In a routine speech with the earnest look, raised voice and pointing fingers Ed Miliband has promised to do for the bad banks, break them up and we shall all live happily, or not, ever after. Shares promptly fell adding to the problems of many public service pensions funds.
It seems he is talking about the banks we can see but that world has many and various banking institutions few of them based in the UK. Even banks which we might assume to be based here may well not be if you look hard at the structures. There is a great deal more that we do not see than we do.
More to the point one of the major areas of concern is the world of shadow banking and by inverse logic it may be that world that is the real one where credit is concerned. Vox has a long article on Shadow Banking which is a difficult and complicated read. The Conclusions below may not help you much but need to be weighed against the naive simplicities of Miliband speak.
Thanks to the safe harbour rules, a shadow bank can hold risky illiquid assets and earn full risk premia with funding at the overnight repo rate. In what is essentially a synthetic bank, repo and collateral swap haircuts act as market-defined capital ratios.
Liquidity transformation across states and entities has procyclical effects.
It enhances credit and asset liquidity in normal or boom times, at the cost of accelerating fire sales in distress. While any reform to the shadow banking funding model should take into account its favourable effects on asset liquidity and credit in normal times, the associated contingent liquidity risk is not at present controllable (nor is it well measured!). There is an academic consensus that a balance has to be struck (Acharya et al. 2011; Brunnermeier et al. 2011; Gorton and Metrick 2010; Shin 2010).
Appropriate tools are also necessary to align capital and risk incentives in banks and shadow banks (Haldane 2010). Security lending may also undermine Basel III liquidity (LCR) rules.
At a time when all lenders seek security, questioning the logic of safe harbour provisions may seem unwise. Yet at the system level, it is simply impossible to promise security and liquidity to all. Uncertainty on the stock of pledged assets may create a self-reinforcing effect, feeding a frenzy among lenders to all seek ever-higher priority. This is already taking place, and is ultimately unsustainable at the individual and aggregate level.
Finally, it is questionable whether the highest level of protection should be granted to collateralised lenders, and to shadow bank funding, over all other investors. For all these reasons, regulators and the wider society need to make an informed decision.
To make matters worse there is the question of whether much of the financial sector is now a criminogenic culture. Rowans Blog by Rowan Ashworth-Davies this week says it is. Personally, it is possible that barely anyone in either Parliament or government have much if any understanding of the way it works.
And Miliband has far too many in his party too involved to allow him to do anything more than make a cosmetic touch to a handful of the easiest targets.