What the bankers are holding
A report was published today by the New Economics Foundation about the “hidden subsidies” currently enjoyed by the British banking industry. It is evident that the language, techniques and accounting procedures used within the banking system are such that they obscure both the full extent of the support that banks are accepting from the taxpayer and the comparatively small amount of “banking skill” that banks executives contribute to their own “profits”.
Since 2008, known public support for the financial sector has been unprecedented in scale.
Since the Bank of England came to the rescue of Northern Rock in 2007, with a £25 billion emergency borrowing facility, the sums have grown. Subsequent systemic bank failures meant that the public purse would have to support the whole financial sector, not just individual banks.
Many schemes of different types were introduced. They all lacked transparency so that the amounts are still hard to summarise. Together,the schemes added up to £1.2 trillion of backing to the banking system, equivalent to about 85 per cent of the UK’s national 2009 income.
The UK scale of intervention, in spite of the vast differences in GDP was comparable to that of the United States.
But is it possible that there is still more to the story? Research from the Bank of England, the Office of Fair Trading, the Institutional Investors Council and Moneyfacts (which provides independent rate comparisons) reveals a range of other hidden subsidies to the big banks.
Chancellor George Osborne’s recently announced bank levy is minuscule in comparison to all the bank subsidies which we do not know about. The Chancellor was pulling a very small rabbit from a very large hat. The Independent Commission on Banking has yet to publish a complete list of the de facto hidden subsidies currently being enjoyed by the banks. What we know so far amounts to no more than scratching the surface.
Increased scrutiny of the financial system in the wake of the banking crisis has shed light on a number of practices previously taken for granted, which now might be viewed in a different light. The sheer complexity of modern banking (itself one of the conditions that brought on the crisis) has worked to shield the sector from difficult questions. But with the dust of public interventions now settling, a number of anomalies are emerging.
The ‘Too Big to Fail’ subsidy. Having concluded that our major banks are “too big to fail”, the government now provides a public guarantee. That effectively is insurance against a bank going bust. In business terms, this gives the banks a huge commercial advantage over other organisations. All commercial enterprises need to borrow money and the banks are no exception. However, they can borrow money much more cheaply than any other type of company because of the fact that the public is guaranteeing anything that they borrow.
Answers from leading auditors questioned by the Treasury Select Committee confirm this. The hidden subsidies save the banks a large amount of money – at least £30 billion annually– and thus helps them generate “unearned” profits. To put it simply, they save billions on the cost of their own borrowing and so make MUCH MORE profit that they would have done without that taxpayers guarantee.
It also means that when the banks pay bonuses to senior staff for “performance” as well as dividends to institutional investors, the rewards of the public’s “insurance” are headed in the wrong direction. They should be coming back to the taxpayer.
The quantitative easing windfall subsidy. When it was decided that the economy needed more liquidity (cash), the Bank of England pumped money in using the technique called “quantitative easing”. Many people refer to this as “printing money”. However, there is slightly more finesse within the system than a bit of pressure applied to a printing press button .
Take Government Gilts, for instance.(Gilts are bonds issued by governments and they pay a fixed ate of interest twice a year. Governments use Gilts to raise money)
The Bank of England is not permitted to buy UK gilts directly from the Government as this is considered to be “monetising” government debt, or in other words directly funding government expenditure through “creating money” .
Instead the Debt Management Office first sells the gilts to banks and other investors and then the Bank of England buys them back from the banks at a higher price, with money that it has “created” . The bankers then reward themselves for completing these “deals.”
That gives the banks “new” money plus a cut of every trade.
The ‘make the customer pay’ subsidy. Thanks to an apparent lack of forward planning (and understanding), the government has created a paradox which really has placed the banks “between a rock and a hard place”. They have been given two contradictory goals by the government. The first is to lend money (which is what caused the majority of their problems in the first place) and the second is to hold onto their money so that they can rebuild their capital.
The banks could manage this problem in any number of ways. However, they have taken the easy option which is to charge more when they lend and at the same time, pay less to their own savers and investors. The difference between what the banks charge their borrowers and pay their savers is known as the “interest rate spread” or margin.
So the government, by way of using the taxpayer to guarantee that banks cannot fail to repay their debts has meant that banks can now “buy-in” money cheaply and resell it at a vast profit. That also means that they don’t have to pay their private savers very much at all. Technically, they are punishing the very people who are subsidising them .
