“We’re not going back to business as normal. The banking sector is going to have to accept discplines on the way it operates, regulatory disciplines, and there is going to be a restructuring”. With these words Vince Cable, a Liberal Democrat and the UK’s new Secretary of State for Business, Innovation and Skills, demonstrated his intention of wielding his new influence to reshape the UK’s banking sector (see article). The hung parliament and subsequent coalition between the Conservative and Liberal Democratic parties has raised anxiety levels among the UK’s largest lenders. Under Labour, large banks flourished in the UK. The Conservatives, meanwhile, have placed a great deal of emphasis on putting the Bank of England in charge of supervising the financial sector. Less well documented were pledges in their manifesto to enact a levy on banks (unilaterally if necessary), pursue international agreement to prevent retail banks from engaging in activities that put the stability of the system at risk (e.g. prop trading), and increase competition in the banking sector via the sale of their stakes in various lenders. But the Lib Dems’ manifesto is far more aggressive: its central promise in the financial field is to “break up the banks … to establish a clear separation between low-risk retail banking and high-risk investment banking”. It also proposes a banking levy – which would rise to almost £3bn by 2014/15 – to last until the break-up is complete, and attacks bankers’ bonuses. All this is no surprise; Vince Cable has long been the most irksome political thorn in the banks’ side. And that was from his position of financial affairs spokesman for one of the UK’s smaller parties. Now that he is in government, the key question for the financial sector is: how much influence will he wield?

If the coalition agreement hammered out on the 11 May between the Conservatives and Lib Dems is anything to go by, the answer is: quite a lot. It proposes a bank levy, robust action against bonuses and the use of net lending targets for the nationalised banks (which Mr Cable has consistently advocated), hitting their bottom lines. He has also long been a fan of building societies – he recently spoke proudly of fighting the demutualisation of the building societies ten years ago – and the coalition agreement promises to “promote mutuals and create a more competitive banking industry”. It also states that the parties will establish an independent commission with a one-year remit “to investigate the complex issue of separating retail and investment banking” (a key Lib Dem proposal) and waters down the Conservatives’ original plan to give the Bank of England responsibility for supervising the financial sector. Instead, the agreement states that the parties will bring forward proposals to give the Bank of England control of macro-prudential supervision and oversight of micro-prudential supervision”. In other words the much-maligned FSA, which many had assumed would be absorbed by the Bank, could survive and continue its work under the Bank’s watchful eye.

The Lib Dems’ ideas clearly feature heavily in the coalition agreement, suggesting that Vince Cable will have considerable influence over government policy. In his own words, “this [bringing the banks to heel] is a fully joint exercise between myself and George Osborne”. What might this mean for the UK banking sector? It is clear that the road ahead leads to more competition on the high street, and that the government’s sale of its bank shares will be tailored to this objective. It may well be that Northern Rock, when it is sold, could become a building society rather than a bank, offering competition to Nationwide, which dominates the mutual sector. A banking levy – probably structured a tax on bank profits and remuneration, as proposed by the IMF – now also seems inevitable. However, none of these proposals should unduly trouble the UK’s largest financial institutions. While their profits might be dented by these measures, they would comfortably survive. For example, even if the future levy amounted to £3bn per year, as originally envisaged by the Lib Dems, this amount could easily be absorbed by banks: Barclays alone made over £9bn in 2009. But any moves to introduce the UK’s very own Glass-Steagall Act would shatter the power of large financial institutions – particularly those, like RBS and Barclays, that have significant investment banking operations. Until now, such a move was unthinkable as neither of Britain’s two major parties supported it. But now that Vince Cable wields power, the unthinkable could become reality.

Nick Smallwood - Credit Analyst

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