Preventing banks that are benefiting from government guarantees from using depositors' funds to support their own market trading.

A sound banking system is as necessary to a modern economy as is the supply of water or electricity. There must be a functioning payment system, the ability for people to deposit their money and be assured that it is safe and a process for individuals and organisations to borrow that money for worthwhile projects.  

In the United States the Glass-Steagall Act was enacted in 1933 after the Great Crash to separate commercial banking from investment banking.  The Act was repealed in 1999 (following a $200 million lobby by Wall Street firms following Citibank's otherwise disallowed purchase of Travelers Insurance) despite a prescient 1987 report by the Congressional Budget Office:

1. Conflicts of interest characterize the granting of credit - lending - and the use of credit - investing - by the same entity, which led to abuses that originally produced the Act.

2. Depository institutions possess enormous financial power, by virtue of their control of other people's money; its extent must be limited to ensure soundness and competition in the market for funds, whether loans or investments.

3. Securities activities can be risky, leading to enormous losses.  Such losses could threaten the integrity of deposits.  In turn, the Government insures deposits and could be required to pay large sums if depository institutions were to collapse as the result of securities losses.

4. Depository institutions are supposed to be managed to limit risk.  Their managers thus may not be conditioned to operate prudently in more speculative securities businesses.

Former Citibank Chairman John S. Reed has apologised for the merger with Travelers and recanted his advocacy of the repeal of Glass-Steagall.  In January 2010, President Obama said: 'We should no longer allow banks to stray too far from their central mission of serving their customers.  When banks benefit from the safety net that taxpayers provide, which includes lower cost capital, it is not appropriate for them to turn around and use that cheap money to trade for profit.  Banks will no longer be allowed to own, invest or sponsor hedge funds, private equity funds or proprietary trading operations for their own profit unrelated to serving their customers.  If financial firms want to trade for profit, that's something they're free to do.  Indeed, doing so responsibly is a good thing for the markets and the economy.  But these firms should not be allowed to run hedge funds and private equities funds while running a bank backed by the American people.'

The Bank of England Governor, Mervyn King, said in October 2009: 'In other industries we separate those functions that are utility in nature, and are regulated, from those that can safely be left to the discipline of the market.'  In response to President Obama's proposals, Lord Turner, Chairman of the Financial Services Authority, said in January 2010: 'The crucial phrase is there should be limits to proprietary trading unrelated to customer service.  I absolutely agree with that and the crucial question is how we operationalise that.  There need to be processes of market-making, but it needs to be in support of customer service.'

In the UK there was no equivalent of the Glass-Steagall Act as traditionally commercial and investment banks were separately owned.  However in the last 25 years commercial banks bought investment businesses as well as other commercial banks (e.g. NatWest/Midland/TSB/Bank of Scotland), so reducing competition.  

In January 2010, the New Statesman magazine said: 'Though different in form, the UK's Big Bang of 1986 had a similar effect, allowing banks to engage in securities trading.  Between them, these reforms created organisations that were ridden with basic conflicts of interest while being 'too big to fail' - or perhaps, as some prefer to put it, 'too big to succeed'.  Commercial banks have the capital, whereas investment banks have the brains and the aggression. The combination is potent and intoxicating.  It is also dangerous, because players sometimes take the wrong gambles.'  

This Jury Team Proposal will allow banks still to undertake trading on behalf of their customers but only to trade on their own account in order to make a market (up to 10% of their capital as with Glass-Steagall).  This will only affect UK banks which either have a government guarantee of their loans or which belong to the government scheme to protect deposits.  These could either divest their UK commercial banking business or agree to its being financially ring-fenced.  It should release other international banks based in the City of London and elsewhere in the UK from some of the very heavy regulation which is now otherwise proposed for them.

 

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