoming government to punish the banking industry for the taxpayer-funded bailouts and stimulus measures that were needed to avoid a meltdown on the scale of the famous 1929 crash. The bank tax levy and banking commission, investigating competition and whether to introduce a UK version of the old US Glass-Stegall Act, are just two of the instances of this general trend, but they are at least sensible measures to acknowledged problems. Avoiding any unnecessary and onerous regulatory challenges must be the aim of the industry moving forward, but some change is inevitable and indeed desirable post-crunch.

The interaction between European-level regulatory changes, such as the Alternative Investment Fund Managers (AIFM) directive, newly imposed on the hedge fund industry despite the new Chancellor's opposition to it, and Angela Merkel's banning of naked short selling in Germany, are likely to mean just as much to the wholesale banking arena as any national regulations, if not more. After all, London is an international centre for finance so continent-wide and global rules apply. For the retail banking arena, the national policies will be more important. Any fissures in the coalition government are likely to be over the European issue, with the euro-skeptic Conservative party diametrically opposed to the pro-Europe Lib Dems. Just keeping the coalition together may prove to be the greatest challenge facing the new PM, and winning the prize of entry into number 10 Downing Street may prove to be a poisoned chalice, with no money in the Treasury and warring partners.