Obama bank reforms

Labour must grasp the nettle of separating banking activities

When President Obama announced a new set of bank reforms last week he changed the agenda for politicians and bankers alike. Obama announced a separation of banking activities and a limit to prevent banks becoming too large. In the UK, the government said it would not adopt the reforms here. Yet the financial crisis has forced governments to think the unthinkable and take the sort of action they previously opposed. Banking separation falls into that category. Labour needs to stay ahead of the reform agenda. Separating banking activities is essential to prevent another systemic financial crisis. It is also just the sort of reform a progressive party should be pursuing.

Such has been the inability of the banking sector to reform itself or fully acknowledge responsibility for the financial crisis, that ideas previously considered too radical are being seriously investigated. Before Lehman Brothers filed for bankruptcy, I argued on the Progress website that banks should pay an insurance premium against future bailouts. I cannot claim any credit but in any event it is now on the agenda. For years, those calling for a Tobin Tax were rebuffed. Now the Treasury is pushing the idea. We must hope for a similar about-turn on banking separation.

President Obama is calling for the establishment of the ‘Volcker Rule', named after the former Federal Reserve chairman who has advocated banking separation for some time. The rule limits the scope of banking by ruling out most proprietary trading and ownership or sponsorship of private equity and hedge funds. It also puts a limit on the size of banks, measured by market share. This latter measure might be a distraction because it focuses on size rather than systemic importance, a point Alistair Darling has made. Nevertheless, while we might debate some of the details the measures are attractive because they address what banks do rather than just how they behave. They come on the back of US moves to impose a banking levy, also ruled out by the UK.

We know that stronger regulation is essential and the UK government is pushing for this through the G20. However, we also know that over time regulations are eroded. We know this because we have just seen it happen. Regulators, bankers, and politicians alike were seduced by new risk models and so-called financial innovation, which turned out (once more) to be just new ways of borrowing more money. Banks are engaging in the debate on regulation but any attempt to change what they can actually do prompts cries of outrage. We have seen this with the reasonable demand that bonuses reflect profits and ability rather than the advantages given by government guarantees and easy money from the Bank of England. We are seeing it again with Obama's proposals.

The financial sector remains important to the UK economy and there is no reason to attack it unnecessarily. However, bank reform is in the national interest and in the City's interest. We all need banks which work and which do not threaten to bring down the whole system from time to time, taking billions of pounds of taxpayers' money in bailouts and guarantees in the process. That means we need to separate casino-style banking from retail banking, something the Christian Socialist Movement has been calling for in an early day motion. The problem the critics of banking separation face is that they cannot show how their alternative measures would better prevent another systemic crisis.

A progressive banking policy will focus on ensuring that we have a banking sector which provides services to individuals and businesses, protected from systemic failure, while allowing ‘casino' banking activities to continue away from taxpayer guarantees. Obama is focusing voter outrage into essential reform. Labour has the opportunity to do the same.

This article was first published on the Progress website.