Step up competition for banks and rating agencies

Sir, Martin Wolf’s proposals for financial regulation (« Seven habits that finance regulators must acquire« , May 7) is very much to the point, and could be completed by another one that could be called coherence. The market economy is supposed to work best with competition and without subsidies, but the financial sector is incoherent on both criteria, relying on regular state subsidies and lacking openness and competition in some key areas.
Competition could be improved in two major sectors of finance: investment banking and credit rating. Credit rating agencies are an oligopoly because the Securities and Exchange Commission gave a privileged position to three of them, and the Basel Committee gave them an exaggerated role. Let regulators and central banks delete any reference to rating agencies; let them be more responsible themselves for assessing the quality of banking assets; let investors be responsible for the quality of assets they purchase, and if they want to use credit rating services, let them pay for any external advice. The investment banking sector probably also needs some trust-busting. For instance, legal separation of corporate finance and broking would reduce conflicts of interest, insider dealing risks and market power (for instance for the « 7 per cent commissions » initial public offering cartel), and create a welcome evaluation step in the rather uncritical originate-and-distribute model.
The financial sector gets a massive subsidy in the form of a free insurance against systemic risk, since governments and central banks let them take full advantage of the fat profits in the good times and bail them out in the bad times. Since public interest seems to justify public intervention to avoid systemic risk, at the very least let the financial sector pay for this insurance. A kind of Tobin tax on market transactions (inspired by Keynes, like Mr Wolf’s concluding remarks) could have the double advantage of limiting the most speculative transactions and be used to fund a systemic risk insurance scheme; a funding contribution based on banks assets would also be logical; a contribution based on league tables would be both logical and economically sound if one is to believe there could be a perverse relationship between league table rankings and the quality of performance, as a recent study (Bao and Edmans, 2007) suggests.

Eric De Keuleneer,
Solvay Business School,
University of Brussels,
1050 Brussels, Belgium

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I think the letter hereunder is a good example of the mechanics of the” battle for hearts and minds”. Of course it is impossible to indicate that Tim Congdon who wrote it, and is apparently respected as an academic in London, is part of a banking lobbying. But his discourse is claiming to aim at the general interest, and is prima facie convincing, although there are some fundamental flaws with it, in this case the definition of the Lender Of Last Resort (which for him is pretty close to a notion of bailing out at any cost). Some of his claims seem almost comical, of course with hindsight. Still, this was a few months before Lehman…

UK banks act as subsidisers of the welfare state

Sir, Was I your only reader to be struck by the discrepancy between your “UK bank losses will hit tax bill and public purse” (May 12) and the main letter in your correspondence section on the same day headed “Step up competition for banks and rating agencies”?
According to your news report, the UK’s banking, finance and insurance sectors paid corporation tax in 2005-06 of £11.6bn, about a quarter of the total. The figure is impressive, because the financial sectors certainly do not account for a quarter of employment.
On the face of it these sectors make a disproportionately large contribution to tax revenues. But in his letter Eric De Keuleneer, taking his cue from Martin Wolf (May 7), claims that finance relies on “regular state subsidies”, because – in his words – it receives “a massive subsidy in the form of free insurance against systemic risk”. He apparently believes that governments and central banks “bail [the banks] out in the bad times”.
What is Prof De Keuleneer talking about? If he is referring to a central bank loan to illiquid commercial banks on lender-of-last-resort terms, he is simply wrong. A loan of that kind is at a penalty rate and must be repaid.
To the extent that it is not repaid and the borrowing bank has a capital deficiency, the shareholders suffer a loss and are not bailed out. But what otherwise can he mean by “regular state subsidies”?
The exposure of banks’ shareholders to market forces has been demonstrated rather conclusively in recent months by the rights issues announced by the Royal Bank of Scotland, HBOS and Bradford & Bingley, as well as by the government’s apparent determination to steal Northern Rock from its shareholders even if its lender-of-last-resort loan is repaid in full.
The truth is that our banking and financial industries are very large subsidisers of the British welfare state. Indeed, the corporation tax payments are only part of the story. It should also be remembered that the highly-paid individuals who work in the City of London also make substantial income tax payments, with their share of total income tax revenues again being out of all proportion to their numbers.
These individuals and their employers may or may not want to remain indefinitely in our country. Much will depend on the regulatory and fiscal regimes they confront in future.

Tim Congdon,
Huntley Manor,
Huntley, Gloucs GL19 3HQ, UK

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