When banking crises did not occur and what we can learn from that
Just as we need to know when banking crises occurred and why, it is also useful to know when they did not – and why not. It happens that none of any significance occurred in the first 28 years after the Second World War, uniquely in the history of capitalism. What was being done right?
Since the 1970s the UK has ridden a merry -go -round of changes in its system of bank regulation. Regulations have been regularised internationally at the Bank for International Settlements (BIS) in Basel. However, these changes did not prevent further bank failures. On the other hand, throughout the era when there were no failures there was in Britain no formal prudential regulation. This suggests that the avoidance of bank crises is not caused by this sort of regulation.
Banking, or the context in which it operated, was then different in at least 14 respects. They rendered banking safer than it is now. For example, the clearing banks operated a cartel; the building societies, which monopolised mortgage lending, formed another cartel. It was emphatically not a highly competitive system.
Banks also did not lend to other banks. The growth of interbank lending has altered the banking system fundamentally , as was recognised by experts during the 1980s, including the BIS itself.
Northern Rock, the first bank to fail during the 2007 -08 crisis, did so not because depositors queued up to withdraw their money but because six weeks earlier other banks had stopped lending to it, and so the funding for its own lending dried up: it relied on short -term interbank loans for over 70 per cent of that funding. That degree of dependency would have been unacceptable to bankers in any previous era. The wholesale markets of the early 21st century are further complicated by financial derivatives, much of the trade in which takes place between banks. A year after Northern Rock, the failure of Lehman Brothers – a New York investment bank with large derivatives positions – occurred in the same way.
It is this danger to the wider economy that now makes governments bail out failed banks, as they never did when banks had to rely on their own deposits. Interbank lending is one of the main reasons for banks’ political power.
Ecological theory suggests that a system will be most resilient when it is divided into compartments to protect it from external dangers. The banking system should be set up in this modular way too, without financial interconnectedness between banks. For this reason the report proposes severe restrictions on interbank lending and derivatives trading, and a reintroduction of exchange controls designed, among other things, to sharply reduce international flows of money between banks. A retail bank’s loan assets should never be allowed to exceed its deposits.
These are three out of 13 specific reforms that the report proposes. Other leading ones are that new rules should be as simple and clear-cut as possible, the assumption that competition makes banking safer needs to be abandoned, and a bank’s social responsibility to its depositors should be recognised as more important than its fiduciary duty to external shareholders.