As a matter of interest, there was a time when banks and building societies had an operating margin (Difference between what they charged borrowers and what they paid investors) of 4%.That means that in today’s climate, borrowers could be charged say 10% and savers could be paid 6%. That excludes mortgagors whose borrowings are secured – their rates could easily be of the order of 3% .
Although the banks have taken the “screw the client”option, they could speed-up their recapitalisation through eliminating bonus payments and dividends. The banks’ hidden subsidy created through overcharging their customers is estimated at £2.5 billion per year.
The Fake Money Subsidy. The nature of money is such that when a bank grants a loan, it does not have the money. It is allowed to create money to hand-over and makes a profit from the interest rate which it charges. That is another form of subsidy – as the government has effectively given banks another licence to print money. Money is “lent into existence”. The old days when banks only lent money left by savers have gone.
So if this is considered another subsidy, it is worth tens of billions per year.
The whole essence of the contemporary monetary system is the creation of money out of nothing, through the medium of lending.
The government and the taxpayer are no longer dealing with individual banks. We are dealing with a very powerful cartel which not-only negotiates as a single organism but has left the very concept of “competition” far behind. Furthermore, if you study the various interest rate charges and products, you may be forgiven for assuming that price-fixing appears to be taking place.
The UK retail banking industry is unusually concentrated. Not only do the largest five mortgage lenders have a market share of 82% but the range of providers was much diminished by the demutualisations of the late 1990s. This concentration of the market has all but killed competition.
Mortgages: Current mortgage interest rates, compared to the bank base rate and the rates at which banks “buy in” money suggest that the banks are profiting greatly from their mortgage clients.
Using figures from Moneyfacts on the average rates offered for the benchmark two year tracker mortgage since June 2007, we can see that rates have fallen from 6 per cent to 3.5 per cent. But the Bank of England base rate has fallen by much more – from 5.5 per cent to 0.5 per cent. The mortgage interest rate spread has therefore increased from around 0.5 per cent to 3 per cent.
Some readjustment in mortgage pricing was necessary, but even taking a conservative view of long-term spreads as being around 2 per cent, the increase to 3 per cent since the crash represents additional interest revenue of around £1.6 billion per year from 2009 gross lending and a further £1.5 billion per year from 2010 gross lending.
Increasing the margin on new mortgages has certainly been a factor in bolstering bank profits since the crash. Furthermore, despite the reductions in base rates and wholesale funding costs, key lending rates have hardly moved since the crash.
It seems therefore that the burden of “rebuilding” bank balance sheets is being borne by bank customers and certainly NOT by bank shareholders and their executives.
Sneaky Fees: It is not only in retail banking that the customer is getting a raw deal. A study by the Office of Fair Trading (OFT) into the equity underwriting market, published in January 2011, found that “the market lacks effective competition on price”. This followed an earlier report by the Institutional Investor Council (IIC) which tracked how total fees for raising equity capital, using rights issues, had increased over the past decade.
It has risen from 2% per cent to as much as 4%. Within this, the amount kept by the organising investment banks in their roles as broker, underwriter and adviserhad risen threefold from 0.75 per cent to 2.25 per cent! There appears to be little justification for bank fees trebling and would explain for instance why a bank such as Barclays Capital (the investment arm of the bank is now generating more profit than its retail arm)
Investment banks have collected over £1billion in “excess” fees and over 90% of that has been generated since the 2008 crash.
Banking is the only business which, when in trouble increases its prices. It can do this because it has a captive audience.
It therefore seems a nonsense for Government to state that it would be desirable for London to remain “competitive” as a global financial centre.
There is nothing competitive about London except bank bonuses. Competition used to be viewed as being based on the cost to the customer and not the income of the company’s officers.
And so…….The really frightening statistic is that notes and coins represent only about 3% of the total money supply. The rest is created as new credit.
According to analysts. estimates, the largest four UK banks are set to report profits before tax for 2010 of around £22 billion between them. By 2012 this is expected to more than double to over £45 billion, as analysts predict a return to “business as usual” for Britain’s large banks.
The same banks had total staff costs for 2009 of around £37 billion, with over £7 billion being paid out in the form of bonuses that were concentrated amongst their elite.
The hidden subsidies to UK banks from taxpayers and bank customers are very similar in scale to current bank profits.
This indicates that far from being efficient, the UK banking sector is deficient and that overall levels of dividends and remuneration, including bonuses are far higher than is economically justified.