Regulation 

Too big to fail and too big to bail out

    CPD
    Approx.30min

    At the root of the banking crisis is financialisation, a tongue twisting term that describes the penetration of financial markets, financial institutions and financial elites into almost all aspects of day to day living.

    It’s a state of affairds that has prompted the Institute for Public Policy Research to issue a report urging reform of the UK finance, but not everyone is so convinced.

    According to the latest report from the thinktank, Don’t Bank On It: The Financialisation of the UK Economy, a forced break-up of the banks would help address risk issues associated with the size of the sector.

    The 70-page report describes the tongue twister of a word - financialisation - by quoting Gerald Epstein (of the University of Massachusetts): “the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies.”

    The report argues that the financial crisis has exposed the risks associated with a large financial sector, the growth of which it suggests does not greatly benefit the rest of the economy.

    Tony Dolphin, the report’s author and senior economist for the IPPR, explained that the industry has been the main driver in the process of rent extraction – where an organisation makes a profit by manipulating the economy, rather than by creating new wealth, and without contributing to a society.

    He continued: “There is no evidence that a much bigger financial sector, relative to the rest of the economy, has led to an improvement in resource allocation or to better returns for savers and investors. If anything, the opposite appears to have been the case. The financial sector has grown because it is extracting larger rents from the rest of the economy.”

    However, the report suggests that regulation in this area should not seek to reduce the size of the finance industry, but reduce and eliminate opportunities for the sector to extract rents from the rest of the economy – best achieved, according to the IPPR, through a combination of increased transparency and competition.

    Mr Dolphin said that the sizable incomes secured by the highest earners in the finance industry would strongly suggest that large rents are being extracted, meaning the scope for more competition to reduce rent-seeking behaviour is high.

    He added that with this is mind, the recommendations of the Independent Banking Commission, and the government’s response are “too timid”.

    “Ringfencing bank’s retail activities will reduce the risk of future bail-outs by the taxpayer, but will do little to reduce rent extraction,” he said. “Forcing a split of retail and investment banks would be better.”

    He argued that breaking up the banks would increase competition in the financial sector. Ensuring that no bank is “too big to fail” or “too big to bail (out)” makes it less likely that the taxpayer might have to pump funds into banks in the future to ensure the banking system continues to operate, reduce the effective subsidy given by the taxpayer to the banking system, and reduce the costs of banking services to customers.

    CPD
    Approx.30min

    Please answer the six multiple choice questions below in order to bank your CPD. Multiple attempts are available until all questions are correctly answered.

    1. How does the report define ‘extracting rent’ from the economy

    2. What should regulation do to the financial sector of the UK economy?

    3. Breaking up the banks would increase competition in the financial sector, true or false

    4. Separating investment banking from retail banking would do what, according to one expert?

    5. In one expert’s view, financial transactions taxes are a good way of curtailing the financial sector

    6. What is one expert’s view on how to rebalance the economy?

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